The following questions were submitted by the members of the SME Finance Forum LinkedIn group.

In an emerging economy such as India, SME rating agencies can provide arrange of non-financial services. Are non-financial services a substitute to rating activities or a kind of business plan? Are those services given as part of SME credit facilities?  Is there any cost involved for SMEs while availing these services?

Michel Botzung: This is an interesting reference to SME Rating Agencies. I would expect that some non-financial services (NFS), particularly the most generic ones like business information, could potentially be provided by SME Rating Agencies as a way of reaching out to their target audience.

In most cases, NFS are not part of a credit facility. It is risky making these services mandatory to SMEs for two main reasons:

1) NFS may then be perceived as an additional hurdle on their way to access finance; rather than focusing on the service itself and on its potential relevance, they would in most of the cases just try to quickly go through it with a “passive customer” approach – which is very much unlikely to induce any changes of behavior. I’ve seen many cases where un-relevant family or staff members are been sent to attend training or information sessions simply because they were mandatory, and one didn’t perceive any value in the service.

2) A direct link between the service and the credit operation increases the risk to have the SME complaining that the inadequacy of the advice or information or service has undermined their ability to reimburse the loan …

Just as for consumers, the perceived value of a free service is sometimes limited. I would argue that the more sophisticated and the more tailored the service is, the stronger the case for charging a fee for it. There is also an element of progressivity in the pricing; at early stages it can be more effective to offer services for free to demonstrate their relevance and help building demand for it. There are some interesting experiences (Barclays Kenya i.e.) around Business Clubs with a membership fee – you get access to services once you have paid your membership fee – which is also a way of reducing the transaction cost of billing for each and every service.

What impact do non-financial services have on the overall credit process? What are the pros and cons of outsourcing / developing internally this function? Can it, to some extent, be factored in as a credit enhancer? Under what conditions?

Michel Botzung: There is a lack of research on this specific issue. Subjectively I would say that NFS can impact the credit history but should not be used as a direct credit enhancer. One can reasonably assume that with access to better business information and tools, training and mentoring, an SME has increased chances to grow or at least to weather the crisis, and hence of reimbursing its loan. In a pilot Standard Chartered/IFC project in Pakistan, where financial management courses were delivered to client SMEs, at a time when both the financial and security crisis were hitting hard, an unexpected outcome of the project was the improvement of the participant SMEs’ credit history – which is an interesting dimension for a bank. In another case in DRC with smaller businesses, the Bank’s loan officer valued very much the opportunity to attend training sessions and interact with potential clients…

Outsourcing vs in-house delivery of NFS is a key question. There are pros and cons for each way. By outsourcing, a bank can focus on its core financial business and rely on specialized operators to deliver services. The challenge here is to find reliable and seasoned service providers in the local market; which may be a challenge particularly in smaller and/or in less developed markets. And managing/monitoring the service providers can be difficult. By relying on internal resources, the Bank is in direct control of what is being done, they know the resources, the content – on the other side, it may be a burden on the teams and it is not sure to what extent they will dedicate the time/motivation to develop proper services to SMEs (which may not be perceived as the most fancy clients).

What are the different types of non-financial services that banks can offer to SME clients? How can these services help position a bank in the SME market? Can these services be adapted for specific niches (women, agribusinesses) or SME sectors/industries?

Michel Botzung: The scope of services that can be offered is extremely broad. The NFS study used a very simple typology – based on 4 different kinds of services – ranging from broader (and cheaper) to more specialized and more sophisticated. These services were: Account Manager Support / Information Dissemination & related Events / Training / Consulting services; and each of the 3 last categories does cover a large variety of services.

To be effective, services need to be adapted and tailored to specific niches and sectors. The broader and the more generic the service is – i.e. information about business registration modalities or basic financial accounting principles, the less the need to tailor and adapt – the less adaptation is needed – the deeper the relationship, the more frequent the touch points do become – the more tailored and the more specialized it will be required to be.

The main learning of the report – substantiated by examples like TEB – is that yes, a smart offering of NFS can help a Bank differentiate itself from its competitors in the SME space; and yes NFS can help building client loyalty, increase the SME portfolio, and to some extend maintain its quality. Do you charge for services, and if so, is there cost recovery? How about conflict of interest issues?

Michel Botzung: Not transforming NFS into a mandatory step to access finance limits the potential conflict of interest risk. Ideally the Bank makes NFS available and promotes them, but the decision to use them is better left to the SME itself.

Recovering cost or not is an on-going debate – and they are very different views in the industry. Some charge a flat fee (Business Club model) giving access to a range of services, some collect some contributions to access some services, and some others (like TEB) do mostly offer services for free.

Lack of SME transparency is a common challenge for banks. To what extent are banks providing accounting services directly to SMEs (e.g., directly or indirectly by outsourcing to an accounting firm)? Further, for those banks providing this service, what are the main challenges they are facing (e.g., lack of willingness on part of SME to participate, lack of willingness in part of the SME to pay some portion of the service) and how are they overcoming them?

Michel Botzung: This is a tricky issue. A sound and reliable accounting system is an asset of a well-managed firm. But how do we make this happen, and even more so can a bank play a significant role in making this happen? Here also the perfect is the enemy of the good. Beyond accountants themselves, accounting is frequently perceived as a boring task, nothing attractive and nothing than can directly result in increased sales or increased profit. It also comes across as what the Bank needs to know about the SME; and looks like, we offer you a service so that we can access the information – hardly an effective strategy to develop the relationship … At the risk of sounding cynical, why should a bank embark on NFS by offering a service hardly in demand and not really attractive?

What you’re mentioning are typical (and frequently observed) attitudes of someone who doesn’t want the services (although (s)he would certainly benefit from it) and who adopts an avoidance behavior by not attending or by sending the un-appropriate person or by refusing to pay a fee, etc. A more effective approach would be to offer first exciting services, not available in the market, or less attractively packaged and then progressively move on towards more specialized services (which may include accounting).

Which non-financial services offer the highest return on investment to both banks and businesses?

Michel Botzung: This is a key question; but as NFS to SMEs by Banks is a new area we’re still missing the in-depth assessments and case studies which would help us assessing what offers the “biggest bang for the buck”. A good way of making some progress at assessing which services do offer the highest ROI is to distinguish amongst the various motives of the banks for offering these services: is it client acquisition?, is it differentiating themselves from the competition?, is it improving the overall SME portfolio quality?, etc. and then identify the most cost-effective ways of achieving this. From an SME perspective, studies overwhelmingly tell us that SMEs do value networking opportunities, market information, coaching and mentoring services. Making both ends meet is the challenge ahead.

How do you decide what a bank should provide directly, versus what it should broker through local business service providers?

Michel Botzung: The first step would be to recommend to banks to do a good assessment of what the supply side looks like in their specific market (which services are being offered?, are there relevant services providers? How good are they? How well known are they? How expensive are they?, Is this something we could offer directly?, etc.). It is probably easier for a large bank in a large market to offer some service by leveraging in-house services. ICICI is offering more in-house services than TEB does.

The second element is related to the complexity of the services offered – the more specialized and the more tailored, the least relevant/possible it may be for the bank’s staff to provide them directly.

The third one related to the cost-benefit analysis. Do we have some in-house expertise? Is it available? Will they get the right incentive to provide these services?, etc.

My personal take would be to outsource as much as possible …. whenever possible.

How do you balance the tradeoff between charging fees for sustainability and subsidizing trainings to create access to non-financial services for high potential growth SMEs that don't have the resources to access trainings yet? What types of non-financial services have been found to be most effective in helping entrepreneurs manage and grow enterprises AND have provided the desired return to financial institutions? How do bank's determine what is the right blend of low touch (standardization) and high touch (customization) delivery methods for non-financial services that can be scaled?

Michel Botzung: The short answer to this very good question is we don’t entirely know yet. The report was instrumental at capturing this new trend – Commercial Banks are increasingly getting into this space, partly (but less so) for CSR reasons, partly (and increasingly so) to growth and improve the quality of their SME portfolio. Next step is to measure more systematically which service offers the higher return on investment based on the Bank’s core objective. This is a core component to a more operational review of NFS that IFC is launching. How do banks offering non-financial services (particularly business advice) stop this from adversely affecting their related loan portfolio? The risk, as we at MicroSave have seen it in several settings, is that clients receiving business advice and a loan from the same agency do not feel compelled to repay the loan if the business is not adequately profitable (and particularly if it makes a loss) ... instead they blame the business advice and often refuse to keep up epayments.

Another assumption is that the relationship to SMEs may here differ from a microfinance client – more complex needs and challenges, less physical proximity between the loan officer and the client. Non-Financial Services cannot be a mandatory offering; it’s an opportunity that the end-user or client can size or not. This is a core principle to minimize the risk that you have described Graham.

As long as banks in emerging markets see non-financial services meerely as "side-business", instead of a real opportunity to help SME level up to a "cost-effective data" useful for both sides, these services will always be unconsidered by bank users in general. Do you agree?

Michel Botzung: There are two dimensions to your question: how banks perceive non-financial services and how these NFS are considered by the targeted users themselves.

On the former one, things are changing. What was previously, at best, a marginal CSR activity is now being considered (as highlighted by the NFS report) as an important activity that can help developing the SME portfolio, mitigating risks and differentiating from the growing competition – simply an important component of a core business line.

The latter comment touches upon a core issue: a bank may be developing an offering of NFS, but how does one know if they will be used by SMEs? In this field as in many others building the supply doesn’t guarantee a sustained demand for the services. Just as with any product, it’s key to assess the market to find out what’s missing (or poorly offered), what is in demand, what others don’t do (or badly), what could be offered in a cost effective way, etc. When this is done, one could focus on 3 key elements: a teasing marketing campaign to inform the market about the new services, an approach that increases the perceived value of the services, a systematic data collection about the SMEs using the services.