Jubilee Post News & Views
Anand Prakash Srivastava
Importance of product innovation in manufacturing or service sector enterprises cannot be understated. When it comes to banking sector, it is all the more significant, especially when dealing with MSMEs. In my last article, we had discussed “how” banks and NBFCs can design new products well for the MSME sector ( How banks can design new products well for MSME lending). Today we will explore “why” MSME lenders often need to go for new products.
The one-size-fits-all approach doesn’t work in MSME lending. The reason is sheer diversity of the sector. The financial product needs of MSMEs can vary from industry to industry and cluster to cluster. Sometimes different units within the same cluster may also need different products.
For example, in a micro fruit processing cluster, the fruit collectors mostly need working capital for the months of January to April, which is called the fruiting season. In the next 3 months, the fruits collected are processed by the SMEs and cash flow starts accruing from August. The standard method of calculating permissible bank finance for working capital will not hold good here because each component of working capital cycle needs to be freshly looked into keeping an eye on the cluster specific factors.
Further, the SMEs in the same cluster which want to set up a cold chain afresh or expand the existing one may mostly need term loans. Similarly, the structure of a loan product for financing industrial machinery could be quite different from the design of a climate financing product with or without a green bond mechanism. Product designs for existing and new customers or greenfield and brownfield enterprises in different industry segments or clusters could also be different, demanding different risk assessment and mitigation measures with varied levels of scrutiny. If banks, NBFCs and Lending Fintechs are willing to segment the MSME market and go to such detailing to maximise their outreach and penetration, a profitable and scalable MSME portfolio awaits them.
In a marketplace characterised by continuously changing landscape for banks and financial institutions, especially with the onset of financial technology, product innovation assumes added significance as a growth strategy for lenders. In 2008, Olavarrieta & Friedmann established that organisations that have developed proper new product development methods are able to perform well in overall firm performance. In 2010, Yan highlighted that new product development serves as an important strategy and function in an organisation that enables it to achieve strategic competitiveness and to earn above-average returns.
As a product designer at SIDBI, and after having worked on more than a dozen new products for MSMEs, which resulted into a portfolio build-up of Rs.2500 crore with zero NPAs, people often ask how our team was so successful with new products and what kind of new products should be brought out by an MSME lender to be more impactful in the marketplace. The fact is :the “what” depends on the “why”. A new product design therefore should be seen from the perspective of need, the problems faced by a lender, and the factors compelling it to consider coming out with a new product or products.
Let us focus on need first. Each lender needs to define its own problem statement, because different lenders may face different problems. Let us enumerate a possible set of circumstances that may require designing a new product as a solution.
Growth
For example, lack of growth may be a problem for some lenders. They may be unable to grow their customer base or volume. Typically, this problem is more pronounced in term lending institutions, because even if they are adding 20% customers every year, their growth may still be zero, for about 20% of the loans may get repaid annually. Such lenders are always in need of a quick delivery product which could give them good volumes.
NPAs
Some lenders face problem of high NPAs. Many of them are put into corrective action plans by their central banks. If some of the products show greater concentration of NPAs, one of the reasons could possibly be a faulty product design. In some institutions, as the ticket size goes beyond a threshold, non-performing loans start to rise. The threshold may be different for different lenders. The correlation between ticket size and incidence of NPAs could be linear or curvy-linear, but quite often higher ticket sizes may show higher incidence of NPAs, more so in case of MSMEs. This gets further compounded by the fact that excess capital in the hands of unscrupulous entrepreneurs may find its way into acquisition of unproductive or unrelated assets, resulting into diversion or siphoning, a banker’s nightmare.
Market perception
Some lenders face an adverse market perception. For example, their customer service or TAT may be poor or may not be up to the mark. Customers may often evaluate such lenders as good but not quick, thinking that they may not deliver their loan as fast as they need. Some lenders may be partially or completely out of sync with the market.
Red tape
Some lenders get into too much of paperwork and procedure. In some banks or financial institutions, even a small loan of Rs.25 lakh without any collateral may involve multiple rounds of information seeking and up to 75 pages of documentation before a loan could be disbursed. As a result, such products do not sell well and business growth takes a hit. Cutting down the red tape and coming out with a simplified product to ensure quicker loan delivery may be the need of the hour with such lenders.
Collateral
Some lenders are stuck on the collateral mindset. They are unable to appreciate that some customers want the best of both worlds – they are neither willing to offer collateral nor want to take high-cost loans, but their projects, companies or business models may otherwise be good and may offer exciting investment opportunities. Such customers may not be willing to bear the cost of credit guarantee and may be looking for cheaper loans, as they may already have other lenders pursuing with them. A collateral based lending product will not appeal to such lenders and a different product design may be needed. Modern banking in India originated in the last decade of the 18th century, and despite such a long history, collateral has never been able to solve the problem of NPAs.
Opportunity
The need for a new product may also present itself in the form of a new opportunity knocking at your doorstep. For example, Covid-19 did create huge concerns of deterioration in portfolio quality and rise in NPAs, but it also brought in new opportunities to deploy capital through well designed, customized products targeted at specific market segments.
Demand
Sometimes customers, industry associations or cluster bodies themselves may come out with demand for a particular customised product when the existing banking products are unable to serve their requirements well. Many a times studies conducted to assess financial or non-financial gaps by institutions, consultants, or international bodies such as World Bank, International Finance Corporation or donor agencies like KfW, GIZ etc. bring out such a need. A demand driven product, if well designed, always has a greater potential for success and upscaling.
New Entrants
New players entering the MSME lending space for the first time may also need new products as a differentiation strategy. Such new entrants may attract customers by offering products with design or features hitherto not offered by other lenders. This not only helps them capture the market and develop a good pipeline of bankable proposals, but also offers opportunity to charge a premium and maximise their returns.
Environmental concerns
Following the Kyoto protocol, which came into force in 2005 with 192 signatory nations, the focus on climate change has been increasing year on year. The RBI Bulletin of January 2021 contains a paper on Green Finance in India which articulates that Green Finance is fast emerging as a priority for public policy.
Studies are being conducted on climate resilience financing for MSME sector in India by international bodies. In May, 2021 the European Investment Bank and India’s largest lender SBI entered into a pact to jointly pump Euro 100 million in equity financing into Indian small businesses focused on climate change and sustainability. Given the growing awareness on climate change, it is imperative that the MSME lenders also include in their agenda the need to design special products for climate finance.
Context
Apart from need, the next thing to be aware about is the organisational context of the problem. The context could drive the quest for new products.For example, depleting margins could be a cause of concern for some lenders. Inability to access low-cost resources could be another. Incremental cost of funds may be a real handicap. Manner of resource raising isn’t same for all lenders. Each Bank or NBFC may have its own resources profile. For some lenders, the legacy cost of long-term resources could push them towards an uncompetitive zone.
Similarly, increase in opex could also be a challenge for some lenders and they may be looking for minimising operational costs through efficient, innovative products where they could possibly charge a premium. Some lenders depend too much on concessional funds which may be drying up. In developing economies, some governments earmark special funds for priority sector lending for MSMEs which over the years may have become a depleting resource. Institutions where only a handful of products are selling and that too based on concessional pricing, need more innovative products which could give them higher returns and expand their product bouquet.
(The Author is a former General Manager of SIDBI. His email ID isapsriv@gmail.com)
