The Challenge and Opportunity of SME Finance

Matthew Gamser, Head, SME Finance Forum

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SMEs and Jobs

Employment Shares across countries by Size and Age*

• 50% of all formal jobs in emerging markets are in Small firms and SMEs overall provide 2/3 of jobs

• Older SMEs (>10 years) provide almost ¼ of jobs• The importance of SMEs for jobs is greater in low

income states (LICs)

• SMEs create 86% of new formal jobs in EMs, a number that rises to 95% in low income countries

• While creating the most new jobs, SMEs also have high turnover so their net contribution to job creation is lower – how much is not known

• Small and young firms create a disproportionate number of new jobs, especially in LICs

• It is estimated that about 10-16% of firms are high-growth SMEs and may be responsible for up to 38% of new jobs.

• Another 60% of jobs are in the informal sector which is mostly micro but has some small firms that could grow if constraints were lifted

Share of Formal Jobs

Creation of Formal

Jobs

Informal Jobs

*Source: Small vs. Young Firms Across the World: Contribution to Employment, Job Creation and Growth, World Bank Policy Research Working Paper #5631, April 2011 by M. Ayyagari, A. Demirguc-Kunt and V. Maksimovic; Based on WBG Enterprise Surveys

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Access to Finance is a Major Constraint for SMEs

Challenges faced by HGSMEs in emerging economies

Challenges faced by formal SMEs in emerging economies

Formal SME credit gap remains as large as ever at ~ $ 1 Trillion

SMEs – Vast, largely untapped market

…managed well, SME Banking can be very profitable…

Key observations• ROE can be very attractive (up to 25-35%)• Margin compression inevitable but can be negated

by establishing a “total wallet” P&L• Key profit drivers are typically deposits and

transaction banking, representing between 50-60% of total SME business profitability

• Need to take a 5-year view of product profitability

“We want to double in 3 years. Returns are the best in the Group. Risk-returns are now twice as high as all our consumer banking businesses”

Global Product Head, SME Banking Standard Chartered Sept.2010

Faster Revenue Growth………..

Higher RoA’s………..

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There are 29-35M formal and 101-124M informal MSMEs with at least one female owners in developing world, representing 32-39% of total MSMEs

SOURCE: McKinsey-IFC MSME database; Enterprise Survey; ILO, Human Development Report; team analysis

Number of formal and informal MSMEs with 1+ female ownersMillions

Proportion of MSMEs with 1+ female owners Percent

130-15929-35

Middle East &North Africa 1-2

Total(ex-high income)

1

South Asia 5-64

Central Asia &Eastern Europe 7-84-5 3

Sub-Saharan Africa 10-133-4 7-9

Latin America 24-296-7 18-22

East Asia 84-10214-17 69-85

32-39

13-16

11-14

37-45

25-30

38-46

40-48

32-39

3-4

5-6

31-38

26-32

48-59

45-56

Formal Informal

101-124

1

1

Women Owned MSMEs – a neglected segment

• Provides source of market differentiation in competitive SME markets• Establishes reputation as an innovator • Entry and differentiation in specific sectors where concentration e.g. retail , mobile, youth, health• Creates strong community-based advocacy and enhances corporate social responsibility

Advantages of the Women Entrepreneurs Market

• Female customers have a higher propensity to save both as business and personal customers• Deposits from female customers typically grow at higher rate and stay with the Bank longer• Net funding surplus as a segment

Information Services

• Once main banker status achieved, higher cross-sell ratio’s (between 1 and 2 times)• Higher footings obtained per relationship and higher fee generation • Respond well to relationship management-based models and willing to pay for it• Demonstrate stronger retention rates in many clients

• Take the business relationship, high likelihood that will take majority of family wallet • High advocacy creates strong conversion rates for husband business and personal FS• Up to 85% of family financial decisions made by the women globally

Market Share Growth

• Female customers have lower risk tolerance as both business and personal customers• Women-led businesses outperform those led by men, including start-ups• Stronger business plans can create higher acceptance rates and reduced processing costs• Default rates are either the same or better than male counterparts depending upon market

Information ServicesHigher Cross-Sell

and Loyalty

Strong Savings Propensity

Positive Risk Behavior

Information Services

Linkage to Family Wallet

Description

* - Source: IFC Analysis

SMEs Remain a Challenge to Financial Institutions

1. PoorCustomer Knowledge

6. Poor business enablers

5. Lack of collateral or capital

4. Lack of credit data

3. Low profitability

2. SME skills and

literacy

Common weak models in EM countries today:

• SME treated as corporate for medium SME and/or retail clients for small SME

• 100% secured lending driven with undifferentiated products of service levels

• Limited product program approaches and a lack of cost-effective methods to address segment

• Emphasis upon lending, not SME Banking

• No accommodation for gender concerns

SMEFinance

Challenges

Banks need to build capacity to address these challenges

PoorCustomer Knowledge

Poor business enablers

Lack of collateral or capital

Lack of credit data

Low profitability

SME skills and

literacy

• Government initiatives (e.g. procurement)

• Financial infrastructure• Credit guarantees

• Unsecured/ partially secured

• Loan guarantees• Value chain

financing

• Credit scoring• Psychometric testing• Operating account track

record • Early warning indicators

• Value based sales and service coverage models

• Retail-style products• Automated and reengineered

processes• Low cost channels (e.g internet,

call centre)• Retail and business linkages

• Educate SME through non-financial advisory provision (e.g. SME toolkit)

• Provision of training, information & networking

• Granular definition of SME supported by market research

• Segmentation: Specific value propositions to target specific sub-segments of SME (e.g. women)

• Greater focus upon customer management

IFC Internal Analysis, 2011

SMEFinance

Challenges

Impact of improved credit reporting on financial inclusion

Source: Love & Mylenko (2003)

Full information-sharing increases access to credit

¨Out of every 100,000

loan applications

11,400 are lost if

assessment is based

on negative info only¨

% increase in lending volumes

73.7

83.2

Negative information only

Negative and positiveinformation

Source: Barron and Staten (2000). Note: Figure shows the simulated acceptance rate assuming a default rate of 4% overall

Investment Unlocked Through Moveable Collateral Projects Dwarfs IFC Direct Investment in China and Ghana

Importance of Financial Infrastructure for SMEs

The New Disruptors

SME Financing Needs Vary by Stage of Development

HGSMEs Need Innovative Financing Structures

Banks are not incentivized to seek out and back high-growth SMEs. Yet these high-growth firms have not yet reached the scale to access capital markets.

Private equity (PE) is incentivized to seek out high-growth SMEs, but reaches only a small fraction of them due to high transaction costs and information asymmetries.

• Investments by PE funds in SMEs produced a growth rate of 18% or almost twice the rate of job growth in non-SMEs (9.7%).

• Among IFC PE funds there is a strong positive correlation between fund returns and job creation.

Small Companies Had Faster Job Growth Rates Fund Returns and Job Creation are Positively Correlated

Source: IFC Jobs Study (2013).

Investment in high-growth SMEs has led to jobs and higher returns

Crowdfunding – the ultimate disruptor?

SME FINANCE – TWO MODELS

and

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The SME FINANCE FORUM

mgamser@ifc.org

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