NIB – supporting the SME sector

IH: “Our results were certainly a lot better than what we had been producing in the last couple of years. The main reason is that we initiated our strategy of working with the smaller SMEs about two years ago and these things take time. There is a long gestation period because the loans are small and you need time to build a certain momentum. Over the last two years we have just been investing in people, in converting the branches to the right size and structure.

We bought PICIC in 2007, and 2008 was the first full year of merging the two institutions legally as well as operationally so all those investments are beginning to pay off now. We were always expecting the results to get better, and despite the fact that they are much better than they were, they are still a long way from where they should be, so we’re hoping to continue along this growth path. Fundamentally, our business models are in place and are beginning to pay off now.”

IH: “We have three major businesses: the first is the corporate sector lending business. The second business is the medium and small sized SMEs. The third business is the consumer business which for us also includes entrepreneurs in small and medium sized shops and companies.

Currently I would say that our portfolio is equally divided between these three business segments. But three years down the road, the rate of growth of the smaller business and the SMEs will be more, simply because there are so many more of them in Pakistan and they are not serviced in the way that they should be; they don’t have access to finance.

If you go to an average store, banks don’t lend to them because they aren’t considered worthy of loans. We have a completely different view. We think that a lot of these people can actually grow their businesses; they can improve the quality of their lives and the lives of their families if they are given finance in the right manner. It has to be structured correctly but if they get finance then they can actually grow their businesses.

We have about 98 branches dedicated to a business that we have branded as Salam banking which caters to small businesses. It really works for us. Our growth is in SME and Salam.”

IH: “We agree with that analysis. It’s not physically possible for us to access everybody at the same time. We’re present in 60 cities and towns – that’s a pretty huge distribution and we have approximately 240 branches in all these areas. What we inherited was urban concentrations, so one of the ways in which we expand is to take these urban centres and put down branches wherever we feel that there is a market large enough to do Salam banking.

With SME banking, we don’t need more than the 33 branches we have because those are in all the mid-size industrial areas around the country. All the SMEs are a little larger and they can travel a short distance to actually do their banking. But small businesses can’t travel — they need the bank in their backyard.

Wherever we are, we’re doing our business but wherever we’re not present, once we’ve proved the model and we’ve got it at X productivity level we’ll rapidly roll out and it could be another 100, or 200, or 300 branches of Salam, depending on how large we think the market really is and how widely we can disperse ourselves. Physical presence on the urban centres certainly will expand because that’s where a lot of the bazaars and markets are and that’s where the consumption takes place.

But we won’t neglect the semi-rural or rural areas either. Those areas have other requirements which many banks don’t fulfill right now, for example agri-finance. Our focus is to build Salam to a momentum where we can penetrate the market and actively provide finance and make a difference.

There are approximately three million businesses of a small size so our first target will be half-a-million and then eventually we would like to have a million so we will have about 30% of the market share because it’s a business that we understand. It’s a difficult market, which is why most of the other banks doesn’t do this; it’s a tedious business – each loan is small, maybe Rs150,000  to Rs300,000 and the loan repayments are small so you need to invest in a lot of training and technology to make sure that you don’t end up losing money just by the sheer volume of processing.

A lot of these people are first timers to any financial institution, so they don’t have the financial discipline to understand how to perform with a bank: that you can’t be late on your installment for example, because then the process falls apart. So, educating them along the way, teaching them how to access finance, how to structure their balance sheets — they don’t have cash flows or balance sheets so we create those things for them.

When we say access to finance, it doesn’t mean just giving loans. It is about bringing people into the financial network as most small businesses and SMEs in the country don’t borrow. We do provide a lot of transaction services to these sectors, for example, we have approval from our regulator to take cash from these small businesses rather than making them come to the branch because they can’t afford to shut their shop down for half an hour and go to the bank and deposit their money so we actually go to them. We have an online GPRS enabled machine where they enter their account number and their PIN code. It’s a teller that walks around and does this. He inputs his code, he takes the money in cash, he makes the entry online and their account in updated. So, while sitting in their shop, they are effectively depositing as though they are going to the bank and they get a little receipt with a stamp on it which is the deposit slip. It’s a step further than mobile banking because mobile banking is a bank and it can’t get into a street, you still need to go to it – with this, the teller walks around to every single shop and when he reaches a certain amount he goes to the bank and deposits the money and starts again.

This is a very popular product for us, it works very well, but again, it needs a lot of investment, technology, people and training. It’s those types of things that we think will help people come into the whole wider network of how you do business within the system because these people are completely out of the system. According to our research, they end up borrowing from loan sharks at a rate of 150-200% per annum — with what we offer, they end up saving substantial amounts of money. And, that’s how it spreads. We provide a service that nobody else is willing to give them. So we are in effect building the bank on this very large mass of businesses which are neglected.”

IH: “I won’t say that the others are not successful. It’s just that we have our own way of doing it. It’s just part of the ethos of our bank and for us, it’s not an option, it’s a must-do. We are focused on those segments of the market where other people aren’t focused therefore the returns there are higher. The risks there are higher also, that goes hand in hand, but obviously we do have risk-reward and return criteria that we measure all the time to make sure that we’re still within the ballpark.

We will really develop the SME sector for the country and for ourselves, so we can differentiate ourselves because in any business, in any industry, the people who survive or do well are those that distinguish themselves or have a niche or a differentiating strategy. I don’t want to comment on the other banks but clearly for us the differentiating strategy is to be a strong player, not the only player, but a strong player in the SME businesses because it’s a business we understand; it’s a business where we have made investments over the last two to three years and where we continue to make investments. Without those investments, it is very dangerous to get into these businesses because you end up losing a lot of money because you don’t know what you’re doing. Bankers by nature, human beings by nature are risk averse, so everybody tends to focus on things they understand and which are more established so to an extent we do that. But that’s not all we do; we do like to explore new frontiers!”

IH: “With the SMEs and the smaller businesses, we have just scratched the surface so we think that it is a long term differentiating advantage — clearly this will carry on and it will become an even greater competitive difference for us because not too many other people are focusing on it in the short-run.

The second area for us is corporate business. We combine that and re-combine that with our investment banking expertise, because we have a lot of expertise in investment banking as well. On the corporate front, we expect to differentiate ourselves through combining one other skill set which we believe we have, but everybody doesn’t, some others do, but everybody doesn’t. We are very keen to become a dominant, strong bank in the payment mechanisms, in how money flows in the economy. Unless any bank does that, they can’t really be a strong player in any market.

We have already developed products which are providing solutions to people who have payment issues, so for example, what are they: one is we are very strong on salary processing. This is an area where most banks tend not to work because it’s cumbersome and burdensome but it’s only so if you don’t automate it. We’ve completely automated this and we have about 500 companies which are our customers already.

These can be large or mid-sized companies. We go to the company; they open an account with us and then all their employees open an account with us as well so we debit the company account, and credit all the employees immediately. As a next step, we have a product which we call Direct Pay where a lot of the regular installment payments that people need to make whether it’s for their telephone, or any other utility or for their children’s school bills or for their internet bills, this, that, the other, those payments we take care of on an automated basis as well.

What we do is take the hassle away from the consumer because that is the only way which we think we can add value to an existing service that people are getting from their banks. Right now, what do we people do? Right now everybody has maybe 3 or 4 accounts but one account will be your main account where most of your money comes and goes out so while we also focus on people who have excess money and therefore, are able to place it with us on an ongoing basis, it’s very important for us to also focus on people who have flow money, which doesn’t necessarily stay there as a constant deposit or which comes in and goes out on a regular basis. That again involves a lot of investment; if you process those transactions manually then you’re dead.

Again, we’ll make those investments in the infrastructure, bandwidth, in our computers, applications, software, so we can take care of very high volumes of transactions and process them at a cost which is efficient for us. That will bring us flow money through the bank’s systems and therefore, it’s another form of deposits.

Once you find a solution for one ‘type’ of company, there are at least a few thousand, if not a few hundred thousand other similar companies. If one individual needs a solution, you can bet anything that there’s a few million more who need exactly that. Because we have the size and the distribution now and we have more than half a million customers in all these branches and networks, we are building products which we can replicate like a virus immediately. If it works for one, it’s got to work for at least a million more.

We’re providing a solution as opposed to saying ‘come bank with me’. Whenever we develop products or ideas like Direct Pay, we research the market, we talk with customers, asking, what they are missing in their financial or banking experience, and we use that feedback to design solutions, not just sell financial products. Otherwise why should somebody choose us?”

IH: “On the assets side, it would be foolish of us not to be more cautious than we were two years ago, simply because of the way the economy is evolving. We are in a soft economy nationally as well as globally. We do need to pick our customers more carefully and we’re doing that. Are we piling on as many loans as we could? No. we’re a little cautious about the loans we’re piling on. That doesn’t mean we’re not bringing in new customers – we are – but we’re just a little bit more selective than we were in a booming economy. So that is a challenge that will stay for a while so no growth in any bank will be what it would be if the economy was performing at optimal capacity. How we meet that challenge is by selecting customers in a manner that our credit write-offs don’t start piling up in a year or two from now, because you know loans don’t go bad immediately. They go bad 18 months – 24 months later. We don’t want to create an artificial good growth story where we look like we’re growing phenomenally fast but two years later we start showing signs of weaknesses.”

IH: “In the West and even in Pakistan, some of the consumer businesses for banks really took a beating because the economy nose-dived, people lost jobs, they weren’t available, they couldn’t pay. So that loan challenge remains.

As far as the technology challenge is there, we’re not compromising at all. It’s called T24 and we just rolled nine branches to our latest banking application which is a world leader in terms of banking applications. We had made the plan that we would buy that, invest in it, and we have done that.

Over the next few months we will shift all our branches on to this new platform, which is much more efficient in terms of processing, much more user friendly, more employee and customer friendly. We’ve increased and already invested in the bandwidth of every single branch, for example, when we acquired PICIC, some of the branches were doing banking on 64K bandwidth which is really tiny, we’ve taken almost every branch now to 512K so the bandwidth is much larger and the processing can be much faster and we can do more transactions at the same time. That means money because you pay much more for 512 than you do for 64, but that’s okay. Those are the investments I was talking about that we’ve been making over the last two years. Even as far as our personnel and staffing is concerned,

We brought in our Chief Information Officer, head of IT from Indonesia. She’s not Pakistani; we’re investing in bringing in people to teach our people, We’ll never compromise on spending on technology, hardware and software, to fully utilize the investments we have made, because when you’re building for the future, there’s no way to do that if you cannot spend heavily on automation for the kinds of businesses that we are talking about.

If we were going to be a wholesale bank where we were just doing large transactions then it would be a completely different story – but if we are imagining or if we are envisioning that we should have five million customers which is ten times what we have now, if we don’t invest in technology we’re dead. We just cant get there because we’ll be so slow and so manually intensive that it’ll just never work. So for us, making the technology investment – which right now we’ve made, I would say in the next three years, we’ll have invested around Rs. 3 billion in technology – and we’ll continue to do that, I don’t really see the technology spending slowing down.

Most people confuse banking with lending; the way that we grow the bank is not only by lending. It’s providing solutions to people to let the transactions flow through the system, more efficiently with more ease and with more convenience, and that’s what we’re doing with the transactions side, the Direct Pay, the salary accounts and we have other solutions that we’ve built for companies to pay their suppliers.

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We are one of the few banks that is completely online. A lot of people say they’re online but sometimes they’re just exchanging faxes. All the branches are online. You can go to one branch and credit and debit your account in any part of the country. These are the basic things that everyone should have: convenience and good service. Good service means quick service because nobody has time to waste.

And they want respect. You might get respect, but when the average Joe goes to the average bank, he gets no respect. For us every customer, no matter big, small, poor, rich, is important. That’s why we have different segments to cater to different people. If you would go to a different kind of branch and a small businessperson or a shopkeeper would go to a different kind of branch. You may feel a little out of place in a Salam Banking branch, and perhaps that customer of that branch may feel a little out of place in a Post Mall branch. Each branch caters to a certain segment and to their needs, because different consumers needs change based on their social and economic level. Because all affluent people will have similar needs, all middle income people will have similar needs, all low income people will have similar needs. Some of them will be common, for example everybody would want a house but everybody won’t be able to afford a house. But, let’s say an affluent person may have a greater need for financial advice, how should I invest my money? A lower income person will not necessarily have that need but most affluent people will have that need so that segment has to be structured differently than the segment which is for Salam, because for Salam the guy says help me ease my transaction flow and can you lend me money to grow my business? Every affluent person will not want to grow their business because their business, they might be an employee at a senior level in a company, they might be a business person or a certain starter level so their financing needs are totally different. They may be unconnected to their personal banking needs. But for a small businessman, they’re all intertwined.”

IH: “Unlike the developed world, Pakistan has been relatively unscathed with the financial markets turmoil. So far, we’ve been okay. But the sector will not show the good returns we have seen in the last five or six years. This is a very important point because depositors feel banks should pay them a better return, if they’re making so much money, the borrowers feel the banks should charge less. In Pakistan we often quote a misleading statistic on banking profits, and that’s a simplistic way to look at it.

A 7% spread is the difference between borrowing rates and lending rates, and that’s an average for the industry, it’s not the same for every bank. There are many costs that go into running a bank; for example staff cost, running the branches, and a huge cost is technology. The best banks in the world on a consistent basis spent 40-50% of their revenue on expenses. Historically, that’s the kind of spending banks make. In a company or in a factory, the cost of employment is much much lower than in a bank because the banks main assets are our people, so our people have to be paid better than their counterparts in many other industries because they are the operating assets of these institutions.

The salary expense is a very big expense for a bank. Now, a company that makes widgets and sells them to six distributors does not need a branch network to sell. We do. What do we sell? Financial products: deposits, loans, mortgages, credit cards, auto loans, but from a branch network of a 100 or 200 or 50 branches, so there’s a cost. Rent, electricity, generator fuel, employee salaries, technology, bandwidth, it all adds up. 40-50% of this 7% is spent in operational costs.

Then, we are in the business of lending money, which by definition means we lose money when we lend. All banks, anywhere in the world, lose money when they lend. We have to assume a certain loss. Some years it’s higher and some years its lower, but on average you lose another percent, to around 2.5%, 3% maybe.

We have to pay tax. We’re publicly held institutions. We pay 35% tax on our profit before that, so when you work this into the equation, you end up with 2% 2.5%. Now, that gives a return on equity, the equity that people have invested of about 18%. 18% in businessman’s terms is like a payback period of 6 years or 5 years that’s not a phenomenal return by the way. You ask a lot of businesspeople would you wait six years to get your capital back? They would say no. they’d rather do it in 3. Why 3 in Pakistan and 6 and 7 in the normalized West? Because Pakistan is perceived to be high risk therefore you want your return faster because you want a higher rate of return. If businesspeople and the rest of the country wants a return on 3 years and banks are giving an average of 6 it’s not reasonable to say that banks make tons of money and they make it off our heads because what people don’t understand is that there’s a lot of cost and you can’t run a bank without those costs. So to assume that the 7% spread is your net profit is like me telling your company that your operating profit is your profit after tax, which is rubbish because there’s financial costs, there’s depreciation, there’s salaries, there’s selling, administration all these costs that means I’m ignoring, so I cant ignore those and therefore, we would expect people to think beyond the 7% spread because its actually meaningless. The 7% spread only has one significance which is its there because of the rest of the inefficiencies in our system. If our default rates were lower, let’s say our credit processes and our cost processes were much more efficient, maybe our loss would be lower. If people had to worry about defaulting, that they would make sure they pay their loans on time, everybody, then our credit costs would come down and the spread would come down. So its driven by the costs and because you need to show a certain return to shareholder.

Non-performing loans are rocketing, which generally happens when the economy gets into trouble or gets soft. The perception here is that banks make so much money it’s okay to stick them with these losses because there is a Robin Hood theory. If that psychology prevails, it’s a potential a disaster for the country, because no economy can thrive without a strong financial system. You can do whatever else you want, if you got a decimated financial system, if you beat the banks up till they’re bloody and blue, you will not have an economic recovery.

The government here doesn’t have the finances to bail out like in the West, because we can’t print money and expect the world to buy from us. The banks and the borrowers, the government, the courts, the State Bank, we all need to work together to save. If the banks have certain obligations, when your customers are in trouble, then you’ve got to work together to help them out.

The banks should also work together and could do a much better job, but at the same time, we should not get into this acrimony of the banks feeling or the customers wanting to just dump their problems and their bad loans on the banks and walking away. Because okay, you might be able to do that but guess what? You’re mentioned in the economy and you, because you are part of the economy, you will suffer. Because there is no way out of it, it is one circle and you’re going to come round to where you started, so serious caution on that one.

People are over estimating what they can get away with. I don’t see or hear the right signs or sounds from the government either, or from the courts. If people default we need to figure out who is a willful defaulter, who is not interested, whose company can’t make it. We help, we restructure, we reduce rates, we should do all that too as a bank. I’m not saying for a second that we shouldn’t, but we can only do that with people who are serious about saving their businesses. What can we do for people who are not serious about saving their businesses because they don’t have much invested?

We can’t put new money to save them because it’s not worth it. Their business can’t be saved. We find that if you look at balance sheets of companies in Pakistan on average, and you look at the balance sheets of developed economies companies on average, you’ll find that the degree of leverage, the ratio of debt will be much higher in Pakistan than in developed economies, where it should be the reverse. When interest rates go up, if your debt is three times your equity, you’re going to get hurt badly simply because the quantum of debt you have is way too large, given the amount of equity you’ve invested in your company. Therefore, you’ll never make money because all you do, and people say this who are working for the banks because you’ve taken too much loan.

Both the banks who give the loans and the entrepreneurs who take the loans are equally responsible. Serious businessmen still do take risks, but they make sure their ratios are proper and in line, so they don’t get into trouble.

My solution is that it has to be a combination of the bank being more understanding or the sponsor topping up something into the company as well. You can’t expect the bank to carry on the loan just as we wouldn’t expect to tell the sponsors that we’re not restructuring anything. It has to be two-sided. You’ve built your business, and so do we. We build our businesses on forecasts.

Now, two years ago, we didn’t know that we’ll be paying 10,12,14, 18 percent on some deposits either. The world changes, the economy changes. Business people whether they’re bankers or industrialists, are also business people, we need to be able to cope with challenges, otherwise life would be too simple and easy that way. Everybody’s forecasted and nothing changes for the next five years. It doesn’t work like that!

There has to be, but the reality is there isn’t! That’s the reality, now what can we do? Three years ago did we expect that the global financial institutions would collapse and die? No. The world has changed and the world will continue to change. And Pakistan will change and sometimes it’ll do well and sometimes it won’t do well. But we cannot use that as a reason to say “oh it’s not my fault.” Nobody’s saying it’s anybody’s fault, but it’s everybody’s problem! So, we have to find a way to solve it.