Why banks need a new business model for CMSEs

It is well known that the lack of money and limited access to bank credit pose the greatest challenges to the cottage, micro, and small enterprise (CMSE) sector, endangering the continued existence of these businesses. The main causes of this are bankers' resistance and poor infrastructure for credit. The article today will talk about the subject of bankers' hesitation. 

The difficulties lenders have in analysing credit risk and figuring out the nature of the varied CMSE clients' character and financial situation is the main cause of their hesitation. Because the information needed for risk analysis is either not available or the information that is available is unreliable. 

On the other hand, with small loans, the cost of processing, underwriting, monitoring and administration of each loan account is much higher than that of corporate loan accounts. Due to this, it is difficult for the banks to operate the loan business profitably in the CMSE sector, even though the bulk of the country's vast population is engaged there and in the agricultural sector.

As a result of this view of the bankers towards the CMSE sector, almost all banks in the country are only keen on providing credit facilities to a handful of corporate groups. It is due to the fact that they believe the operational cost of serving corporate groups is much lower than that of the CMSE sector. They also believe there are more opportunities to generate a lot of fee income. 

While it may seem like the case, in reality, the corporate customers of Bangladesh have been able to reduce their loan interest and fee rates to a level that is almost equal to the bank's cost of funds.

Reputable corporations have gone a long way in meeting their credit needs with low-interest foreign loans, including loans from multilateral, unilateral and multinational lending institutions. Many corporations have already received foreign loans, and many more are in the pipeline. 

Those who have already had such loans are trying to increase foreign debt without raising the number of domestic obligations again. In this situation, it becomes difficult for bankers to retain their portfolios in the corporate sector and continue to grow. Banks that have a lower cost of funds are different, but the number of such domestic banks is absolutely scarce.

Although the interest rate on deposits has decreased a lot since the last decade, it remains higher in Bangladesh in comparison to other countries. The main reason for this is the high rate of interest on government savings certificates in this country, as a result of which savers invest their savings in savings certificates instead of keeping them in banks. 

The government cannot reduce the interest rate on savings bonds due to various reasons. Because of this, it is not possible to reduce the interest rate of bank deposits. In this situation, the loan market for good corporate groups is going to foreign lenders and domestic banks that have a low cost of funds. 

Only corporate groups whose overall position is not so strong remain open to domestic banks' loan business. This situation does not bode well for the future of our banking sector. 

There are two avenues open to the banks for reducing the cost of funds: 

1) To increase non-interest-bearing deposits (current accounts) and low-interest deposits (savings and SND accounts).

2) To reduce the operational cost of the banks.

In order to attract low and no-cost deposits, a bank must ensure a high level of service with tailor-made products and processes, which is a long term scheme. And most local banks are not able to reduce the cost of funds in the immediate future. Therefore, they have no alternative but to increase lending to the CMSME and consumer sectors. 

In order to expand credit in the CMSME sector and particularly in the CMSE sector, a new banking business model with suitable technology must be developed and applied. A few banks have been able to reap good harvests from the CMSME sector by using new business models and technologies. However, if analysed, we can see that the customers of the cottage and microenterprise sectors have not been given due attention.

Introducing an innovative business model and a technology-based loan approval and administration process will dramatically reduce loan approval and administrative costs and cut credit risk at a significant rate. 

On the other hand, it will be possible to increase the interest rate for the CMSE sector on the eve of the central bank's indication to lift the interest rate ceiling. However, the lending rates  determined will remain much lower than those of microfinance institutions and moneylenders. 

It will be possible for the banks to enter the CMSE market without competition. This will remove the barriers to CMSE loans, meaning bankers will feel encouraged to increase business in this sector.

It deserves special mention here that most of the banks in our country have tried and are still trying to do business in the CMSE sector by using the business model of corporate banking through branch channels or otherwise, which is not correct at all, as evident from the low penetration in the CMSE sector. However, there is no problem in running the medium enterprise's sector lending business using the corporate banking business model.

Now the question is, "How and from where do we get a technology-based loan origination and administration system aligned with a suitable business model?" 

A little bit of searching can find such world-class technology providers. By working together with technology providers, banks can, through effective UAT, have a customised version of the world-class technology platform, which will be aligned with the industry's best business model. This will in turn enable profitable bank lending businesses in the vast realm of the CMSE sector. Banks can also develop their technology in-house by hiring suitable human resources from the market.

An innovative business model for CMSE lending may be described as the reengineering of the full process from customer acquisition, loan application, verification, analysis, approval, pricing, loan supervision, and administration, including selecting suitable delivery channels and service points, determining the pay structure of the employees concerned, etc. It will be based on the cost-benefit potentials of the CMSE sector. 

For example, it is reasonable to employ a low-cost workforce for the CMSE segment. On the other hand, automated technology should be applied to reduce loan approval and administration costs. Training should be arranged accordingly by creating customised training modules for the workforce, too.

We must remember that CMSE banking is a niche market business. If a bank wants to do business in this field in the traditional manner while co-mingling with other areas of work, there is no possibility of gaining success. Subsidiary companies can be opened to do this business properly. 

As an example, it can be mentioned that if separate subsidiary companies for banks in our country can be opened for brokerage business, merchant banking business, remittance business, etc; then what is the problem with opening CMSME banking subsidiary companies? 

If a subsidiary company is opened, it will be easier to implement specialised business models and technologies with separate mini-arms. If a subsidiary is not opened, a separate business model with appropriate technology is a must for success in the CMSE banking market.

Md Tauhidul Alam is the Senior Faculty and Head of the Learning Facilitation Wing of Mutual Trust Bank Training Institute. Email: tauhidbanker7@gmail.com

Disclaimer: The views and opinions expressed in this article are those of the author and do not necessarily reflect the opinions and views of The Business Standard.