AFRICAN SME BANKING FORUM

The State of SME Banking Today

SME banking is an industry in transition. From a market that was considered too difficult to serve, it has now become a strategic target of banks worldwide. The “missing middle,” describing the gap in financial services provided to SMEs, is shrinking. SME banking appears to be growing the fastest in emerging markets (low- and middle-income countries) where this gap has been the widest. More and more emerging market banks are developing strategies and creating SME units.

Competition in other markets is one reason cited for commercial banks moving “downstream” to serve SMEs. Also, governments around the world now recognize the importance of the SME sector and have worked to support its access to finance, sometimes by addressing legal and regulatory barriers or building credit infrastructure. But the key to the growth of SME banking may be that banks are starting to understand the particular needs and preferences of SMEs, and are developing tailored approaches to overcome the historical challenges of high credit risk and cost to serve. One sign that banks are unlocking some of the potential in the market is that they are reporting higher returns on assets from their SME operations. 

Also, contrary to common perception, the SME market is served by a wide spectrum of banks, not just smaller banks with relationship-based models.

Today, despite the significant challenges posed by the current global economic crisis, and the uncertainty ahead, many banks seem to be holding fast to their strong commitment to the SME sector, especially in emerging markets. While the full impact of the crisis is not yet apparent, banks maintaining their focus on SMEs often cite a strong belief in the importance of the SME sector to the national economy as a whole.

Bank Approaches to the Challenges of Serving SMEs

To effectively serve SMEs, banks have had to change the way they do business, and manage risk, at each stage of the banking value chain. This begins with working to understand the market, and how it differs from both the retail and commercial segments. Next, in developing products and services, banks have begun to understand that SME banking means much more than SME lending and are, therefore, prioritizing non-lending products in order to provide total customer value. Leading banks report that more than 60 percent of their SME revenues come from noncredit products.

Banks have found ways to manage both costs and credit risk as they acquire and screen clients. A bank’s current portfolio provides both a low-cost starting point for generating new business and a source of valuable data that can enable it to understand and predict the risks associated with SME clients.

Developing this capacity to predict risk without completely reliable financial information, by using tools such as credit scoring, has enabled banks to more effectively screen potential clients. In serving SME clients, banks are improving efficiency by using mass-market approaches for smaller enterprises and using direct delivery channels where appropriate. They also build their revenue base by prioritizing cross selling to existing clients. Finally, banks are adapting IT and MIS tools, and building capacity to effectively use these tools for managing information and knowledge in their service of the SME market, especially in understanding profitability and risk.

How to Begin Engaging the SME market

Banks looking to enter the market or expand their SME operations will be able to draw from the lessons of other banks’ experience to date. These lessons apply to operations in five strategic areas: (1) strategy, SME focus and execution capabilities; (2) market segmentation, products and services; (3) sales culture and delivery channels; (4) credit risk management; and (5) IT and MIS. Before putting these lessons to use, however, banks need to follow a process for market entry that begins with understanding the specific opportunity in the SME sector and ends with developing a strategy and implementation plan. Two tools that facilitate this process are a market assessment and an operational diagnostic. A market assessment is concerned with determining the size and nature of the opportunity as well as the competitive landscape. An operational diagnostic helps highlight a bank’s strengths and weakness.  

In summary, serving SMEs is proving to be profitable and rewarding for individual banks, and assisting the growth of SMEs will benefit national economies as well. Banks looking to seize opportunities in the market can use this Guide as a means to learn from industry experience to date. By debunking misconceptions of SME banking, establishing its business case, and sharing global good practices, the SME Banking Knowledge Guide hopes to support banks in building stronger, sounder services for small and medium enterprises worldwide.