3. Review of Bank Lending Practices
Strategy
Strategy is obviously something that is commercially sensitive from the banks' perspective, since it is key to gaining a competitive edge. It is difficult, therefore, to make specific comments regarding the strategies being employed by the various banks. Some general points can, however, be made.
- All of the banks see the SME market as being an important part of their overall lending portfolio, reflecting the "fit" with banks' core business and perceived growth opportunities in the SME market.
- There is broad comparability between the banks in terms of lending facilities offered.
- With two main exceptions, the banks look to lend across the whole SME sector. These exceptions are start-up enterprises, and intellectual property based enterprises, although all propositions will be considered.
- Some of the banks focus on all, or most, segments of the SME business community. Other banks focus on niches that can be defined in a number of ways including size and region.
- The banks' strategies are influenced by whether they have a small, but growing market share, or a larger and existing market share that they are seeking to retain.
- Some of the banks have taken a strategic decision to intensify their research into, and understanding of, the SME sector with a view to substantially increasing their market share.
- The banks are intensifying their emphasis on relationship management.
- Most of the banks are developing credit scoring techniques for assessing SME risk as this has the potential for achieving cost efficiencies (credit scoring is discussed further in Appendix D). Such techniques are already used in the personal banking market.
Policies
Consistent with the strategic view held by the banks that the SME sector is an important and growing part of banks' lending portfolios, a common theme arising from discussions with the banks is that their lending policies are designed and implemented in a way which allows each SME lending opportunity to be evaluated on its merits.
Each bank has policies and procedures documented for their lending practices. These cover:
| Lending Principles and Processes | Loan Conditions |
| |
For most banks, the lending policies are regarded more as guidelines, as opposed to rules not to be broken. Where elements of a lending proposition do not fit strictly within the policy guidelines (for example, lower equity contribution by borrower), it does not automatically discount the possibility of a loan being made to that borrower. For these propositions, conditions may be imposed prior to acceptance of a loan (such as increasing equity stake), or for the duration of a loan (such as more stringent covenants).
The credit policies of the Australian (and other internationally) owned banks are to varying extents influenced by their parent bank. However, the lending policies are subject to input from New Zealand. Comments were made that as the New Zealand market is different to Australia, lending policies are adapted to reflect the local conditions. This was noted with particular reference to the rural sector. In this regard, we also note that virtually all lending decisions in the SME sector are made within New Zealand. Only in very rare instances would approvals need to be made offshore for facilities provided to SMEs.
The attitude of banks toward risk is obviously a critical element of bank lending policies in respect of SMEs and lending generally. Banks have developed sophisticated systems and comprehensive policies and procedures to ensure the risk is properly identified, quantified and managed.17 The intense focus on risk management by banks is reflected in policies and procedures and stems from a number of considerations. While the importance of each of these can vary from bank to bank, in aggregate, the factors help shape banks attitude toward risk:
- All major banks are subjected to continuous and detailed scrutiny from the capital markets - both debt and equity. The quality of a bank's overall lending portfolio is a crucial aspect in the market's assessment of a bank's performance and value.
- Banks are compared to their peers. Any material reduction in loan quality and bad debt performance would ultimately be reflected in an increase in a bank's cost of capital.
- Shareholders (and debt providers) investing in a bank expect policies and procedures to be followed that protect the capital base, facilitate growth and provide a commensurate return for the perceived risk. Several of the banks emphasised that their shareholders do not expect, or desire, banks to invest in risky investments. "Shareholders are investing in a bank, not in a high risk enterprise". That said, two of the banks have established subsidiaries to provide equity finance. One of these has since withdrawn from this line of business.
- Banks are highly geared and accordingly, they are sensitive to the fact relatively small changes in financial performance can have a significant impact on bottom-line profitability.
- Regulations, often imposed by the offshore parent of the New Zealand subsidiary establish, among other things, minimum capital levels and maximum risk exposures. This has a bearing on the acceptable levels of risk a bank is able to accept. This will be even more relevant as the Basel II regulations18 begin to be applied to banks globally. Minimum capital levels will be directly related to the type of loans, security and quality of borrower.
Decision Criteria and Delegations
In broad terms, the approach to decision making in terms of criteria and roles and responsibilities is relatively comparable across the banks interviewed. The diagram below summarises roles and responsibilities within a "typical" bank in respect of SME lending.
Relationship Managers
In all of the banks interviewed, relationship or business managers are assigned to SME customers once they reach a certain size based either on turnover or on facilities granted. Regional or district managers, to whom the relationship managers report, are in place in some of the banks. For those SME customers not assigned a relationship manager, business may be conducted through call centres or support centres, including bank branch support.
Relationship managers are able to approve loans within their discretionary limits. Any loans outside of their discretion are passed on to a credit manager for approval.
We have observed considerable variation between the banks in terms of the discretion limits assigned to relationship managers. In one case, business managers/salespeople have no discretion to approve credit exposures at all and must always seek approval from their credit managers for all facilities. At the other extreme, business managers have discretion to lend up to $1 million on a secured basis per client. Discretion levels tend to be given to an individual, not a position, and vary according to the level of security offered against a loan.
Given the size of loans to SMEs, the implication is that at least in some banks, decisions regarding loans to SMEs are made at the relationship manager level and do not require higher levels of approval.
In situations where approval is required by a credit manager, the approval process has become relatively automated in a number of the banks. Relationship managers complete an assessment and this is electronically transmitted to the credit centre for approval. The length of the assessment varies between banks, from one page up to ten pages, and depends on the complexity and/or size of loan.
The assessments may typically cover a range of factors, including:
- General remarks/narrative.
- Business plans.
- Financial statements.
- Industry analysis.
- Management assessment.
There is a degree of standardisation in the assessment forms, with the use of templates and/or tick box sections. The advantage of this is to reduce information requirements and also reduce the time to make decisions. However, as noted above, narratives of varying lengths are also required.
In some banks, approval from a risk management/credit approval team is required for all facilities.
Relationship managers have the responsibility for communicating the decisions which bank's make in response to applications from borrowers. In instances where applications are declined, the relationship manager will typically work with the customer to explain why the application was declined and to explore options, where appropriate, for modifying the application.
In some cases, applications fail because of the lack of good quality information provided to the bank. While banks do not generally see it as their role to provide professional advice to customers, they will endeavour to point the customer in the direction of appropriate advice. The nature of the advice required varies between customers. Some need assistance with preparation of budgets and financial statements. Others need assistance with business plans. Others require marketing or business development advice.
Analytical Team
The majority of the banks have a dedicated team of people who analyse the financial information (and potentially non-financial information) provided by the SMEs. Analytical teams provide analysis to relationship managers and credit teams to facilitate the assessment and monitoring of risk and credit worthiness. Analysis typically includes four key areas: liquidity, profitability, gearing and operational performance.
This analysis is completed prior to the loan acceptance, and during the loan term.
Credit Approval
Credit managers have considerably greater delegation than relationship managers, ranging from $3 million to $12 million per client, but generally averaging between $3 million and $5 million. This is generally well beyond the size of loans provided to SMEs.
It is worth reiterating that the banks tend to grant lending limits to individuals rather than positions. This is because it is the experience and skill of the individual that is perceived as being critical to good decision-making. The levels of delegation are not uniform, however, across all loan applications. The level of delegation generally falls as risk increases, and distinctions are made between new and existing customers. The level of delegated authority in respect of new customers can be 50% lower than that for existing customers. Moreover, delegation levels vary between well secured and unsecured borrowers.
Decision Criteria
The factors impacting upon lending decisions are summarised in the diagram below. A number of the factors influence the risk grade19 (as shown in the circle in the diagram below) that is assigned to each account.
Risk grading is primarily focused on the probability of default (ie the risk of having insufficient cash flow to meet debt obligations). The level of security offered is also an important part of decision making. Security is particularly relevant in the context of loss on default.
Management Capability
A number of the banks emphasised the importance of the management capability of SMEs:
- Experience - the more experienced the management, the more favourably a bank will look upon the proposition. In general, a young, inexperienced person potentially presents greater risk than an older, more experienced, manager.
- Continuity - in relation to key person risk, a bank will be interested to know that existing management will continue for the duration of the loan term. An owner/manager approaching retirement age may be of concern, if no succession planning has been undertaken to ensure that the business will continue as a going concern subsequent to the retirement.
Individual Characteristics
A bank will be interested in the individual/s who are applying for a loan. In particular, they will consider:
- Credit/Account History - according to the banks interviewed, consideration may be given to an individual's characteristics if these pointed to greater chance of default or funds being used for inappropriate/illegal activities. Relevant applicant characteristics could include, but may not be limited to, credit ratings of the individual(s) and account history and behaviour.
- Key Person Risk - the importance of the person to the organisation is another potential consideration. Key person risk tends to be more of an issue where the individual has specialist skills and/or is critical to the relationship with clients.
Characteristics not focussed on by banks are:
- Ethnicity/Gender - banks were asked whether either of these characteristics were taken into account in lending decisions. In general, the banks indicated that these criteria are not relevant.20
Geographical Risk
Geographical location of SMEs can also be one of the factors considered as part of a loan application:
- Location - some banks limit their exposure to residential property in certain areas. The value and marketability of residential property differs substantially between urban centres and small rural areas. The implication of this is that the level of security (if residential property) in small rural areas may be considerably less, and with less security the margins21 may be higher.
- Geographically Specific Risks - there are risks associated with a geographical area (such as low population bases in the West Coast or the earthquake fault-line in Wellington), which may be taken into account if the risk impacts on the entity applying for the loan.
Notwithstanding these considerations, the banks have indicated that there is no material difference in pricing between regions. The policies regarding security requirements are generally the same irrespective of location.
Performance History
- The banks look favourably upon SMEs with a good track record, and strong financial performance. Size of the entity, as an entity-specific characteristic, was not in itself looked upon as a factor for consideration. However, if the small size of an entity was a reflection of a lack of track record, experience or capital, this could affect the price, or availability, of loan finance.
Level of Exposure
- For larger loans, banks may put more time and resource into understanding the SME business and associated risks. This is because the size of the loan directly impacts the exposure the bank faces.
Industry Risks
- Property Sector - most of the banks referred to property development as a high-risk sector.
- High Risk Sectors - some of the banks identified higher risk industries. Beyond the property sector example, the banks did not have a uniform view as to the higher risk sectors. In identifying high risk sectors, the banks were signalling that loan terms and conditions might be more stringent and/or that the hurdle for approving a facility in these sectors was set at a higher level. A number of high risk sectors were mentioned by one or more of the banks. The extent to which the list applies to any one bank depends on the market position and strategy of that bank. Sectors identified included SMEs:
- operating in the social sector (e.g. rest homes, schools, churches). It is harder to close down this type of business;
- with low margins and/or high failure rate (e.g. logging contractors, small service stations, small transport companies, small cafes in Auckland and country pubs);
- of a specialist nature where the bank did not have the specialist knowledge or expertise to understand the risks involved; and
- involved in a range of other sectors including information technology, agriculture and fishing (shellfish).
- Prohibited Sectors - only one bank had guidelines that specifically prohibited lending to certain industries, which were classified as high risk. In general, the banks indicated that each case would be evaluated on its merits. Higher risk would usually translate into higher margins for SMEs or, in some cases, the decline of loans to such entities.
- Dubious Propositions - banks do not lend to dubious propositions, such as those that might be regarded as having some connection to money laundering, arms/weapons, or political agendas.
Portfolio Allocations
The banks were asked whether they have any limits on the extent of lending to SMEs either in total or according to certain criteria (e.g. sector/industry, geographic location, urban versus rural etc).
Of the four banks that responded to this question, three did not have restrictions on the maximum proportion of the total loan portfolio by value that can be allocated to SMEs. In the case of the one bank that did have a restriction, it was more than five times the current level of lending.
Factors that appear to contribute to the lack of any portfolio limitations include:
- The fact that in lending to SMEs, banks are lending to a very wide cross-section of the New Zealand economy and so are diversifying their risk;
- In aggregate, the value of lending to SMEs is a relatively small proportion of the total loan book; and
- Default by one SME tends not to have flow-on effects to other SMEs. In contrast, a large business may have considerable ramifications for regional economies and/or the national economy.
Information
Quality of information as submitted by the SMEs may impact on the decision to approve or decline a loan application, and potentially will affect the pricing as well. Information often requested by banks includes:
- History of business.
- 2-3 years historical financial statements (preferably audited).
- Budgets.
- Cash flow forecasts.
- Information/background on key individuals.
- Key supply arrangements.
- Key customer arrangements.
- Details of trade terms.
- Security (and valuations).
- Business plans/strategy.
- Industry analysis.
- Credit checks.
The consensus of the banks is that the quality of information varies enormously. Some SMEs provide comprehensive financial statements, forecasts, strategies and business plans. Others furnish very little, and often dubious, information.
Relationship managers often need to work with the customer to get information, and in some instances will direct them to seek professional advice from accountants, financial advisors or various agencies, including regional economic development agencies.
Most of the banks were not comfortable in making the generalisation that SMEs exhibited a significant lack of business planning skills, lack of financial expertise or lack of understanding of working capital management. It was noted that for many SMEs this is an issue but, equally, there is a proportion that possess these skills.
Risk Grading and Security
Risk grading and security are two key factors that determine pricing. The assignment of entities to a risk grade is made in relation to the probability of default (i.e. ability of borrower to meet debt obligations). Security is a major consideration in the determination of loss on default. Both the probability of default, and expected loss on default, have a major bearing on pricing.
The majority of banks use a two-part grading system. For example if an entity has a "D1" grade, the "D" relates to the risk assessment grade, and the "1" relates to the security indicator. A small number of banks combine the security quality indicator with the risk assessment grade to generate a single risk grade.
The terms of reference have required that consideration be given to credit scoring. While this technique for assessing risk is under development among several of the banks in respect of SME lending, it is not currently in use. Accordingly, it is not considered further here, but is discussed briefly in Appendix D.
Risk Grading
Each of the seven banks assign risk grades to each borrower on their books. The concepts, purpose and application of the grading systems were analogous for all of the banks. The systems cater to all customers, not just those in the SME sector.
The diagram below illustrates in a generic fashion the concept of the risk grading systems used by the banks. The actual number of grades employed by each bank varies between banks (and indeed most of the banks have more than six grades), with more categories for SMEs and higher risk accounts.
Higher grades are generally assigned to larger corporate or rated entities; although it is feasible that very high quality SMEs could be assigned an "A" or "B" level grade. Characteristics of entities in these grades would include:
- strong and sustainable cash flow;
- very strong and accountable management;
- good reporting and information systems; and
- credit ratings/proven debt servicing record.
In many of the banks, SMEs are initially assigned a "C" or "D" grade. A "C" grade would reflect:
- good cash flow/strong business;
- strong management capability;
- good debt servicing history (if available); and
- good account history (if available).
A "D" grade would more likely reflect characteristics such as:
- adequate but not exceptional financial performance;
- reasonable management capability;
- good debt servicing history (if available); and
- good account history (if available).
Each of the banks has a cut-off risk grade for which any proposition below will not be approved. This is usually at the "E" grade.
When an existing borrower is downgraded to an "E" grade, it would normally mean that there is cause for concern over the account, although the downgrade may only be a precautionary measure. There are many reasons for a downgrade to this watch-list status, such as:
- Breach of financial covenants.
- Poor financial performance.
- Poor industry performance -Industry risks (such as the travel industry in the current environment, due to SARS).
- Account conduct (for example, excessive use of overdraft facility).
- Pressure on entity from third parties (such as a large creditor or IRD demanding payment).
- High level of gearing.
- Exception reviews from quarterly behavioural assessments. Automated behavioural systems are frequently used by banks to monitor account activity on a regular basis (usually quarterly). These produce exception reports when a borrower's activity is unusual, such as exceeding overdraft limits, defaulting on payments.
The impact on the entity of being downgraded to watch-list status can be:
- The account remains under the control of the relationship manager, unless the account is overly complex or exposure level is sufficient to require credit management involvement.
- Account review/monitoring is undertaken more frequently.
- Discussions undertaken with customer to understand what the issues are, and if necessary, a strategy for improvement.
A borrower, in respect of which there are serious concerns, will be assigned an "F" grade. Causes of this are similar to those issues in "E" grade, but are more serious in nature. For accounts assigned to an "F" grade, the bank takes action immediately:
- The account is transferred (if not already) to the credit management team.
- The customer is interviewed to ascertain why default occurred, and to look at ways to avoid an exit strategy being employed.
- If rehabilitation is the chosen course of action, then a strategy is developed between the customer and the bank.
- Detailed budgets, forecasts and cash flows are required, along with ongoing management accounts and variance reports.
- The level of monitoring is intensified.
- Interest on loans may be suspended to assist the borrower in the short term.
- Professional advice may be required to assist the borrower.
- Investigating accountants may be called in by the bank to assess the reality of the situation faced by the borrower.
- If an exit strategy is agreed upon, then asset sales, receivership or liquidation is likely.
The graph below shows the distribution of SME customers relative to all business customers over the generic grades discussed above. Based on the information provided to us by the banks, our interpretation is that the clear majority of SME loans would be classified in the "D" grade as defined above.
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Source: PricewaterhouseCoopers
Only 3% of SMEs and 2% of all business customers are classified as being lower than D grade.
Security
There are some notable differences between the types of security used to back loans between SMEs and business customers as shown below.
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Source: PricewaterhouseCoopers
Key points arising from the statistical data responses and discussions with the banks are:
- Residential homes are a predominant form of security for SME loans. Banks favour lending against property (commercial and residential) because, in general, it can be easily sold in order to realise value and does not depreciate in value (although value obtained net of costs in the event of default is usually below "market" value).
- The preference for property as security is demonstrated by the data provided by the banks, which indicate that roughly two thirds of the value of SME loans is backed by residential property. This compares to slightly less than one third in the case of all business lending.
- Several banks suggested that the proportion of SME loans with property as security could be in the region of 80%. This is somewhat higher than the figures just noted, but there is not always complete certainty as to whether home loans are for business or personal purposes.
- We note also that independent research provided to us on a confidential basis indicated the approximately 35%-40% of the value of SMEs loans was supported by residential property. This research was based on a survey of customers as opposed to responses from banks. It is possible that the survey results under-state the extent to which residential property is used as collateral because survey respondents may view lending backed by the family home as, in effect, an equity injection by the owner to the business.
- One bank commented that lending over residential property is the most cost effective option for SMEs, as price was often determined without regard for the credit grading assigned. The margins in housing backed loans are regarded as being very fine. SMEs would pay a premium if lending were not in the form of a home mortgage.
- Debtors and stock are not favoured as security. If debtors and stock are used as security, they are heavily discounted typically by between 33% and 50%.
- The clear preference among the banks was not to lend on debentures.22 This is because when it comes to executing a debenture, there are costs involved in realising value (e.g. collecting payments from debtors, selling stock etc), there are usually competing claims against the residual value of the entity and the value realised from company assets is lower than their book value.
- The value of loans made without any collateral backing is negligible for SMEs (around 0.2% of all SME loans), especially in comparison to business customers (3.5%). This is not surprising given the general requirement by many (but not all) of the banks for "two ways out" before approving a loan (i.e. repayment through cash flow and realisation of collateral). Statistics for the number of loans without collateral backing was not available.
- With respect to the very small proportion of SME loans that are unsecured, all of the banks indicated that a number of characteristics must be present:
- Very strong cash flow
- Trading history
- History and good relationship with bank
- Strong managerial capacity
- Quality financial information
- Strong financial position
- Guaranteed future sales/contracts or viability assessments
- Personal guarantees and covenants required to be met.
A security quality indicator is assigned to a borrower offering collateral, which is based on the value of the security in relation to the value of the loan. A higher indicator would be assigned for a loan of $100,000 where security offered was $200,000 than for a loan backed by only $50,000 security. The security indicator is influential in setting loan terms, including price.
Relationship between Security and Cash Flow
The banks all require adequate levels of cash flow and security to ensure that the risk of default and loss on default is minimised.
Interestingly, all but one of the banks classified themselves as cash flow lenders, as opposed to asset lenders. In reality, however, given that a very small proportion (less than 1%) of lending to SMEs is unsecured, cash flow lending is very much the exception rather than the rule.
To an extent, there is an element of trade-off between security and cash flow. While ideally all banks would prefer strength in both cash flow and asset backing, if an SME is particularly strong in one dimension, then it tends to lower the extent to which reliance is placed on the second.
For example, if a loan application was made that was to be secured against a house that was twice the value of the loan, then the emphasis on cash flow is lessened (although no bank will lend if there is poor cash flow).
Similarly, the banks have indicated that they will lend at lower levels of security if the cash flow is particularly strong.
Variations exist between the banks in relation to the definition, number and allocation of the grades, but all utilise comparable risk characteristics and all place heavy reliance on having the two sources of repayment.
Pricing
Banks base their pricing primarily on risk grade, adjusted by the level and quality of security held in respect of the facility. The risk grades used by the banks are correlated to statistical data held by the banks, which is used to estimate the probability of default and likely loss on default. Due to relationship and/or competitive reasons, however, it is quite feasible that two entities in the same risk grade with equivalent facilities and security may pay different interest rates. Equally, two entities with different risk grades may pay the same rate of interest.
The banks were invited to provide information regarding interest rates and margins23 with respect to business and SME loans generally and with respect to loan type and nature of security. Four of the seven banks provided some information in relation to these questions but, for a range of reasons, the information is rather limited in scope. Accordingly, the comments below need to be treated with considerable caution and are indicative only:
- As noted earlier, a large proportion of SME loans are backed by property (often residential). Home mortgages are an important source of financing for SMEs and the interest rates for these are a very cost-efficient form of financing. Currently, a typical margin for a standard home loan product is in the range of 1.3% - 1.5%. A range of 1.0%-2.0% for a large customer with collateral would be typical.
- Short-term loans and overdrafts for SMEs who have collateral will attract higher margins than this. The range varies from around 2.0% up to around 3.5%.
- Margins for SMEs with no or little collateral can range up to 7.0%. A large commercial customer without collateral might be charged a margin of roughly half this amount (i.e. 3.0%-4.0%) but it will depend very much on the specifics of the customer.
- These margins compare with an average margin across all businesses (including SMEs) in New Zealand of roughly 2.5%.
In discussions with the banks, the comment was made that the margins on SME loans have tended to remain constant, or declined slightly, over recent years.
Each bank has different methodologies for pricing, consistent with their business strategies. For confidentiality reasons, we are not able to disclose the differences and we have not been provided with details of pricing methodology.
A number of general observations can, however, be made. Prices are generally combinations of fees and margins. Fees are charged to cover the costs incurred by the bank for establishing and servicing the loan. Margins are charged to provide a return commensurate to the risk inherent in the loan and reflecting the cost of capital faced by banks.
The proportion of fixed interest term loans (by value) taken on by SME customers is very similar to the proportion for all business customers.
| | SME Customers | All Business Customers |
| Fixed Interest Rates | 50% | 52% |
| Variable Interest Rates | 50% | 48% |
A number of banks use a matrix (setting out risk and security, as well as customer need/product type) to ascertain an appropriate base price, and then adjustments are made to reflect the relative risk of the SME. This may increase or decrease the base pricing. Relationship managers or credit managers have discretion to change prices as necessary.
In respect of micro SMEs, it is more likely that a uniform rate of interest will be charged (with no, or little, variation in interest rate between micro-business customers).
There was a view from most, but not all, banks that the risk/reward relationship in respect of SMEs is attractive for the banks at present:
- The banks reported that the profitability of the SME sector is perceived to be higher than personal banking.
- Some of the banks regarded SME lending as their most profitable sector.
- An interesting comment was that the SME market has a higher risk of default, but a lower loss on default, and should be priced accordingly.
While risk grading is a primary driver of pricing, there are generally four other considerations in relation to the pricing of loans to SMEs:
- competitive pressures;
- target return on equity;
- future potential; and
- level of cross-subsidisation.
So long as the risk grade is above the cut off point, one or more of the other considerations may take precedence in determining price.
- Competitive pressures are a key influence on margins, and some banks feel that this is eroding the risk-return relationship (notwithstanding comments made regarding the profitability of lending to the SME sector). The banks consider that the industry is highly competitive and that they tend to be unwilling to lose a customer primarily due to price.
- Target return on equity is a high level consideration in setting price, but other factors are more important on a case-by-case basis. Target margins ensure the desired level of profitability is achieved. However, banks tend to match rates or negotiate pricing to win new business, or more importantly to attempt to retain business under threat from a competitor.
- Future potential earnings are a consideration when banks price facilities. For a SME with good growth prospects, a bank may provide loans at discounted rates or margins, in order to secure what potentially could be a long-term profitable customer. This is beneficial for both the SME and the bank - the SME can access the funds at very competitive rates to enable its growth, and the bank secures a profitable client.
- Level of cross subsidisation is taken into account. This encompasses the fees received from the customer from other accounts held within the bank. Certain banks have more sophisticated pricing models that are based on the overall relationship profitability, rather than individual product profitability.
Monitoring and Relationship Management
Once the decision has been made to approve a loan, the bank will maintain an ongoing relationship with the customer.
Monitoring
The level of ongoing monitoring depends on a number of factors:
- Account conduct, such as overdraft usage, cash inflows and outflows, number of transactions. In the event of unusual conduct, a bank may monitor an account more closely.
- Risk level, in reference to the SME itself, industry and economy in general. The higher the risk assessments, the higher the level of monitoring.
- Borrower preferences for contact with the bank/relationship manager - some borrowers prefer a lot of contact, whereas others desire as little as possible.
- Borrower needs for further facilities and/or facility restructuring, which would impact on the level of monitoring required by banks.
If the account does not exhibit any adverse trends or exceptions, then it will generally be subject to an annual review. The annual review focuses on:
- movements in balance sheet items;
- cash flow;
- analysis of financials (preferably audited); and
- discussions with the borrower.
Many of the banks utilise an automated behavioural system that can identify when account conduct changes for the worse. This is useful in providing early warning of impending cash flow or profitability problems. According to the banks with such systems, a relationship manager can tell up to three months ahead if an account may be having issues. Where such systems are in place, many accounts will only be reviewed when exceptions occur.
If an account gets into considerable difficulty, then procedures will be followed along the lines outlined in the risk grading section earlier in this report. Monitoring may then occur as frequently as once a month.
When a customer is downgraded below a certain level as a result of the bank becoming concerned with the adverse trends affecting the customer, the account may be transferred to a credit or asset management team. This team works with the customer to determine a strategy for rehabilitation, or if rehabilitation is not considered possible, then an exit strategy is formulated by the bank and normally executed with minimum delay.
Relationship Management
There is some evidence that banks are beginning to bring back more of a relationship approach to the SME market, and to place more resources at the customer interface level:
- There is a trend toward increasing the number of employees per branch.
- The number of branches has remained fairly constant over the past four years in contrast with earlier and significant branch closures.
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Source: KPMG Financial Institutions Surveys, 1998-2003
The number of customers per relationship manager ranges from 25 (for the largest of the medium sized businesses) to 300 (for small/micro businesses). On average, relationship managers are responsible for approximately 84 SMEs. This figure has fallen over the past three years as shown below.
Source: PricewaterhouseCoopers
The trend toward more intensive relationship management applies less in the case of micro and small enterprises. For very small or micro enterprises, which do not require regular contact with a bank manager or specialist skills, business is often conducted through call centres or support centres. Telephone, internet, email and post are the "new" interface for customers in more isolated areas, where there may not be a branch. Farmers, for instance, are increasingly adapting to doing their banking on the internet.
Most banks provide specialist services and/or locate specialist expertise in specific areas within the bank. These individuals would have a greater understanding of the risks and technical aspects of particular industries/markets and services. Specialist areas include international trade, insurance, payment services, investments, property finance, as well as specific industry sub-sectors.
A number of banks reported that if a business was overly complex, regardless of size, then it might be transferred to a division where a more comprehensive service could be provided.
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