Challenges and Opportunities for Financial Institutions in Emerging Markets International Finance Corporation February 11, 2002 Making Micro and Small Business Finance Profitable

© International Finance Corporation Globalization of the Financial Services Industry Commercial and Retail Market Underserved Market Current Clients MSB and Mass-market Large Co’s and “A” Clients Opportunity: Leverage financial, information & communication technologies to reduce transaction costs and improve portfolio risk management thus expanding services to micro and small businesses (MSB) - profitably. In Emerging & Transition Economies:  Historically:  limited competition, banks not under pressure to target the underserved  Today:  growing competition, banks have incentive to tap new markets,  but, lack strategies & skills to tackle impediments associated with micro and small business (MSB) finance.

© International Finance Corporation Shifting the Productivity Frontier Lower unit costs per transaction or service Broader service offerings & higher asset quality Productivity Frontier (Future state of Best Practice) Limited services to limited number of customers UNPROFITABLE How? Generating Growth: Through profitable marketing strategies Improving Asset Quality: Through enhanced risk management Increasing Operating Efficiency: Through technological innovation

© International Finance Corporation Basic information services & market infrastructure accessible to FIs  Credit bureaus  Shared credit scoring solutions  Payment systems (e.g. smartcards & mobile payment systems) Supporting FIs and MFIs through:  New distribution channels  New decisioning technologies (e.g. credit scoring)  Good corporate governance  Highest environmental/social standards FI MFI FI Market Infrastructure Advancing the Frontier: IFC’s Two Levels of Intervention

© International Finance Corporation  Segment markets and build up In-depth knowledge of customers  Develop wide range of demand-driven products & services  Leverage on appropriate technologies  Develop multi-channel networks for delivery of products & services  Use of advanced, cost effective tools for comprehensive risk management  Align organization structure to target market segments  Develop efficient integrated MIS systems  Good governance and transparent reporting  Adherence to highest environmental & social standards Small Business Finance What do FIs need to do? Benefits to the FIs:  Highly profitable: ROAA of 3% and higher for leading US small business lenders  Risky but manageable: Write-offs below 4% for leading US small business lenders

© International Finance Corporation NEW FINANCIAL TECHNOLOGIES FINANCIAL TECHNOLOGIES GLOBAL INITIATIVE Increasing efficiency, volume and profitability of financial services for MSBs by capitalizing on innovations in financial technologies Building strategic partnerships with global leaders in small business finance and providers of key financial technologies Adapting new technologies in proven business cases to client needs and country infrastructure Promoting investments in advancing financial technologies Providing expertise for design of IFC investments and TA in FIs adapting new financial technologies

© International Finance Corporation Global Initiative Pilot Banks The Advisory Assignment  Adapt proven business models and technologies to the respective market and institution  Work with best practice partners and outside experts from leading technology providers  Take a comprehensive approach to small business finance covering lending, saving, transactions and value-added services  Develop step-by-step a cohesive business plan with the client team, encompassing:  market research  product and services design  delivery channels  organization  and IT/systems Market Research Products/Services Delivery Channels Organization Business Plan IT/ Systems

© International Finance Corporation The Importance of Credit Information and Credit Scoring for Lending Decisions What is Credit Scoring? Scoring is the method by which data are used to predict a particular outcome of interest. The score represents an estimate of the probability or odds of an event occurring Basic Requirements A sufficient random, representative portion of recent accounts with known payment behavior, plus declined applicants An agreed performance definition, e.g good payers and bad payers

© International Finance Corporation Example of a Simple Scorecard <.5 16 GT 100, Yes – 30 Years in Business Total Assets Negative File Information.5 – < LT $100, No – < 5 27 N I 10 No Investigation 0 5 – < 8 34 N I 0 8 – < Single Own 40 < 1 18 Prof. Services 38 Heavy Manuf. 8 Marital Status # of Dependents Residential Status Years at Address Industry Industry - continued Married Rent 15 1 – < 3 20 I.T. 35 Others 27 Divorced Parents 20 3 – < 6 25 Other Services 30 N I 27 Other 14 NI 14 3 – 4 10 Company 18 6 – < Retail 27 4 – High 5 N I – < Catering – High 40 N I – < – < – < – < Age of Owner 40 – < – High 42 N I 10 N I 25 Building 10 N I 20 © 1995 Fair, Isaac and Co, Inc.

© International Finance Corporation Evaluating the Credit Applicant C H A R A C T E R I S T I CJ U D G M E N TC R E D I T S C O R I N G +–+–+––+++–+–+–– Age Marital status # of dependents Residential status Time at address Industry Time in Business Total Assets Negative file information ? ODDS OF REPAYMENT 17.8:1 OVERALL Decision + Accept 190 Accept © 1995 Fair, Isaac and Co, Inc.

© International Finance Corporation Efficiency Gains with Credit Scoring Enter Data Generate Score Apply Decision Strategy Auto declineAuto acceptReview High risk Medium risk Low risk

© International Finance Corporation Advantages of Credit Scoring Can be automated Consistent decisions Management has control Increases revenues by: –Increases approval rate %, while holding the loss rate constant –Risk-based pricing Reduces costs –Reduce losses %, while holding the approval rate constant –Reduces time and manual steps in processing each application –Reduces number of applications needing manual review –Reduces training time for new credit staff

© International Finance Corporation New Role for FIs? Difficult Implementation New Strategy New Role Financial Institutions FIs that build enduring relationships with customers will survive and prosper Relationships will depend on meeting and anticipating customers’ needs Traditional banking structures very resistant to change

© International Finance Corporation Leveraging IFC’s analytic skills and experience to become a pro-active partner in developing sustainable financial institutions serving the MSB market What is IFC’s New Role? Investor at multiple levels - Debt and/or equity in FIs and/or global partnerships Strategic Advisor and Coach - Advising on strategy and coaching throughout implementation Innovator and Catalyst - Sharing global expertise across diverse markets - Establishing and disseminating best practice Match-maker - Facilitating partnerships between FIs and global leaders in strategies and technologies for MSE financial services