What is Relationship Banking?

• Relationship banking is defined as the provision of

financial services by financial intermediary that:

– Invests in obtaining customer-specific information, often

proprietary in nature

– Evaluates the profitability of these investments through

– multiple interactions with the same customer over time & or across products

– RB concept emphasizes:

– On the establishment of a long term multiple service relationship:

– on satisfying the totality of the client’s financial services needs;
– on minimizing the need or desire of clients to splinter their financial
business among various institutions

– RB may be also defined as

– the provisions of financial services by a financial intermediary on the basis

of long term investment in obtaining firm specific information
– through multiple interactions with diverse financial services
 Shortcomings of RB Lending
• Mostly bank’s evaluate SMEs

– As small corporate customers

– Use the same delivery channels used for corporate lending

• In most instances information provided by the customer to loan officer is

exaggerated

• In most instances the (audited) financials provided by SME are not reliable

• Credit proposal preparation & approval process increases TAT

• Banks focus on customers with established credit history & often engage in
price war

• RB lending is mostly focused on banker’s personal confidence in borrower

• More chances of biased decision & overrides

 Client Relationship Management
Conducting Site Visits
– First & initial visit-Visit before Disbursement-Visit after Disbursement

• Gathering Financial & Non Financial information

• Participation in Events of SMEs
• Helping Customer in preparing Financials & understanding borrower’s business
practices
• Segment the Market
– Build up in depth knowledge of SME Clusters
– Identify good potential customer groups
– Understand their needs

• Reduce Cost of acquisition of new customers & retain creditworthy customers

• Develop wide range of demand-driven products & services

• Offer a range of tailor-made (but mass-customized) financial services (credit, savings,

transactions/payments, life cycle products)

• Maximize profit contribution per customer, not per product

• Develop Resource with proper training & understanding of customer’s cluster &
working practices

• Develop standardized processes to reduce TAT

• Develop strategy for Cross Sell activities to reduce pricing impact to pass on benefit
to customers
• Establish Business Consultant Group to keep helping customers in managing their
borrowing issues &
 tips to help the bank
learn your business
Supply your business banker
with:
1. Videos and/or pamphlets of your business or
products.
2. Your business plan.
3. A profile of your business and its founding
members.
4. A paragraph on what your company does (keep it
simple).
5. Information on your biggest clients.
6. Accreditations, certificates or awards.
7. All telephone, cell phone and fax numbers, email
and
 Information Sources to determine Cash-flows
How Proxies help to Authenticate all?
• On-site interview of the potential borrower

• Documents that sustain cash-flow information, e.g.

– cashbook, personal notes, invoices from suppliers, bank

statements on current and savings accounts etc.

• Sales & purchase books to verify the orders placed by

customers & orders placed to suppliers

• Credit terms offered to customers & its impact on

Receivables & cash flows

• Credit terms offered by suppliers & its impact on Payables &

cash flows

• Physical assessment of the inventory of finished, semi-

finished goods and raw materials to match this inventory
with the production system & overall inventory valuation
 Information Sources to determine Cash-flows
How Proxies help to Authenticate all?

• Physical assessment of fixed assets, e.g.

– machinery to verify the life of the machinery to calculate

depreciation
– verify the depreciation method used as it does affect cash flows of
the business

• Use of informal information sources:

– family members, neighbors, reputable members of the local
community

• Comparison with peer family households and SMEs

• Taxes paid if tax registered- Tax returns filed of the last year

• Informal Borrowing from brokers- very important factor to

verify financial strength & repayment capacity

– Confirm the current borrowing from broker & amount of

interest being paid to verify the mark up rate & its impact
on cash flows
– This will help to highlight the difference between borrowing
 Structure of Cash Flow Statement

Net profit from actual P&L

+ Depreciation Expenses
- Taxes actually paid
Cash from
-/+ Changes in Receivables
Operations
+/- Changes in Payables
-/+ Changes in Inventory

-/+ Investments in Fixed Assets Cash from

Investments
+ Bank Loans and other Borrowings

- Repayments on Bank Loans and other Borrowings

- Dividends Cash from

- Private Withdrawals Financing

+ Cash in Hand and Bank Accounts at the Beginning of the Period

= Cash in Hand and Bank Accounts at the End of the Period

 Sources & Uses of Cash
Sources Uses
Cash generated from Cash absorbed by
Operations operations
Equity Increases Owner Withdrawals

Sale of Fixed Assets Purchase of Fixed Assets

Disposal of Assets Acquisition of Investments

Short or long term debt Repayment of Debt

Dividends Payment to Non-Owners

Govt. Grants Closure or redundancy cost

 Cash Flow Ratios for SME Analysis

Ratios Calculation What it measures

Cash Flow to CFO/Net Revenue Cash generated per
Revenue Rupee of revenue

Cash return on assets CFO/Average Total Cash generated from all

Assets resources

Cash return on Equity CFO/Onwer’s Equity Cash generated from

owner resources

Cash to income CFO/Operating Cash generation ability of

Income operations

Interest coverage CFO Ability to meet interest

+ interest paid+ taxes obligations
paid/interest paid
Future Cash-flow Projections
• Minimum period: following 12 months

• Monthly basis if strong seasonal variations are expected

• As an input, forecast of balance sheet and P&L

• Special attention to the following:

¬ Forecast of expected tax payments
¬ Forecast of likely private withdrawals
¬ Forecast likely changes of payment patterns
¬ Forecast likely changes in inventory turnover
¬ Forecast likely changes in fixed assets
¬ Forecast likely borrowings (own loan and others)
under different conditions

Loan to be approved if there is a sufficient liquidity

cushion after loan repayment
 Collateral Based SME Lending
Only option to avail Financing
• Role of Collateral
– Taking collateral over a borrower’s assets is a form of insurance & a
safeguard to protect lender against a borrower’s primary source of
repayment failing.
– Secondary source of repayment.
– Imprudent lender indeed who lend on collateral value alone

• Why banks take Collateral?

– A form of insurance in case cash flow repayment fails
– To ensure full commitment of borrower to their operations
– To reduce chances of loosing the whole money
– To protection in case borrower deviates from planned course of action
outlined when credit was approved

• Collateral Issues
– The Method of Appraisal
– The Loan to Value ratio
• Qualities of Acceptable Collateral
– Realistic Value & readily saleable
– Collateral condition over a period of time
– Perishable or Non Perishable
– Subject to rapid depreciation or deterioration
 Summing Up All
Making the lending Decision-Ten Commandments
• Quality of Loan
• Two ways of being repaid (Cash Flow &
Collateral)
• The borrower’s Character & Integrity
• Are you comfortable with your decision?
• Assessment of management quality
• A good decision requires adequate facts
• Collateral is no substitute for payment
• Realistic Assessment of collateral’s value
• See where is the money being spent
• Do not lend to any business that is not
understood
 Assessment of Macro & Industry Risk
• Govt. Policies
– fiscal Policies affecting purchasing power & corporate profit, investment incentive, impact on labor
relations,
• Inflation- effects on total economy & international competitiveness
• Foreign Exchange- volatility & effect on imports & exports
• Environmental issues- effects on product marketability & non-productive
manufacturing cost
• Country Risk- Country’s capacity & willingness to repay its obligations

• Assessment of Industry Risk

• Rate of Growth
– Rapid, mature industry, cyclical/fashion sensitive, boom time for competition, decline causing margin
pressures

• Balance of power between buyer/seller, What alternatives available?

• Barriers to entry- Monopoly? Proprietary technology?

• Govt. Polices

– Protectionism, subsidies, tax exemption

• Substitute Products-level of competition

 Assessment of SME Risk
• Asset conversion cycle
– Under control or excessively out
– Terms of trade buyers/suppliers
– Stock & debtor control

• Labor Resources
– Adequate
– Labor problems
– Is SME labor dominant?

• Premises- age, condition, suitable to run business in future, rented/owned

• Plant & Machinery- Condition, age, utilization, owned or leased

• Products & markets- market share, are the products demand

increasing/decreasing?

• Costing & prices

– What are the strategies?
– Are Products price-sensitive?
– Do they have a high fixed costs?
 Assessment of SME Management Risk
• Composition of Management

– Family owned, average age, close to retirement, succession,

turnover

• Track Record

– Innovative- keen to diversify when necessary

– Brave enough to restructure/close down when necessary

• Technology based or manually operated

• Business objective-clear, focused on profit/productivity/market

share

• Motivation of staff & workers-good communication down the

ladder, career planning, worker-management relationship
OPERATIO
N RISK

• Operational risk is the risk of loss

resulting from inadequate or failed
internal processes, people, system &
from external events.
 Operational Risk Assessment & Qualification
• Operational risk stems from the time products or procedures are adopted by
bank for SME Lending.

• Ignoring complications with SME sector & its monitoring,

– banks often rely on the already established systems & procedures which are not
adjusted to the requirements of the SME lending methodologies

• Separate operating system backed by Operating Manual should be provided to

ensure dual efficiency

• Operating procedures of SME Lending should incorporate the nature &

requirement of the segment to run with less failure

• The banks should systematically track and record frequency, severity and other
information on any loss originated at front end to remove loss occurrence &
repetition

• Misuse of Authority & duty hurt both SME segment & bank in portraying image

• Another risky area is lack of trained staff to properly manage the operational
activities of SME Lending

• No concept of second in command makes operational risk more obvious to occur

• Procedures adopted lack monitoring & well functioning

 Mechanisms to improve operational Efficiency-SME
Financing
• Set of streamlined, simple standard forms & procedures-Follow the rule
of “KISS”

• IT support systems critical - high level of automation in pre & post

lending procedures

¬ From loan application to loan repayment all forms automatically tied

together
¬ Use of innovative technical features to reduce manual procedures
¬ Daily automatic reporting on loan portfolio performance
¬ Storage of all current and historic data

• High start-up investment in building the relationship with a new

borrower will later be offset by simpler procedures for repeat borrowers

• Incentives for borrowers to follow the procedures through appropriate

carrots and sticks

• Incentives for loan officers to ensure efficient and effective loan

procedures compliance
• Preparation of well-experienced loan officers that establish close
relationship with the borrowers & back office to control early
deficiencies

• Creation of a comprehensive database of customer information

to facilitate determination of filter mechanisms/scorecards and
speed up processing repeat loans

• Decentralization of decision-making, empowering branch level

• Adjustments of internal control systems due to highly

decentralized operations

• Enhancing operational efficiency and maintaining high loan

portfolio quality by providing a combination of “carrots and
sticks” to loan officers and borrowers alike
CREDIT RI
SK
• Credit risk arises from the potential that
an obligor is either unwilling to perform
on an obligation or its ability to perform
such obligation is impaired resulting in
economic loss to the bank.
 Common Lending Mistakes in SME Lending
leading to Credit Risk
• Treating SMEs as Corporate
• Following pet projects of Higher Management
• Using standard Credit Proposal Templates
• Pre-assumed SMEs as Risky venture
• Concentration in few sectors
• Not geographically diversified
• Meeting Business Targets in absolute amount
• Biased view of business team or Management towards a particular
SME Sector
• Not interested to see what lies beneath
• Credit Risk in New SME Customer & Existing SME Customer
• Overall reliance on collateral in SME exposes more to credit
risk as focus is not on cash flow or repayment capacity
• Over & under exposure to SME-portfolio not balanced
• Risk-Reward not justified, Charging high price to SME even
bank has low risk in that lending
Key Credit Risk Indicators-Early Warning Signals for
SME
• Frequent uninformed access over limit
power
• Financial Position and Business Conditions.
• Conduct of Accounts
• Loan Covenants-Non fulfillment of
conditions
• Non-compliance with repayment schedule
• Re-Scheduling
• Change in ownership structure
• Sale of division or fixed assets
• Market watch or intelligence
• Collateral Valuation
• Over leveraged
PROGRAM
BASED LEN
DING
NEED OF T
HE HOUR
GOOD BYE TO CONVENTIONALIST
LONG WAY TO GO FOR NEW COMERS
 What is program based lending?
• Program based lending is a methodology via which
banks

– Establish a general qualification criteria

– Based upon market research & need analysis
– To meet specific financing requirements of businesses in
particular industry
– Through establishing acquisition & delivery channels
– For quick processing of large volumes
– Defining end-to-end processes
– Establishing assembly line philosophy
– While identifying mitigates to optimize credit risk.
 Why we need Program Based Lending
• Allows the financial institutions deeper penetration into the target market by
going to the customer’s doorstep, whereas in case of RB the outreach is limited.

• Multiple sectors can be targeted at one time in parallel.

• Cost & time efficient approach as one criteria is applied to the whole sector
using the assembly line (backend approval). As the portfolio grow the cost
further decreases.

• To encourage viable customers to borrow from formal sources while catering

for their concerns of excessive documentation & cumbersome loan approval
procedures.

• Credit decision is based on industry/sector research & objective.

• To stream line credit decision process on the basis of objective pre-established

criteria with an approach to minimize reliance on exaggerated or inaccurate
information provided by customer.

• To minimize TAT & develop channels to handle high volume of business.

• To target those segments of industry which are presently ignored by financial

institutions.
 Program Based Products
• Program based products are of two types
– Generic Products
– Industry Based Specific Products

• Generic products

– Generic products lay emphasis on the strength of the individual business rather
than specific industry segment.
– Eligibility criteria is developed on some minimum acceptable parameters with
major focus on cash flow cycles in business.
– Business Power (Union Bank), Business Line (UBL) Business Sarmaya (MCB Bank)

• Industry Based Specific Products

– Based on thorough research these products are designed to meet financing

requirements of business operating in a specific industry segment
– Eligibility Criteria is established on the basis of borrowers position in industry &
cash flows are derived on the basis of pre-established industry specific models.
– Tana Banna, Rang Hi Rang, Agri Deal (Union Bank), Business Cash Advance (MCB
Bank), Karobar (Atlas)
 Program based VS Relationship Based Lending
Program Based
Address masses financial needs via in-depth
understanding of targeted sectors
Cluster/sector oriented solutions
Smaller Ticket Size, larger number of loans
Credit approval based on research based
criteria with no subjective discretion
Low acquisition cost
Event Based- TAT Control
Automated mass service solutions
Takes into account the industry/sector risk in
addition to Borrower Risk
Follows End to End Process, No Skipping
Involved in credit decision
Relationship Based
Cater to individual clientele financial needs,
with little or no analysis of the customers
business sector/industry
Customized individualistic solutions
Larger Ticket Size, Smaller numbers of loans
Credit approval based on partially reliable
information & credit officer’s discretion
High acquisition cost
Minimum or no benchmark for TAT Control
One to one service excellence
Caters to only borrower Risk
No proper End to End Process, Skips
processes to service the client, creates
loopholes & more risky for the bank
Clustering
Progress for
The Road Traveled
The way
Ahead
 What is a Cluster?
• An industrial cluster is

– a loose, geographically bounded collection of similar and/or

related firms
– that together create competitive advantages for member
firms and the local economy
– producing homogeneous products.

• “Geographically bounded concentration of similar,

related or complementary businesses,

– with active channels for business transactions,

communications and dialogue that share specialized
infrastructure,
– labor markets and services,
– that are faced with common opportunities and threats”.
• United Nations Industrial Development Organization
(UNIDO) defines cluster as:

– “A sectoral and geographical concentration of enterprises

faced with common opportunities and threats which:

a) Gives rise to external economies (e.g., specialized suppliers

of raw materials, components and machinery; sector specific
skills, etc;

b) Favors the emergence of specialized infrastructures and

services;

c) Enables cooperation among public and private local

institutions to promote local production, innovation and
collective learning”

One of the predominant elements of clusters is the presence of

micro enterprises. SMEs engaged in manufacturing related
products get together and give rise to various kinds of
economic and non economic linkages.
 Cluster Attributes
• Region Specific

• Homogeneous in nature

• Homogeneous Products & Services

• No formal borrowing

• No management style

• Limited numbers of entities

• Low probability of default based on coordinated & community based

relationship

• Supplier to large entities- strong demand for their products- can exercise price
war

• Low overheads

• Continuous business structure

• Work on low margins but still operative

• No threat of competition
 Broad Classification of Clusters
Industrial Clusters
Traditional SME Clusters
(including power looms, but
excluding Ancillaries and
exporting clusters)
Ancillary SME Clusters
Export SME clusters
Artisan Clusters Services Clusters
Handicraft Service clusters (e.g. Health,
Clusters Information technology,
Business
Process Outsourcing, Software,
Repair, Recycling, Tourism,
Education, logistics, business &
financial services, research &
development services etc.)
Handloom
Clusters
Tiny Small Scale
Industries clusters
 A Typical Cluster Map
Commercial Services Providers
(Designer, Testing Laboratory, Transporters,
Financiers)
Production System Forward
Backwar Linkages
d
Linkages Firm Firm
Selling
Raw
Material Agents
Supplier

Firm Firm
Machiner Direct
y Consumer
Supplier

Firm Firm
Firm
 Why Clusters are Important?
• Increase in production & new direction for Economic Policy

• World is a global village, geographical boundaries demolished but still companies

are operating in tight geographical boundaries like software & information
technology companies in silicon valley in Seattle (USA) or Bangalore (India)

• Better accessibility of both hardware & software components of business

• Skilled & experienced labor is spatially concentrated

• Clusters have economies of scale which further lead to collective efficiency

• Clusters encourage healthy competition among firms functioning within

particular cluster

• Clusters help firms take collective risk, develop product niches, access remote &
international markets, upgrade skills & overall productivity

• It helps create an environment for sustenance & growth through proper policy
interventions

• In Pakistan, a study shows that clusters account for 69% units, 72% employment,
55% investment, 62% output & 72% export of small scale industries
 How to make product for CBF?
• Analyze environment conducive to Cluster

• Working environemnt, business practices, living standards,

borrowing habits, repayment systems, management style & vision
for future, Profit margins & demand-supply analysis

• Financial strength by assessing investment in business, property,

investment in other areas

• Risk of reduction in demand or any regulatory sanctions

• Cash flow generation & saving pattern

• Contingency planning if any

• Capacity planning- workers dominant industry or self participatory

• Supply side issues

• Product-locally meet the demand or country wide acceptability of

product
 The development of the Daska metalworking cluster

The small town of Daska in Pakistan has for several decades been
a thriving centre of metalworking. A cluster of several hundred
SMEs employing thousands of people has emerged. The cluster
originally produced low-speed diesel irrigation pumps, through
an intricate system of specialist inter-enterprise subcontracting
of production and assembly.

In the early 1980s, the market for these pumps was sharply
reduced by the introduction of high-speed diesel pumps which
the Daska SMEs could not manufacture. At about the same
time, the large-scale Pakistani tractor manufacturers were
facing cost-reduction pressures, which induced them to look for
ways of outsourcing the production of certain components. An
arrangement of mutual commercial advantage developed with
the Daska SME Association, which obtained the orders and
allocated them among its members.

As confidence grew on both sides, the large manufacturers have

come to deal mostly with individual SSI suppliers and/or small,
tightly knit supplier groups. This is not the only way the Daska
SMEs have diversified. Some of them are now manufacturing
metal-based consumer durables, on much the same basis of
inter-SME process specialization as they used in producing low-