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

1. 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

2. 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

3. 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

4. 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

5. 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)

6. 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

7. 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

8. 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

9. 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

10. 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

11. 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.

12. 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