Sharing Laxmi Bank’s experience in lending to SMEs.
Since its inception in 2002, Laxmi Bank has always viewed the SME segment as a genuine and worthy sector to invest in. The Bank has managed to develop a successful SME portfolio that is based on mutual and long term benefits to the entrepreneurs and itself. Laxmi Bank measures the success of its SME approach not only in terms of the portfolio quality in general but also in terms of how many of the middle market borrowers will grow into corporates in their own right.
Although retail banking, mainly in the form of Consumer Finance, has given a new lease of life to some of the older and established banks whose risk appetite for commercial and industrial (C&I) loans has been at the lowest, the fact that Nepal, unlike developing economies does not have a sufficient critical mass of the affluent segment (main targets of consumer finance products) big enough (or growing fast enough) to satisfy the appetite of 17 commercial banks and 40 plus finance companies means that banks will again have to look elsewhere to grow their risk portfolio.
One area of retail banking that banks in Nepal have traditionally missed is the small business segment (loans of less than Rs. 5 million in size). Loans to this segment are generally classified as a C&I loan and hence approached with the same principles and practices that the bank would follow for other C&I loans. Given this approach, it is not surprising that banks in general exit their small business relationships when their loan portfolio grows big enough to sustain the desired level of bottom line. In this context many small businesses opt to borrow funds at a higher cost (from finance companies, co-operatives or even from private lenders) rather than from commercial banks where they are not comfortable with the approach and risk and they are asked to repay their loans earlier than the maturity date due to changes in the lender's strategy.
Small Businesses generally display the following characteristics:
# Personal and business cash flows are interdependent. They are owner-managed, hence financial accountability is non existent,
# Financial statements do not conform to the standard accounting formats or principles and integrity of data is suspect (more out of incompetence rather than any bad intention), and
# Single product (usually working capital) needs.
These challenge the lenders who approach this segment with risk assessment tools used to assess C&I loans. These lead to classifying small business segment as "not credit ready".
At Laxmi Bank, we view things differently. Small businesses are indeed "credit worthy" and "credit ready" - but are the banks ready? Assessing risk in Small Business Loans makes sense if this segment is treated as a hybrid of C&I and Consumer Finance, where the relationship management techniques of C&I is combined with the portfolio based approach of Consumer Finance.
# Relationship Manager (not Sales Manager): We recognise that small business owners need partners, advisors and at times people to talk sense into them (when they want to expand beyond their capacity or diversify into other businesses). This makes the role of the small business relationship manager surprisingly similar to that of a C&I relationship manager.
# By very definition Small Business Loans taken individually will never make sense to the lending institution. Hence like Consumer Finances, small business needs to be viewed as a product and managed on a portfolio basis - volume being the key to any profitable retail risk asset.
# Laxmi Bank has developed in-house a Credit Scoring Model that is based on experience and historical data. This scorecard helps in assessing the business risk in an objective manner that is both scientific (although banking is not an exact science) and adds the element of human judgment. Such methods help in reducing the time taken to turn around an application without compromising on the credit standards.
# Know your customer: Unlike the consumer finance approach of "fill it and forget about it", small businesses need active monitoring (at least on a quarterly basis). The relationship manager stays closely in touch with the small business owner and helps in managing his/her finances wherever necessary. Simple things such as managing the borrower's receivables, simulating financials based on daily/ledger records or correcting balance sheet mismatches goes a long way towards understanding the business and cementing the borrower's loyalty.
Laxmi Bank has taken the saying "the best way to predict the future is to invent it" quite literally. We recognise retail business as an integral part of banking in Nepal and will continue to find more relevance in the days ahead. Alongside the consumer finance business (mortgage, auto and cards) we will continue to grow the small business loans portfolio.
We believe that "innovation" and "simplification" are the keys to building a quality small business loans portfolio. Small business entrepreneurs never cease to amaze us with their creativity, resilience and, most of all, integrity. Laxmi Bank is privileged to be associated with these entrepreneurs and commits to continue growing existing partnerships and finding new partners.
(Shah is the Head, Retail Financial Service at Laxmi Bank)
