The importance of cost control in SME lending

Successful SME Banking

A wide-ranging blog series covering the many and varied aspects of successful SME banking and financial services, in general. The GBRW team will regularly update this blog with posts on some the successful approaches used and key lessons learned over many SME banking and finance assignments around the world.

The importance of cost control in SME lending

One of the challenges of lending to SMEs is that the loan amounts are relatively small, so that even if loan margins are higher than when lending to mid-caps or large corporates, profits can swiftly be eaten up by operating costs. This is especially true if the bank applies the same credit approval procedures to SME lending as it does to large corporate lending.

Part of the answer may lie in cross-selling a range of products to SME customers. Another part of the answer could be to seek to minimise borrowing costs, and not pass on the savings to customers, thereby increasing the margin. In that regard the treasury and Asset & Liability Management functions are as important as the Credit function in ensuring a profitable SME lending business.

A third element, and in my view probably the most important, lies in reducing operating costs, principally by simplifying the internal approval process for making a loan to an SME customer. This is not so easy, as by and large SMEs represent a greater credit risk than mid-cap or large corporates.

There are a number of approaches to addressing this issue, and that is what I want to explore. The first priority is to select the right customers, and that is where the segmentation model comes in. Then it is essential to have the right standardised products for your target customer segments, and a loan approval process that to the greatest extent possible minimises input by your staff.

A process without any staff input at all is not possible, or at least most unwise, when lending to SMEs. At some point somebody from the bank has to visit the customer and form an opinion as to their business, their acumen, honesty, and motivation for being in business. However, every hour spent travelling to and meeting with the client eats into the overall profitability of the loan. How often should the loan officer visit? If you have one, what weighting should be given to the credit scorecard or rating model in the final credit decision?  80%?  60%? 30%? What on-going checks can be made on the business, automatically and remotely?

These are some of the issues that I would like to explore, and would welcome your views.