VSE vs. Micro-lending VSE/SME WorkshoP Prague November 5, 2015 MFIs UPSCALING

Doing business as usual with higher amounts Introduction There are two extreme tendencies when moving into VSE lending Doing business as usual with higher amounts Trying to copy banks as a protection from higher risk

What is the VSE Segment? Banks Financial Institutions MFIs Challenges to downscale Challenges to upscale 10 # of employees 300 50 5 Small VSEs Enterprises Large Medium Small Micro Informall DEFINITION: Very Small Enterprises (or “VSEs”) is the financing gap between asset-based lending (by traditional financial institutions) and behavior-based lending (by MFIs). Informal enterprises are also the scope of the VSEs Source: IFC Innovative Financing for Unbanked Small Businesses, July 2013 2

KEY CHARACTERISTICS & NEEDS OF VSEs Definition of VSE will vary from Country to Country and can differ across FIs BUSINESS High concentration of semi – formal firms Defined Business location & some fixed assets Often no legal formalization Organization structure and management is more sophisticated compared to Micro Have informal employees (including family members) Prime household income source Heterogeneous groups with divergent financial needs More vulnerable with volatile growth, but also more flexible (compared to SME segment) FINANCIAL MANAGEMENT Minimal formal financial records Bookkeeping is more sophisticated compared to most Micro- but still opportunity for improvement May have tax ID/ pay minimal or partial taxes, OWNER(S) Have some with basic financial education but could benefit from additional financial, accounting, and management skills CHARACTERISTICS CREDIT Fast decision making on credits Solutions for working capital financing and/or investments Higher loan limit, compared to Micro customers Demand investment products and some fee based services Lower requirements in terms of collateral (compared to SME Segment) & cash based analysis NON CREDIT Tailored solutions/ products bundles for daily banking Simple solutions for deposits and cash management Simple and fast FI access (e.g. accessible channels) Insurance solutions to absorb shocks Non-financial services to increase their access to market opportunities, training (e.g. financial management, accounting), and network to improve their business performance OTHER Predictability of costs for banking and financial services (transparent banking policies) NEEDS 3

How is VSE Financing Different from Micro-? 1. Micro Loan often ‘cycle’ based - business is ‘eligibility requirement’ 2. Micro Loan is dependent on client character for repayment – most households with multiple income sources, are capable of repaying Micro Loan, even if business is weak 3. Loan often exceeds Assets – business used to obtain consumer loan

Dealing with diversity Micro VSE Standardized Approach Semi-standardized Approach (allowing flexibility), but still being efficient Simple marketing and communication Customized marketing according to needs Business and Household visit to verify Business and household visit to verify due to still unreliable documentation LO can usually handle entire credit cycle LOs need to apply more critical thinking to assess the business LO feel able to handle most clients LO may feel intimidated by size or type of activity, therefore needs experience and strong back-up capacities (internal and external) and/or separation of some tasks (i.e. sales)

Dealing with Financial Needs Pro-active cross-selling becomes important Know your customer needs to be taken serious Different delivery channels become a must Product flexibility and diversification Customer Service becomes even more important

Dealing with Credit Risk 1_Loan Analysis Loan analysis has to focus on business risks and on financial risks and in addition also take into account the character and household Crosschecks (also with documents) and financial analysis become more crucial as we cannot see everything the client does. Supplier and buyer checks and market knowledge become increasingly important to assess the overall risks. Loan should contribute to business growth

Dealing with Credit Risk 2_Credit Risk Management Definition of risk appetite, limits for LO and other exposures become important Different incentive schemes apply (also for PAR management) Loan processes needs more checks and balances due to complexity and high exposure and increased fraud possibility Material collateral becomes important as loan amounts cannot be easily collected from friends and family

Dealing with Financial Structure Cash Flow is King! Profitability of business and cash to cover all payments are crucial LOs need to be able to understand the cash flows of different VSEs. They need to identify their financing needs and repayment capacities by analyzing the cash flows

Dealing with Formality LOs need to know documents required for different types of businesses and need to know to analyze them Documents Checks of official documentation need to be in place and functioning Procedures

How to Organize VSE Lending in your MFI? Separated from or integrated into existing business? No hard rules – can be a separate VSE unit or integrated into existing credit department as a separate product Dependent on Structure of MFI’s current business And the extent and concentration of market opportunity Separate VSE unit can discourage ‘graduation’ of clients as Micro officers may be reluctant to ‘give-up’ their best clients In any case, VSE loans should only be processed by appropriately skilled & trained staff Promotion to VSE-level or being ‘Certified’ to do VSE lending – can be a good motivational tool too! Not essential for VSE loan officers to do only VSE loans.

Do Don’t Do’s and don’ts Have excellent customer service (short queues, customer service assistants, speedy handling of requests, good communication) Ensure a sound funding base as the portfolio may grow disproportionately Have checks and balances and sound documentation Don’t Lower interest rates too much from the start. Banks have often hidden costs and customer service is often the competitive edge Ask for business plans Rely on official financial statements for loan decisions Have sound decision mechanisms for deciding on loan amounts according to VSE needs and capacities Be –over-optimistic using financial projections