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How to improve small business and its very small success rate

Posted on by MSC

MSME is a term which covers a very wide range of businesses—from micro, the first ‘M’, to medium, the second ‘M’, with S(mall) in the middle. They share two things in common in developing markets:

  • The first is the essential role they play in terms of local employment (up to 45%) and contribution to both Gross Domestic Product and Gross National Product. (“D” is location of production; “N” is ownership. MSMEs can account for up to two-thirds of GDP/GNP in some of the emerging countries.) Strong MSMEs mean a growing economy and more jobs.
  • The second is a dearth of readily available and affordable financing. In some areas, almost two-thirds of all such enterprises lack sufficient capital and access to finance, according to an IFC-McKinsey report.

The middle is always easy to overlook. Multinationals and established businesses seeking to enter emerging markets have no difficulty obtaining favourable loans, tax holidays, and beneficial foreign-exchange agreements. Most readers of this blog are also well aware of the micro-credit and funding options available to capable low-income individuals who hope to establish tiny enterprises and the success stories that require more capital to expand and diversify. This takes them into the MSME domain, which is also referred to as the missing-middle because financial products and delivery channels have not evolved for this segment.

MSMEs with less impressive balance sheets still need capital to survive. These are not an unlucky few; they comprise an estimated 365-445 million units (considering the informal enterprises, the numbers increase substantially to 900-950 million), and up to 60% of local businesses in Southeast Asia and Sub-Saharan Africa. The total unmet need for small-business credit in the formal and informal, emerging market sectors ranges from $2.1-2.5 trillion, according to a recent McKinsey report, “Two trillion and counting”.

This is a lot of money, in fact approximately the same amount the UN estimates global natural disasters have cost governments, banks, insurance companies, and individuals since 2000. The reason governments and insurance/re-insurance providers in particular might want to note the correlation is that less developed countries are invariably the most vulnerable to drought, famine, floods, earthquakes, and other disasters that will only increase with climate change.

Successful small businesses help ravaged landscapes recover more quickly and effectively. And in the aftermath of the global financial crisis, which many of the weaker emerging markets are still struggling with, the role of small businesses becomes even more important to the local economy and job creation. If two-thirds of MSMEs are already strapped for cash, however, reconstruction in both scenarios will take a lot longer and the poorest segments of the population will suffer even more.

Both banks and MFIs are coming to understand that strong MSMEs are in fact essential to economic growth and stability. Nevertheless, the key question that remains for both is, what’s necessary and how difficult is it for banks to downscale and MFIs to upscale to serve MSME segments?

Issues they must both address are:

  • MFIs have traditionally served the low-income customers under the group-lending model. This model fails to address the credit needs of MSMEs.
  • Microfinance institutions have also had their fair share of bad publicity and problems with individual loans in recent years. Trust may be an issue for some MSME clients. (For in-depth analysis on this topic, please see MicroSave’s research papers and related materials).
  • Banks, in turn, rely on collateral for their lending model. Most perceive MSMEs with no/low attachable assets as too high a credit risk.
  • To change, and to support MSMEs, banks will need new credit assessment and risk methodologies, new training for their staff, new marketing, and better “last mile” connections and availability for remote MSME customers.

Neither banks nor MFIs are known for their nimble ability to adapt and change. It will take time for MFIs to expand both their credit assessment and their credit offerings to better fit small enterprises. Banks will need to rethink how loans to micro and small businesses can work without hard collateral guarantees and in remote areas their branches do not usually serve.

The rewards will still outweigh the risks in most cases. Financial inclusion does not just mean more individuals with more active bank accounts. It means a flourishing economy with formal banking and loan services for even the very poor and the very small business enterprise.

Why do (some) MNOs sprint and (most) banks limp?

Posted on by MSC

A previous MMU blog “Can India Achieve Financial Inclusion Without the Mobile Network Operators?” concluded “MNO-led systems therefore have a hugely important role to play to create the market – to build people’s confidence in digital financial services and local agent-based systems – and thus lay the foundation for digital financial inclusion.”

All well and good… and of course MNO-led mobile-money models have been more successful than bank-led models in several parts of the world. This is in part because mobile money is a more natural “fit” to MNOs’ high volume, low value transaction and agent-based business. But also the business case for MNOs is based on reducing customer churn and digitising payments for airtime, in addition to the revenues for managing payments transactions.

Furthermore, payments are inter-spatial transfers that can be confirmed either by receiving the money, and/or with a simple call by the sender to the receiver – thus building instant trust. These factors (together with MNOs’ natural advantages as first movers in this market) put them in the perfect position to make the market for digital financial services.

Conversely, banks are much more comfortable handling low volumes of high value transactions in their own premises (and certainly not with dispersed agent networks). And the business case for banks is primarily based on offering a range of products. Furthermore, since many of these products (for example insurance and savings) are inter-temporal (as opposed to inter-spatial) in nature, immediate confirmation and thus trust in the new digital financial system is much more difficult to achieve.

But …in markets where the Central Bank insists on bank-led models and prohibit MNOs from issuing e-money, are MNOs likely, or able, to play the market making role for digital financial services? The moves from Airtel with Axis Bank and Vodafone with ICICI Bank in India suggest that (after many false starts) MNOs will indeed play a very significant role as agent (or business correspondent) network managers.

Why? Well, MNOs have several significant advantages as agent network managers:

  • They have established multi-layer distribution networks, with many thousands (in India’s case 1.5 million!) of retailers selling airtime and providing extensive urban and rural coverage.
  • The MNO business model is based on usage (those high volumes of small value transactions), and therefore more aligned to the willingness and ability of the poor masses to pay in small sums; unlike the traditional bankers’ business model that is based on float.
  • Mobile pre-paid platforms that manage high volumes of low value electronic recharge are very synergistic with the needs of digital financial services. These platforms also allow the ability to offer highly customised and relevant products (supplemented with capabilities for fine segmentation and analysis of usage trends).
  • MNOs have high levels of brand awareness amongst poor and rural customers that can be leveraged well for cross-selling financial services. MNOs also invest regularly and extensively in marketing and promotions to create channel and consumer awareness.
  • Telecommunications is a well regulated service industry, similar to banking. Thus mobile retailers acquiring new subscribers are well equipped to handle KYC norms and service activation processes.
  • Telecommunications is also an investment intensive and long gestation business. Thus mobile operators have superior capability to source funds, and make large investments with long time horizons for returns.
  • MNOs work through extensive partnerships, aggregating third party products seamlessly into their offerings – essential for the success of digital financial services.
  • Last, but quite importantly, in many countries there is severe competition, price-wars, and commoditisation of voice and basic services, so MNOs are highly motivated to offer stable, diversified value-added-services that promise substantial upsides in terms of reduced churn, decreased airtime distribution costs and increased revenue.

Digital financial services in one of the few industries that has a clear first mover disadvantage. Building the trust of low income people in electronic money, the systems that manage it and the agents that provide the cash in/out services is a very challenging proposition. But MNOs are, in many ways, better placed than banks to meet these challenges – they are likely to be essential to achieve digital financial inclusion, even in India and other bank-led model markets.

Financial services that poor people want

Posted on by MSC

Financial institutions trying to serve the mass market rarely seem to have the time to the conduct market research necessary to identify prospective clients’ real needs and aspirations. Many rely on “bath-tub product development” – product ideas developed on the basis of the senior management team’s experience and “gut instinct”, and often rolled out without any pilot-testing … let alone consultation with the target market.

Others prefer the “me too” strategy and thus simply wait, watch and copy products offered by their competitors. India’s “No Frills Accounts” rolled out by a wide variety of banks are a case in point – with dormancy estimated to be 80-90% despite the government’s attempts to push conditional cash transfers through them. MicroSave’s research into this phenomenon revealed that there were a series of features to which poor people aspired and needs that they could clearly articulate … and that poor customers were, in the main, willing to pay for these services.

MicroSave research over the years across Africa and Asia has highlighted that people need (not just want) financial services that are convenient, accessible, affordable and appropriate … and of course reliable in that they are consistently available, on demand. A single transaction account like the No Frills Account is unlikely to meet these criteria … particularly when delivered through traditional banking branch infrastructure.

  • Convenience requires proximity and longer opening hours – most obviously through a distributed agent network.
  • Accessibility often necessitates ATM cards or mobile money solutions to obviate the need to negotiate overcrowded branches, complex forms and intolerant bank staff, and is likely to require us to rethink how we communicate products.
  • Affordable needs to encompass direct costs (transport to the branch and food when the trip take a full day), indirect costs (lost wages and other opportunity costs); and hidden costs (brides and commissions for filling up and processing forms) – and not just the “on the board” fees/interest rates that are formally charged by bank.
  • Appropriate must reflect how poor people live and how they think about and manage their money.

Poor people’s need for appropriate products mean that they need a range of products (just as you and I do) to reflect their life cycle. They also need disciplined systems that break down their accumulation of lump sums into small manageable amounts (saving up, through or down).

The products used to accumulate lump sums should ideally be differentiated and ear-marked for specific needs, in the same way that poor people often ear mark specific income streams for specific uses to help with their mental accounting. For example: savings for a bicycle, to buy some land and for old age are very different in terms of the time horizons and instalment amounts.

Similarly, loans for a medical emergency and for investing in a fixed asset are very different in terms of loan size and structure, as well as the pace at which they need to be appraised and disbursed. This has very important implications for financial institutions seeking to offer a range of products to the lower income market segment: a single transaction account will not help manage a series of complex savings goals; and a standard working capital loan repayable in weekly instalments over a year is only appropriate for a limited set of business people.

As a bare minimum, therefore poor people need a suite of products that includes:

  • A transaction or very basic savings account (linked to a reliable and efficient payments/remittance system that is not too costly);
  • Recurring deposit accounts for different goals (with an attached overdraft to which they have automatic and immediate access – up to 90% of the value of the amount deposited);
  • A general short-term (up to one year) loan (that can be used for working capital as well as consumption smoothing, education etc.);
  • A longer term loan (secured against assets acquired with the loan).

Clearly ,this suite of basic products need to be tailored for, and communicated to, specific markets and market segments – but a market-led approach to product development is essential if we are to have real positive impact on the lives of poor people. Just try imagining how you would manage your finances if you only had access to a typical microcredit product – a loan repayable weekly for 50 weeks!

Principles and Models of an Effective Credit Scoring Tool Design

Posted on by MSC

In this video, MSC’s expert Anup Singh, Domain Leader for MSME financing, discusses the utility of credit scoring tool for standardised appraisal of prospective MSMEs for financing. He mentions about the key design considerations that the banks and financial institutions must keep in mind while developing credit scoring tool for MSMEs’ appraisal. He compares the statistical and judgmental models of credit scoring tool design and discusses cases when each of these can be used.

Digital Financial Services Volume V

Posted on by Parul Tandon

The Digital Financial Services (previously called E/M Banking) Volume V is the tenth publication under the Optimising Performance and Efficiency (OPE) Series. The OPE Series brings together key insights and ideas on specific topics, with clear objective of providing microfinance practitioners with practical and actionable advice.
In response to repeated demands from practitioners, MicroSave has developed this fifth compilation of brief publications on digital financial services. This compendium presents a bouquet of articles addressing digital financial services in India and its scope. The compilation further covers experts’ views for mobile-phone based banking.

Product Development: Reasons why MFIs Fail to Focus on It

Posted on by MSC

In this video MSC expert Anant Jayant Natu talks about the inherent constraints in the operational context of microfinance institutions (MFI) that limit the possibility of a rigorous focus on product development. He also touches upon some factors that can drive the product development process in spite of these constraints. The intangible nature of financial product and a demand driven microfinance market are presented as two key reasons for MFIs’ lack of interest and focus in product development. However, under competitive pressures faced in maturing markets, where client retention and market expansion become an absolute necessity for survival, MFIs have indeed shown that they adopt product development as a deliberate strategy.