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Credit Analysis and

Management for
Examiners

SME Banking
1

What is SME

Stands for Small and Medium Enterprise.

Stands between the traditional microfinance and larger


enterprises (commonly referred to as corporate) in
developing countries. (missing middle)

Defined by:

number of employees

sales volume

assets

Definition of SME (IFC, EU)


Employ
ees

Assets

Annual
Sales

Microfinanc
e

<10

<$100,00
0

<$100,00
0

Small
Enterprises

10<x<5
0

<$3
million

<$3
million

Medium
Enterprises

50<x<3
00

<$5
million

<$5
million

Definition

What is the definition of SMEs in Bangladesh?


Who defined it?

How the definition was reached?

Business landscape

Definition

Bank definition
Many banks define SME in terms of their loan size.
Often defined as being loans between $1,000 and $250,000
or $300,000, sometimes up to $500,000.

SME characteristics

Often family
business
Traders predominate
(70%)
Often multiple
business pursuits
Lack formal
documents, records
rough

Banks involved in SME lending

SMEs are high volume.


Growing businesses with growing finance needs.
Traditionally return for new loans.
Can cross sell other bank products.
Serve to diversify portfolio.
Less risk per client since many clients.
Bank Traditional Approach Too
Restrictive. SME Lending needs
NUMBERS
Restricting
lending to
known
borrowers
with good
reputation

Collateral
Focus of
Analysis

Reliance on
formal
financial
statements

SMEs in Development Agenda

The World Business Council for Sustainable Development


(WBCSD) showed that in the developing countries, more than
90% of all firms, outside the agricultural sector, are SMEs and
microenterprises and generating a significant portion of GDP

The World Banks Doing Business reports indicate that a


healthy SME sector corresponds with a reduced level of
informal or black market activities

Local SMEs can function as an important source of supply and


service provision to the large enterprises of both national and
internationals

SME is also good for communities itself, because through


employment creation and growth, it will help improve the
standard of living of the communities.

In Bangladesh, enterprises of less than 100 employees account


for 99% of firms and 58% of employment

Bangladeshi SME Market

Group Activity: Help Define the following

What are the key characteristics of the market?

What is its size and scope?

Distribution and concentration?

Breakdown in terms of Small and Medium?

Industrial sectors/clusters?

Women entrepreneurs?

Main challenges?

Access to Finance?

SME Programmes?

Credit Risk Management System Is


Fundamental

SME loans are somewhat more risky than regular bank


corporate loans.

Therefore, establishing an effective credit risk management


system is essential to maintain a healthy SME credit
portfolio and to ensure that the SME division contributes to
businesses, more vulnerable to
bankSmaller
profitability.
downturns.

Owners more likely misjudge their resources.


Over-ambition.
Internal information may not provide accurate
picture of business.
Accumulations of account receivables.
Can be squeezed by powerful buyers/suppliers.

Risks in Lending to SMEs

Smaller capital base


Mistakes have a greater impact
Unsophisticated management
Lack of diversity in product/service
Concentrated market area
Inadequate financial information, lack of transparency
Less bargaining power with suppliers/customers
Risk Takers - looking for that next opportunity

12

Risk management in SME banking value chain

Common approaches to risk management

Format of SME Loans

Especially in initial practice, SME lending banks use TERM


LOANS as the basic lending format, with monthly repayment of
both interest and principal, as this is generally lower risk.
Subsequently, banks can use other approaches geared to the
specific SME clientele they are looking to serve:
leasing
overdrafts
factoring.

Would You Have Invested In Them?

SME Lending Stages

Marketing

Prescreenin
g

Analysis

Approval/Pr
e-Disbursal

Monitoring

Problem
Loan
Manageme
nt

SME Lending Stages

Marketing
Finding clients that fulfill eligibility requirements.
LOs approach a client, not the other way around, in order to
cut down on fraud.
Pre-screening
During Initial Meeting, examining to see if meets eligibility
requirements.
Making Snap Decision whether borrower meets minimum
requirements.
Most un-bankable proposals are excluded at this stage.

Analysis

CHARACTER

REPAYMENT CAPACITY
Evaluate
borrower
according to

RISKS

COLLATERAL

SME Lending Stages

Approval
Credit Committee
Verification of Documents
Registration of Collateral
Informing Client of Obligations, need to Repay
Customer Service/Good Relations with Borrower
Monitoring
Continuous relation with the client.
Watching to detect problems as soon as possible.
Reminding borrower to repay.

Information sources

Sometimes reliable and sometimes consistently


prepared financial statements period to period
Rarely volunteer to provide interim data
Not sure what you need or why
Insecure about disclosure
Usually not significant participants in their industry- no
comparative data
BUT..

Information sources

Banks should be able to differentiate between family


finances and business finances the lender has what he
or she needs to:
Identify a borrowing cause
Quantify the need
Determine whether the business is likely to be able to
service its debt and other obligations.

Problem Loan management

Devising Work-Out Plan to Recover Funds In Arrears.


Diplomatically communicating with delinquent borrower.
Preparing Possible Legal Action against delinquent borrower.

The Importance of Documentation

Documentation is indispensable in each step of the credit


process.
Loan officers need to train themselves from the first day to fill
out necessary documents in a precise and exact form.
This is a fundamental requirement of their job!
Operational risk issues !

SME in Basel framework

Capital = Risk weighted asset x 8%

Risk weighted asset = Exposure x Risk Weight

Standardized
Defined

IRB
Calculated based on :
PD, LGD, ,
EAD

Standardised approach: Retail loans

Qualitative requirements:

Quantitative requirements:

Capital relief:

Definition of a Retail
portfolio
private individuals
smaller companies
...
Max single credit of 1
million
Sufficient diversification of
the Retail portfolio
(Possibility: Max credit
volume of 0.2% of total
Retail
Portfolio)
Standard
risk weighting
of 75%

26

Standardised approach: Corporate


loans

Risk-weight scheme for corporates (Basel 2)

Loan of 1000 to a corporate with an external rating


of BBB+
Capital charge = 1000 x 100% x 8%=80

27

Credit Risk Mitigation

CRM techniques transfer credit risk between two parties,


one of which is willing to reduce or mitigate a credit risk
exposure whereas the other is willing to undertake the
risk.

C
d
itT
R
is
k
M
itig
a
trie
o
n
e
c
h
n
iq
u
e
s

C
o
la
te
ra
ls

O
n
tb
a
le
a
e
G
u
a
ra
n
tes C
re
d
itD
e
riv
a
tiv
e
s S
h
e
N
tn
ic
n
g

28

Comparison
Capital Required For 100 Unsecured Loan
Basel I

100

100%

Corporate
Basel II
Standardised
Approach

20%
50%
100 X
100%
150%
5m

1.60
4.00
8% =
8.00
12.00

8%

8.00

Retail
100 X

75%

X 8% =

6.00

50m

Basel II

*11.3% - 14.4%
0.90 to 1.16
X
IRB Approach
100
X 8% =
(PD 0.03% to 20%;
X
LGD 45%)
188% to 238%
15.07 to 19.06
*Shows Firm size adjustment effect
From Basel II Annex 3
for Sales of 5m and 50m

4.45%
100 X

0.36
X 8% =

100.3%

8.02

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