0. Fuelling the Indian entrepreneur – Opportunities in SME
DEL-ZXO (TT)-(2)
Fuelling the Indian entrepreneur – Opportunities in SME
Bancon 2010 Panel Discussion
Presentation by Ramnath Balasubramanian, McKinsey & Co
December 3rd, 2010
CONFIDENTIAL AND PROPRIETARY
Any use of this material without specific permission of McKinsey & Company is strictly prohibited

1. DEL-ZXO (TT)-(2)
India has more than 8 million SMEs contributing significantly to the country’s GDP, exports and employment
Number of
Companies
CAGR
(no. of co.’s)
Turnover cutoff
Rs. crore %
Contributes to ~39% of country’s manufacturing output
Contributes to ~34% of exports and ~20% of imports
Provides employment to ~68 mn people in rural and urban areas of country
SME sector in India
Large corporates
>500
1,500 22
Mid corporates
4,000 19
Medium SME
200,000 18
SME
Small SME 2-10
1,500,000 22
Micro SME <2
6,500,000 25
SOURCE: Prowess database; market interview; India Budget ; team analysis

2. DEL-ZXO (TT)-(2)
SME banking revenue pool will grow at a CAGR of 16% over the next five years with growth being uniform amongst various products
ESTIMATES
SME revenue pool
Mix of SME revenue pool
INR '000s crore
INR '000s crore, percent
Investment banking 32
65-75
100% 1 1 3 3
CMS
FX and rates
16%
Trade finance
Deposits
Lending
FY 2009
2015E
2015E
FY 09
FY 15
SOURCE: RBI data; Prowess data; market interviews; McKinsey analysis

3. DEL-ZXO (TT)-(2)
Over 70% of SME advances revenue is concentrated in the top 15 cities and 9 industries
ESTIMATES
SME advances revenues
SME advances revenues
Percent
Percent 1
Mumbai 1
Whole Sale Traders 2
Delhi
Remaining citiesRemaining cities 14 3
Chennai 2
Textiles
Remaining sectorsRemaining sectors 4
Kolkata 30
25 Cluster citiesCluster cities 3
IT and professional services 11 5
Bangalore 6
Hyderabad 4
Retail traders 7
Ahmedabad 8 5
Coimbatore
Metal works 9
Pune 6
Food processing
Top 15 citiesTop 15 cities 75
Top 9
sectors 10
Chandigarh 70 7
Real estate 11
Ludhiana 12
Jaipur 8
Transport and logistics 13
Vadodara 14
Ernakulam 9
Auto and Auto ancillary 15
Surat
SOURCE: RBI; McKinsey analysis

4. DEL-ZXO (TT)-(2)
SME is a relatively profitable segment, but returns could vary based on operating model and ability to manage risks
ESTIMATES
Percent of average advances
Risk-adjusted ROA for high performing SME Bank
Three key drivers of profitability of SME segment
Lending
NII
Risk cost
Risk adjusted NII
Deposit
NII
Fee
Income
Opex
Risk- adjusted ROA
Ability to manage risk (loan losses)
Cross sell deposit and fee income-related products to SMEs
Manage operating costs of serving SME segment
Risk-adjusted ROA for under-performing SME segment
Lending
NII
Risk cost
Risk adjusted NII
Deposit
NII
Fee
Income
Opex
Risk- adjusted ROA
SOURCE: Central bank data; expert interview; 2008 Asia Pacific SME Banking Report

5. SMEs’ financial needs can be broadly classified into three categories
DEL-ZXO (TT)-(2)
SMEs’ financial needs can be broadly classified into three categories +
Complexity of cash management needs
“Enabling
day to day
business”
Conducting
daily transactions
Managing and investing
high cash flow
“Creating flexibility and acquiring assets”
Traditionally served
Core
financial
needs
Lifespan of assets and liabilities 1
Managing and financing
working capital
Acquiring and
maintaining assets
“Managing business-related risks”
Complexity of risk protection
Single
“isolated” risks
Multiparty and
complex risks
Stake-holders related
needs
SME owner and shareholders
“Serving stakeholders’ financial needs” 2
SME employees and management
SME suppliers and/or customers
Rarely served
Life-cycle related
needs
Lifecycle-based long-term financing needs
“Supporting
strategic
growth” 3
Starting
the business
Changing
the business –
SOURCE: McKinsey

6. Similar trend observed for transacting bank as well%
DEL-ZXO (TT)-(2)
SMEs are extremely loyal to their primary bank with ~70% of SMEs have banking relationships of more than 6 years
Tenure of relationship with lending bank (percent)
Top 15 cities
Cluster cities
10 or more years
6-9 years
3-5 years
Upto 2 years
Similar trend observed for transacting bank as well
SOURCE: McKinsey SME survey

7. There are 7 key elements of a successful SME business
DEL-ZXO (TT)-(2)
There are 7 key elements of a successful SME business 1
Appropriate customer segmentation and value proposition to ensure different types of SMEs are served according to their needs 2
Business model choice– in terms of traditional lending based vs. liability led vs. technology led (e.g., supply chain financing) 3
Servicing model to ensure rapid turn-around times at low cost to serve (e.g., internet, loan factories) 4
Relationship management and branch architecture to cover and provide specialised services to SME 5
SME-specific risk rating tools in a relatively data-scarce environment using qualitative credit assessment based techniques 6
Suitable operating architecture in terms of centralisations vs decentralisation of mid and back-office functions 7
Putting in place the appropriate organisation construct and business performance management system to ensure the right focus on the segment
SOURCE: McKinsey

8. Value proposition: Bundled offers can help drive cross-selling
1. Segmentation and value proposition
DEL-ZXO (TT)-(2)
Value proposition: Bundled offers can help drive cross-selling
Description
Examples
Deposit and cash flow packages
Combination of business account and/or personal account in one single package (or two business or personal banking products tied-up) with a fee discount
Volume correlated products
Interests/loan size relationship benefits on business/individual account, e.g.,
Business offset services reduce amount of interest on business loan based on balance in personal deposit account
Loan size determined based on deposit balances with bank
Sector specific offers
Combination of business and individual oriented products that are tailored to a specific sector (e.g., doctors, lawyers)
1 Limited number of sector specific offers available including non-profit, agricultural and professional services
SOURCE: McKinsey; mystery shopping; company websites

9. Business model choice : Supply chain based approach
DEL-ZXO (TT)-(2)
Business model choice : Supply chain based approach
CLIENT EXAMPLE
Traditional
Supply chain
Example of channel financing strategy deployed by a successful bank
Impact achieved
Profitability of supply chain lending vs. traditional lending
Needs-based segmentation, focus on SME within large corporate’s supply chain
Performance management and incentive system driving cross-unit collaboration
Use of proprietary scoring model and client profitability in credit assessment and pricing
Streamlined, seamless IT-platform across segments and products, leveraging full transaction information
Basis points, indexed
100
800
Risk adjusted revenues
Cross-sell opportunities on supply chain finance
Basis points, indexed
100
~65
~75
~55
~300
Risk adjusted lending revenue
Trade services cross-sales
Cash management cross-sales
FX cross-sales
Total revenues
SOURCE: “Serving Asian SMEs” KIP team, 2008; expert interviews

10. 5
2. Business model
DEL-ZXO (TT)-(2)
Business model choice : Integrating business and personal wealth needs of SMEs
ASIAN CLIENT EXAMPLE
Impact achieved
Example of integrated business and personal relationship approach
Additional profits from cross sale of SME banking products to wealth management SME customers
Indexed
Identified overlap and cross-sales potential for both wealth mana-gement and SME banking
Developed of SME owner specific wealth management offering based on insights from SME interaction behavior
Refined organization model with aligned performance management and incentives to further cross-unit collaboration
Installed referral system and eventual collaboration model to facilitate cross-unit sales
Current profit from SME owner’s WM
~100
Net interest income
~245
Net fee income
~75
Operation cost
~145
Risk cost
~65
Profit
~110
~210
Additional profits from increased WM penetration of SME and wallet share of SME owner’s WM
Indexed
Current profit from SME owner’s WM
~100
Increased wallet share of SME owner’s WM
~195
Increased WM penetration of SME
~180
Operation cost
~110
Profit
~265
~365
SOURCE: “Serving Asian SMEs” KIP team, 2008; expert interviews

11. 6. Risk management
DEL-ZXO (TT)-(2)
Effective mitigation of risk in SMEs will need a combined quantitative and qualitative credit assessment approach
Quantitative rating
(statistical score)
Statistical techniques
Logistic regression
CHAID
Neural networks
Focus on quantitative or quantifiable data
Financials
Credit bureau information
Demographics (e.g., age)
Account information (e.g., balance, monthly turnover)
Combined rating
One overall rating and Probability of Default
Method of combination chosen based on the relative performance of the two underlying ratings
Qualitative credit
assessment
Appraisal of the business
Operating environment
Cash flow forecasting
Asset valuation
Management, etc.
Presented as a series of questions with pre-defined answer options (check boxes)
SOURCE: McKinsey Risk Management Practice

12. 6. Risk management
DEL-ZXO (TT)-(2)
A combination of quantitative and qualitative models has consistently yielded better results across markets
Quantitative model only
Quantitative model + separate QCA
Predictive power (GINI) in points, sample cases
The QCA (Qualitative Credit Assessment) adds unique insights to credit assessment
Quantification of inherently qualitative factors such as management quality
Validation of financials and other fraud indicators
Flexible approach to limited data availability (e.g., by quantifying also degree of uncertainty around a data point)
India
Taiwan
Hong Kong
China
North America
SOURCE: McKinsey Risk Management Practice

13. DEL-ZXO (TT)-(2)
In summary 1
SME is a large, fast growing and attractive opportunity for banks and financial institutions and a significant contributor to the economy 2
Needs of SMEs are evolving rapidly - financial institutions will need to look beyond core financial needs for this segment 3
The segment is very local and can be very profitable for banks – but managing profitability will require a very sound business model 4
Financial institutions will need to create a differentiated model to serve this segment and build excellence in one or more of seven dimensions
SOURCE: McKinsey

14. DEL-ZXO (TT)-(2)
Backup

15. DEL-ZXO (TT)-(2)
Proximity to branch and competitive prices appear as the top two buying factors
Key Buying Factors (KBFs)
Percentage of respondents stating in top 5 factors
KBFs – lending bank
KBFs – transacting bank
Factors
Factor importance
Factors
Factor importance
Proximity to branch
Proximity to branch
Competitive prices
Competitive prices
Brand name/reputation
Brand name/reputation
Trustworthiness of
the bank
Trustworthiness of
the bank
Turnaround time
Turnaround time
Level of documentation
Level of documentation
SOURCE: McKinsey SME survey