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Wef fs redefining_emergingmarketopportunity_report_2012

Wef fs redefining_emergingmarketopportunity_report_2012



World Economic Forum Report 2012 - Emerging Markets Oppo

World Economic Forum Report 2012 - Emerging Markets Oppo



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    Wef fs redefining_emergingmarketopportunity_report_2012 Wef fs redefining_emergingmarketopportunity_report_2012 Document Transcript

    • Insight ReportRedefining the EmergingMarket OpportunityDriving Growth throughFinancial Services InnovationPrepared in collaboration with The Boston Consulting Group
    • Insight ReportRedefining the EmergingMarket OpportunityDriving Growth throughFinancial Services InnovationPrepared in collaboration with The Boston Consulting Group
    • The information in this report, or upon which this report World Economic Forum USA Inc.is based, has been obtained from sources the authors 3 East 54th Streetbelieve to be reliable and accurate. However, it has 18th Floornot been independently verified and no representation New York, NY 10022or warranty, expressed or implied, is made as to the Tel.: +1 212 703 2300accuracy or completeness of any information contained Fax: +1 212 703 2399in this report obtained from third parties. Readers E-mail: forumusa@weforum.orgare cautioned not to place undue reliance on these www.weforum.org/usastatements. The World Economic Forum, the WorldEconomic Forum USA, and its project advisers, The World Economic ForumBoston Consulting Group, undertake no obligation to 91-93 route de la Capitepublicly revise or update any statements, whether as a CH-1223 Cologny/Genevaresult of new information, future events or otherwise, and Tel.: +41 (0)22 869 1212they shall in no event be liable for any loss or damage Fax: +41 (0)22 786 2744arising in connection with the use of the information in this E-mail: contact@weforum.orgreport. www.weforum.orgThe views expressed in this publication have been based Copyright © 2012on workshops, interviews and research, and do not by the World Economic Forum USA Inc.necessarily reflect those of the World Economic Forum. All rights reserved No part of this publication may be reproduced or transmitted in any form or by any means, including photocopying and recording, or by any information storage and retrieval system. ISBN-10: 92-95044-58-4 ISBN-13: 978-92-95044-58-6 A catalogue record for this book is available from the British Library. A catalogue record for this book is available from the Library of Congress.
    • Contents Case Study 4: Rationalizing the Branch-Banking.........................75Contributors v Model to Deliver ‘No Frill’ Services Case Study 5: Savings-Linked Conditional Cash.........................79Preface vii Transfer Programs Case Study 6: Using Legacy Payment Data................................83Executive Summary ix and Infrastructure to Expand into Consumer Loans Case Study 7: Developing the Broader Ecosystem......................87Part 1: Financial Services Opportunities 1 for Technology-Enabled Channelsin Emerging Markets Case Study 8: Instant Disbursement of........................................91 Vehicle-Based FinancingChapter 1: Unleashing Growth Opportunities 3 Case Study 9: Adopting a Franchise Model to.............................95in Emerging Markets Expand Low-Income Financial ServicesAppendix A: Supporting Figures....................................................13 Case Study 10: Using Equity to Finance SMEs in..........................99 Credit-Constrained MarketsChapter 2: The Opportunity in Consumer 17 Case Study 11: Federalizing Product Development.....................103Financial Services to Tailor Loan Products to SMEsStage 1: Exploiting Existing Infrastructure and Capabilities............22 Case Study 12: Adapting POS Networks..................................... 107Stage 2: Enhancing Mass-Market Distribution Channels...............27 to Deliver SME LoansStage 3: Delivering a Balanced Portfolio of Services.....................29 Case Study 13: Using a Pawnshop-Bank Partnership................. 111 to Improve Propositions for CustomersChapter 3: The Opportunity in SME Financing 31 and ProvidersStage 1: Developing Key Institutional Competencies.....................34 Case Study 14: Using an Electronic Platform to Provide............. 115Stage 2: Transforming Economics through Partnerships...............40 Supply-Chain Financing for SMEsStage 3: Setting the Stage for Future Growth................................43 Case Study 15: Finance SME Suppliers through......................... 119 National Reverse Factoring InfrastructureChapter 4: The Opportunity in Corporate Bonds 47 Case Study 16: Developing the Venture Capital........................... 123Stage 1: Laying the Foundation......................................................52 Industry through Co-InvestmentStage 2: Building Scale for Corporate Bond Markets.....................54 with Foreign InvestorsStage 3: Enhancing Liquidity and Deepening Markets...................55 Case Study 17: Forging Central Bank Partnerships to................. 127 Build the Market for a Region’s BondsPart 2: Case Studies 59 Case Study 18: Building a Bond Investor Base through.............. 131 Pension Fund and Insurance ReformList of Case Studies 61 Case Study 19: Building Liquidity in Government........................135 Bonds to Pave the Way for CorporateCase Study 1: Community Partnership Models...........................63 Issuances for Efficient Product Delivery Case Study 20: Overcoming Institutional Voids to.......................139Case Study 2: Bundling Products to Encourage..........................67 Issue Corporate Debt Experienced-Based LearningCase Study 3: Delivering Consumer Loans to..............................71 Low-Income Consumers through Acknowledgments 143 Utility Company Infrastructure Redefining the Emerging Market Opportunity | iii
    • ContributorsPROJECT TEAM EXPERT COMMITTEEErnest Saudjana Thorsten BeckProject Manager, Redefining the Emerging Market Professor, Tilburg UniversityOpportunity project, World Economic Forum USA Erik Berglof(on secondment from The Boston Consulting Group) Chief Economist, European Bank for ReconstructionJames Bilodeau and DevelopmentSpecial Advisor, Financial Services Mario BlejerWorld Economic Forum USA Vice-Chairman, Banco HipotecarioRanu Dayal Walid ChammahSenior Partner and Managing Director, Chairman and Chief Executive Officer, Morgan Stanley InternationalThe Boston Consulting Group Janamitra DevanTodd Glass Vice-President, Financial and Private Sector Development,Project Associate, Emerging Markets Finance, International Finance CorporationWorld Economic Forum USA Ismail Douiri Co-Chief Executive Officer, Attijariwafa Bank Chris Furness Managing Director, Standard Chartered Kamesh Goyal Head of Group Planning and Controlling, Allianz SE Frank Hatheway Chief Economist, The NASDAQ Stock Market, USA Fawzi Kyriakos-Saad Chief Executive Officer, Europe, Middle East and Africa (EMEA) and Member of the Executive Board, Credit Suisse Nkosana Moyo Founder and Executive Chair, Mandela Institute for Development Studies Rajat M. Nag Managing Director General, Asian Development Bank Mthuli Ncube Chief Economist and Vice-President, African Development Bank Steven Puig Vice-President, Private Sector and Non-Sovereign Guaranteed Operations, Inter-American Development Bank Mark Richards Partner, Actis Sergio Schmukler Lead Economist, World Bank Barry Stowe Chief Executive, Prudential Corporation Asia, Prudential Fernando Alvarez Toca Chief Executive Officer, Banco Compartamos Levent Veziroglu Executive Vice President, Dogus Holding Redefining the Emerging Market Opportunity | v
    • PrefaceKEVIN STEINBERG, Chief Operating Officer, World Economic Forum USA, andGIANCARLO BRUNO, Senior Director and Head, Financial Services Industries, World Economic Forum USAThe World Economic Forum is proud to release this tap into the aforementioned opportunities in advanceReport, Redefining the Emerging Market Opportunity: of capacity building. Many of these models have theDriving Growth Through Financial Services Innovation. potential to be transferrable across borders. The ReportThe project was initiated to explore innovative models is accompanied by nearly three dozen real-world casefrom financial institutions that accelerate development of studies and cases-in-point. These illustrate strategiesopportunities in emerging markets. and initiatives that have transformed unmet emerging- Over the past few years, emerging markets have market need and demand into opportunity and progress,played a major role in driving global economic growth. as well as challenges encountered along the way. CaseEven faster growth can be observed in the financial studies include new models in distribution models,services space, contributing to high shareholder return product development, and risk assessment, as well asby emerging market institutions. approaches to overcoming institutional barriers. Despite this strong growth, penetration of financial The Report itself is the result of a year-longservices remains low in many developing countries. The collaboration between the World Economic Forum,World Economic Forum’s Financial Development Report The Boston Consulting Group, and leading industry2011 highlighted the fact that many emerging economies practitioners, policymakers, and academics participatinghave undeveloped areas within their financial systems. in interviews and workshops around the globe.Developing these opportunities will be critical to realizing Throughout this process, intellectual stewardship andeconomic growth and prosperity for people in these guidance was provided by an actively engaged Expertregions. Committee. This Report highlights two broad conclusions: We trust that this publication can help overcome asymmetries in knowledge and experience across • The most powerful and compelling opportunities for financial services firms to promote growth and different regions and organizations, and help realize stability in emerging markets lie in three specific the untapped opportunities within the financial services areas: consumer financial services, small and space in emerging markets. Moreover, we hope that this medium enterprise (SME) financing, and corporate Report can provide relevant input and catalyze dialogue bond markets. among the private sector, governments, investors, and other stakeholders in implementing innovative models in • ”Leapfrog” innovation in these three areas, rather various emerging economies. than simple capacity building, will be the key to success in driving broad economic growth. At the On behalf of the World Economic Forum, we wish to same time, capitalizing on these opportunities will thank all who have contributed their time and expertise provide institutions and their investors an avenue for to this Report, particularly the Expert Committee, the long-term growth and shareholder return. interview and workshop participants, Project Manager Ernest Saudjana, Senior Advisor James Bilodeau, The Report showcases a shortlist of proven, Project Associate Todd Glass, and our project advisorinnovative approaches that financial institutions from from The Boston Consulting Group, Ranu Dayal.around the world have successfully implemented to Redefining the Emerging Market Opportunity | vii
    • Executive SummaryThe rising importance of developing economies has led emerging-market economic expansion contributedto an increased role for financial institutions in emerging US$8 trillion, or roughly 60 percent of global GDPcountries. The result is a historic opening for financial growth, during that half-decade. Many emerging marketsservices firms to provide new financial services to have also achieved unprecedented financial stabilityupwardly mobile low-income populations as well as to and economic resilience. The growth of developingregional companies evolving to world-class competitors. economies has been accompanied by an even faster For financial providers committed to understanding evolution of financial services.and unlocking the potential, there is unparalleledopportunity to build long-term growth and superior SUPERIOR SHAREHOLDER VALUEshareholder value. At the same time, providers can Financial institutions active in emerging marketshelp empower small and medium sized enterprises and have benefited from tremendous growth in marketlow-income people by providing financial access and a capitalizationpotential path out of poverty. Financial institutions in different parts of the world have seen very different outcomes for their market valueThree key opportunities: consumer financial in recent years. In high-income countries belongingservices, SME financing, and corporate bonds to the Organization for Economic Co-operation andThe purpose of this Report is to provide a guide to those Development (OECD), the market value of financialopportunities as well as a framework for action. Among institutions sustained a US$1.5 trillion decline from 2006the Report’s key conclusions: to 2011. At the same time, in non-OECD high-income countries, it grew by US$243 billion, and in emerging • First, the most significant opportunities for financial markets, values soared by US$572 billion. A five-year services firms in emerging markets lie in three total shareholder return (TSR) analysis of financial business activities: consumer financial services, institutions globally shows that the majority of top small- and medium-sized enterprise (SME) financing, and corporate bonds. institutions in emerging markets performed above the median level, while most of the large financial institutions • Second, innovation of financial products and in developed markets ranked in the bottom half. Of services—through lower barriers to entry, increased the 30 leading emerging-market banks, 75 percent productivity, and transformed economics of service performed in the TSR ranking’s first quartile—but none of delivery—is the main driver of success in emerging top 30 developed-market banks did. markets. Capacity-building of traditional services is not sufficient. The rise of financial institutions in emerging markets This Report is accompanied by nearly three dozen has reshaped international competitioncase studies and short “cases-in-point” highlighting Emerging-market banks in the top 200 tripled in numbersuccessful, real-world innovations. These profiles from 22 to 66 between 2005 and 2011 and now accountdocument strategies and initiatives that have transformed for one-third of leading global institutions. The rise ofunmet emerging-market needs and demands into emerging-market competitors is even more strikingopportunity and economic progress, as well as the within the top 100 institutions, where the number grewchallenges encountered along the way. (Case studies are from nine to 33 in the same period. In the middle of thegathered in Part 2; cases-in-point appear in boxes within 2000s, the emerging-market financial institutions risingthe report.) to the top ranks came mostly from China. More recently, institutions from Brazil, Chile, Indonesia, Thailand,Strong economic growth in emerging markets Malaysia, Turkey, India, and South Africa have made theirunderpins the new opportunity for providers way up the rankings, as well. The GDP growth of emerging nations stronglyoutpaced that of high-income countries from 2006 to2010. Developing economies grew at an annual rate ofroughly 15 percent, compared with growth averaging just3 percent for the developed world. In absolute terms, Redefining the Emerging Market Opportunity | ix
    • Executive SummaryCompetition will grow, requiring financial providers Successful providers focus first on filling a specificto create new business models in order to adapt mass-market needMany emerging-market institutions have advanced by Financial institutions usually find it difficult to createadopting highly innovative approaches in their own profitable services for low-income consumers whenmarkets. They have overcome infrastructure limitations they use legacy business models created to serve moreand addressed local needs through creative distribution affluent clients. Simply adjusting traditional businessmodels, risk practices, and partnerships. Some models—that is, relying on capacity-building initiatives—institutions, for example, can disburse financing to small is not enough. Innovating new channels, products, andbusiness customers within 10 minutes through electronic processes is necessary. Successful providers usuallychannels and without documentation or guarantor started by meeting an express and specific mass-marketrequirements. need and only then introduced additional products.Countries and financial institutions must steer clear A three-stage framework for developing consumerof potential macro- and micro-level risks financial servicesCountries need to ensure that they can respond to Our research suggests that consumer markets inglobal shocks, as macroeconomic conditions are closely emerging countries can best be developed in threelinked to the health of financial systems. Countries that stages of activity:have little fiscal and monetary flexibility must manage the Stage 1: Exploiting existing infrastructure andrisk of future macroeconomic challenges. capabilities. Institutions explore partnership models On a micro level, for financial providers, there is a to expand their reach to mass-market customers withrisk of reduced returns, as the high interest margins in minimal capital expenditure.emerging markets are expected to go down as marketsmature and competition intensifies. Financial providers Stage 2: Enhancing mass-market distributioncan overcome top-line compression by improving channels. Providers develop cost-effective models toefficiency, lowering costs, and diversifying income build and expand channels.streams. Institutions need to expand beyond credit Stage 3: Delivering a balanced portfolio ofrevenues. services. Governments establish an environment andCONSUMER FINANCIAL SERVICES: ENABLING infrastructure enabling providers to deliver a full set ofGROWTH AND REDUCING POVERTY services more efficiently in the long term.While emerging countries are growing faster thanmature ones, consumer financial services have not Case study highlights: Consumer financial servicescaught up Case studies accompanying this Report documentSavings accounts, insurance, loans, payments, and successful innovations in developing consumer financialsimilar offerings—where they do exist—penetrate services, including:unevenly and often reach only higher-income • Sales and distribution partnerships betweenpopulations. As a result, the enormous potential of financial providers and non-financial organizationsmass-market consumers to drive economic growth including utility providers, retailers, supermarketin emerging countries has barely been tapped. In the chains, and community organizations.portfolio of the poor, three key services are greatly in • New models for low-cost, paperless retail branches,demand but often inadequately provided: managing technology-enabled delivery channels, andmoney on a daily basis, building long-term savings, franchised distribution of mass-market services.and borrowing for various needs. Providing insuranceproducts will also be a significant opportunity. • Use of legacy consumer payment records in risk assessment and credit benchmarking.Providers will benefit by embracing financial SME FINANCING: BATTLING THE CREDIT PARADOXinclusion for lower-income populations Emerging markets face a credit paradox that hindersFor providers of consumer financial services, the most small- and medium-size businesses (SMEs), as wellsignificant “white space” opportunities for emerging- as their banks. Only one-third of SMEs, on average,market growth lie in mass-market services and products. have access to credit and loans, even though three- Financial inclusion of the poor will also benefit quarters of them maintain bank savings and checkingemerging countries. Consumer financial services can accounts. Banks, for their part, lack sufficient accessreduce poverty, improve health care, and increase the to shared data—such as tax records, credit history,consumer’s ability to afford needed goods on a more and legal status—to risk lending to many SMEs. As aequitable basis. The infrastructure for these services also result, many businesses lack much-needed cash tosupports and improves the society’s broader efficiency grow, while financial institutions miss the opportunityin raising capital, making payment transactions, and to tap into the huge pool of potential SME borrowers.distributing wealth. Emerging economies suffer because they dependx | Redefining the Emerging Market Opportunity
    • Executive Summaryheavily on smaller companies for economic growth and respect to products, services, risk management, andjob creation. SME client segmentation. Stage 2: Transform business models andSMEs play a major role in economic development offerings through national-scale partnerships andSMEs account for a significant share of employment collaborations with formal and informal organizations.and GDP around the world, especially when taking into Create shared infrastructure—such as repositories ofaccount the informal sector. SMEs provide an average SME data—and employ financial channels to deliverof 67 percent of the formal employment in developed government loans and subsidies.countries and around 45 percent in developingcountries. They also contribute a sizable share to formal Stage 3: Set the stage for future growth byGDP, 49 percent on average in high-income countries improving the business and financial managementand 29 percent on average in low-income countries, capabilities of SMEs themselves and thus theirrespectively. While that share may seem modest, the creditworthiness and attractiveness for investors outsideinformal sector—most of which comprises SMEs— the banking system.accounts for up to 48 percent of the total labor forceand 37 percent of GDP. The corresponding proportions Case study highlights: SME financingfor developed countries are just 25 percent of the labor Case studies accompanying this Report documentforce and 16 percent of GDP. successful innovations in SME finance development, including:Innovation can overcome SME financing challenges • Client micro-segmentation and customizationA number of innovative institutions are working actively strategies based on SMEs’ detailed financial needs,and creatively to topple the barriers to SME financing along with new models for rationalizing SMEin emerging markets. We have conducted a global services, such as “remote” relationship managers.review of these efforts and present in this Report asummary of those that have been the most successful • Using transaction information and psychometric testing to develop credit risk-assessment tools andand scalable. These models can be adopted or adapted benchmarks.by financial providers seeking to broaden their rangeof SME financing opportunities. There is little doubt • Adapting POS electronic networks to approve andamong global financial institutions that SMEs are a key deliver SME loans.source of profits now and that they will continue to be • Developing specialized financing sources, includingso in the future. In a 2008 survey of 91 banks in 45 venture capital and equity financing.countries, more than 80 percent of the banks describedthe SME market as a large and attractive one. More than CORPORATE BONDS: PROVIDING STABILITY AND70 percent said profitability was the top driver of their REDUCING RELIANCE ON TRADITIONAL CREDITinvolvement. Corporate bond markets provide many advantages, in the nations where they thriveThe private sector needs alternative mechanisms to Economies, companies, and investors all receive clearhelp new SMEs develop their capabilities and measurable benefits when corporations competeTraditional banks are often not the right institutions for transparently to raise funds by selling debt. Domesticserving start-up companies. Financial institutions, due corporate bond markets help diversify economies,to their risk-management approach, typically prefer to reduce systemic risk, and mitigate exposure to currencyfinance companies with clear cash flow that are already swings. As economies evolve, local companies growoperational. Additionally, formal financial providers larger, too, and develop more complex funding needs,often have scant knowledge of quickly evolving high- such as handling larger investments and managingtechnology industries and their SME business models, liquidity, interest-rate, and foreign currency risks. Bankand are inclined to reject loans for those entrepreneurs. credit alone cannot meet these requirements.As a result, emerging economies are deprived ofthe innovation, energy, and competitive capabilities Corporate bonds provide a valuable alternative tothat start-ups and other SMEs bring to developed bank financingeconomies. Venture capital, private equity, and similar The macroeconomic and financial dislocations thatstart-up financing operations are crucial to support followed the crises in emerging markets in the latenew SMEs trying to expand into the next stage of 1990s highlighted the importance of developing localdevelopment. bond markets as an alternative source of debt financing. Bond markets can strengthen corporate and bankThe three stages of action to improve SME financing restructuring and thus accelerate the resolution of aOur research suggests that financing for SMEs in crisis. Well-functioning local corporate bond marketsemerging countries can best be developed in three also provide institutional investors with an instrument thatdistinct stages of activity: satisfies their demand for fixed-income assets, especially of long maturities that match their long-term liabilities, Stage 1: Develop and improve primary while providing higher yields than government bonds. Forinstitutional competencies and business models with Redefining the Emerging Market Opportunity | xi
    • Executive Summarythe same reasons, corporate bonds can also strengthen • Creating central bank partnerships to promotethe balance sheets of pension funds and life insurance development of regional bond markets.companies. • Building a bond investor base through pension fund and insurance reform.Two pillars support corporate bond markets:economic size and level of development As this Report demonstrates, emerging economiesThe ability of a country to develop a corporate bond cannot rely solely on capacity building to acceleratemarket is largely determined by two factors: the size financial development. Traditional models often areof its economy and its level of economic development. unsuitable for seizing new opportunities. In manyA sizable and strong economy is required to sustain a countries, the best path for accelerating financial gainsliquid sovereign bond market, a prerequisite to creating will be “leapfrog” innovation that crosses borders,a corporate bond market. A government bond market platforms, and concepts at a single bound. This kind ofserves as a crucial stepping stone to corporate issuance bold change, and the policies that support it, are crucialin several ways. For one, government bonds provide to ensure that emerging markets are able to realize theirvaluable price and yield benchmarks for corporate economic potential and improve the lives of their citizens.debt. Big economies also directly promote the viabilityof corporate bond markets, as their scope allows morecompanies to grow large and flourish.There are considerable barriers to corporate bonddevelopment in emerging economiesDeveloping a corporate debt market is a complex taskrequiring a systematic approach. Initiatives to improveliquidity are required in order to attract a wide range ofinvestors. Several key conditions need to be achieved,including sustained investor demand and bond issuancesupply, strong business and legal environments, and afast and efficient issuance process.The sequential path of development for corporatebond marketsDeveloping a corporate bond market requires asequential approach. Based on our research for thisreport, we have divided the development process intothree distinct phases. Stage 1: Laying the foundation. The marketis very small and unsophisticated. Bond issues andinvestors are few and the sovereign bond market isunderdeveloped. Transactions occur sporadically andusually by private placement. Stage 2: Building scale for corporate bondmarkets. The primary market is sound, with a fairlystable macro-political environment and several high-quality issuers. Stage 3: Enhancing liquidity and deepeningmarkets. An active secondary market is growing. Duringthis phase, primary issuance remains active.Case study highlights: Corporate bond marketsCase studies accompanying this Report documentsuccessful real-world innovations in corporate bondmarket development, including: • Developing multi-stakeholder engagement to support issuance and private placement of bonds in the least developed markets. • Creating investor syndicates to lower issuance costs for large, repeat issuers.xii | Redefining the Emerging Market Opportunity
    • Part 1Financial ServicesOpportunitiesin Emerging Markets
    • CHAPTER 1 As wealthier nations emerge from the financial turmoil and economic retrenchment of recent years, they are relying on the developing world to serve as the engineUnleashing Growth of global growth. Emerging economies, despite the turbulence, have managed stronger and more sustainedOpportunities in economic expansion than developed ones. These economies have been bolstered by a record of improvedEmerging Markets financial and fiscal stability. The growing importance of developing economies has led to an increased role for financial institutions in those regions of the world. Both trends are likely to continue. The result is a historic opening to provide new financial services to low-income populations rapidly transitioning to middle-income status, as well as to regional companies evolving to world-class competitors. For financial providers equipped to understand and unlock the potential, there is an unparalleled set of opportunities to build long-term growth and superior shareholder value. The purpose of this Report is to provide a guide to those opportunities as well as a framework for assessing them and taking action. Research has been based on expert interviews and discussions among Forum stakeholders, including global and emerging-market financial institutions, regulators, multilateral organizations, and academics. On that basis, the Report highlights two key themes: • First, the most significant immediate opportunities for financial services firms in emerging markets lie in three specific realms of activity: consumer financial services, financing for small- and medium- size enterprises (SMEs), and corporate bonds. It is there that new financial services will have the largest impact in driving broad economic growth while creating new sources of future value for their own institutions and their shareholders. • Second, the main driver of accelerated success by financial organizations in emerging markets is product and service innovation. Innovation is critical to accelerate progress and expand the market for financial services, through lower barriers to entry, increased productivity, and transformed economics of service delivery. In some cases, as discussed below, innovation must be preceded or accompanied by coordinated, multi-party capacity- building initiatives to lay the groundwork for success. There are many ways for institutions to innovate, and each must find its own. This report highlights a shortlist of proven, creative approaches, accompanied by nearly three dozen real-world case studies and cases-in-point. These are intended to illustrate strategies and initiatives that have transformed unmet emerging-market needs and demands into opportunity and economic progress, as well as challenges encountered along the way. STRONG AND PERSISTENT ECONOMIC GROWTH CREATES A FINANCIAL SERVICES OPPORTUNITY The economic expansion of developing economies has been accompanied by an even faster evolution of financial services in those regions of the world. The key to maximizing that opportunity going forward lies Redefining the Emerging Market Opportunity | 3
    • Chapter 1: Unleashing Growth Opportunities in Emerging MarketsFigure 1: Growth of financial services assets Figure 1a: Banking asset growth Figure 1b: Insurance premium real growth rate 120 20 +9% 100 15 Banking assets (US$ trillions) Real growth rates (percent) 80 10 60 5 40 0 n  Low and Lower middle income EMs –5   Emerging markets 20 n  Upper middle income EMs   Industrialised countries n  High income countries 0 –10 2006 2010 1990 1994 1998 2002 2006 2010Sources: Economic Intelligence Unit, Financial Indicator database (consulted March 14, 2012); Swiss Re, 2011.in understanding the complexities—and occasional The developing world’s economic expansion hascontradictions—of that remarkable expansion. precipitated an even faster growth of financial services. The GDP growth of emerging nations has strongly Emerging countries contributed nearly 40 percent of theoutpaced that of high-income countries from 2006 to global growth of banking assets in absolute terms from2010 (see Figure A1 in appendix). Developing economies 2006 to 2010 (see Figure 1a). This translates to an annualgrew at an annual rate of roughly 15 percent, compared growth rate of more than 20 percent for banking assetswith growth averaging just 3 percent for the developed in emerging markets themselves, compared with a rateworld. In absolute terms, emerging-market economic of just 6 percent in high-income countries. The growth ofexpansion contributed US$8 trillion, or roughly 60 banking assets in emerging markets has outpaced GDPpercent of global GDP growth, during that half-decade. growth there, because of the low initial level of financial In addition to their faster expansion, many emerging development and penetration in many of those markets.markets also demonstrated unprecedented financial The insurance industry also has expanded robustlystability and economic resilience during the two-year in emerging countries since the early 1990s. The growthperiod of turmoil beginning in 2008. While developed of premium income was triple the rate in developednations’ aggregate GDP fell from US$44 trillion in 2008 countries (see Figure 1b), expanding by nearly 10to US$41 trillion in 2009, emerging market output percent annually in real terms over the last two decadesremained constant at US$13 trillion. while growth in high-income markets averaged just That economic performance and financial stability 2-3 percent. In 2010, the contrast was even morehave continued, prompting numerous sovereign credit pronounced: emerging market premiums grew 11rating upgrades of emerging economies since mid- percent, while those in developed countries inched2010. At the same time, recurring financial turmoil has forward an average 1.4 percent.triggered downgrades in the Euro zone. Over the two-year period ending in February 2012, five emerging High growth + high returns = superiorcountries—Brazil, Bulgaria, Colombia, Indonesia, and the shareholder valuePhilippines—received sovereign credit rating upgrades The high-growth, high-return nature of emergingfrom Moody’s Investors Service. The January 2012 markets makes it a valuable area for financial institutionsupgrade for Indonesia returned Southeast Asia’s largest globally to target in order to generate shareholdereconomy to investment grade for the first time since the return. Institutions need to place significant attention onAsian financial crisis 14 years earlier. A sixth developing emerging markets to drive growth, improve profitability,country, Turkey, had its local-currency debt rating raised and generate long-term value.to investment grade by Standard & Poor’s in September The last five years have created tremendous value2011. for financial institutions active and successful in emerging4 | Redefining the Emerging Market Opportunity
    • Chapter 1: Unleashing Growth Opportunities in Emerging MarketsFigure 2: Total shareholder return of global financial institutions, 5-year TSR (2006–2011) 1 Top 30 banks by market First capitalization from emerging quartile markets 150 Top 30 banks by market capitalization from high Second income countries quartile TSR ranking 300 Third quartile 450 Fourth quartile 600 –80 –60 –40 –20 0 20 40 60 Average annual total shareholder return (percent)Sources: Thomson Reuters Datastream (consulted April 2, 2012); BCG analysis.Notes: TSR derived from calendar year data in local currency; Rank (n=582); Median average annual TSR: First quartile, 14.1%, second quartile, 1.6%, third quartile, –8.3%, fourth quartile, –22.7%.markets, where those institutions’ growth in market spread—the difference between return on equity andcapitalization has been concentrated. In high-income cost of equity. Although emerging markets are known tocountries belonging to the Organisation for Economic have higher cost of equity, their significantly higher returnCo-operation and Development (OECD), the market on equity offsets this impact.value of financial institutions sustained a US$1.5 trillion The spread generated by emerging marketdecline from 2006 to 2011. At the same time, in non- institutions is significantly higher than that in developedOECD high-income countries it grew by US$243 billion, markets. More than half of leading developed-marketand in emerging markets, values soared by US$572 institutions operate at a negative overall return spread.billion. By contrast, the majority of such institutions in emerging A five-year total shareholder return (TSR) analysis of markets are operating on positive territory, manyfinancial institutions globally shows a striking contrast in exceeding 5 percent. The higher return spread resultsperformance between institutions in emerging markets in much higher valuation multiples for institutions inand those in developed markets. While the majority of emerging markets.top institutions in emerging markets performed abovethe median level, most of the large financial institutions in Developing markets will continue driving globaldeveloped markets ranked in the bottom half (Figure 2). growth while remaining resilientOf the 30 leading emerging-market banks, 75 percent Developing markets are expected to continue their roleperformed in the TSR ranking’s first quartile—but none of as the engines of global economic growth. In the fivetop 30 developed-market banks did. years through 2015, the International Monetary Fund It is important to understand what drives (IMF) forecasts that emerging-market GDP will grow atshareholder return over the long term. Growth is, by far, around 10 percent annually, compared to 5 percent inthe most important driver of long- term TSR for top- high-income countries (Figure A2). This is equivalent toperforming financial institutions (Figure 3). Changes in roughly 55 percent of global GDP growth in absolutevaluation multiples can also drive value creation in the terms.short to medium term, but the impact is diminished over Financial institutions will need to build capacity andthe longer term. This means institutions must be able to expand their offerings to continue to realize this growthdrive continuous, sustained growth even under uncertain potential, especially since financial services penetrationmacroeconomic conditions. and development remain low in many emerging markets Examples from the banking sector highlight despite recent growth. There is still significant room forthe stark contrast in the valuation of institutions in healthy growth of banking assets, as penetration is stilldeveloped versus emerging markets (Figure 4). This very low (Figure 5a). Seventy-six percent of emergingvaluation premium closely correlates to the overall return markets have a banking asset-to-GDP ratio of less than Redefining the Emerging Market Opportunity | 5
    • Chapter 1: Unleashing Growth Opportunities in Emerging MarketsFigure 3: Sources of value creation for top-quartile global FS performers, 2001-2011 40 n  Change in free cash flow n  Change in multiple (P/E) 30 n  Change in margin (EBITDA) n  Revenue growth Value creation (TSR %) 20 10 0 –10 3 years TSR 5 years TSR 10 years TSRNote: TSR derived from calendar year data in local currency. Sample size are financial institutions from S&P 1200 and top 200 financial institutions by market capitalization as of December 2011.Figure 4: Profitability and valuation of banks 5 Emerging market banks Developed market banks 4 Price-to-Book Value 3 2 1 –15 –12 –9 –6 –3 0 3 6 9 12 15 Return on Equity (ROE)–Cost of Equity (COE) (percent)Sources: Bloomberg (consulted on March 14, 2012); BCG analysis.Note: Data are as of December 2011.6 | Redefining the Emerging Market Opportunity
    • Chapter 1: Unleashing Growth Opportunities in Emerging MarketsFigure 5: Banking penetration and asset growth projection Figure 5a: Banking asset penetration Figure 5b: Banking asset growth estimate 2010 banking penetration(banking assets / GDP) 8 150 Lower middle income 120 6 Upper middle income Banking assets (US$ trillions) High income 90 4 60 2 n  Low and lower middle income EMs 30 n  Upper middle income EMs n  High income countries 0 0 0 25,000 50,000 75,000 100,000 2010 2015 GDP per capita (US dollars)Sources: Economic Intelligence Unit, Financial Indicator database (consulted March 14, 2012); IMF, World Economic Outlook Database, September 2011.Notes: 76% of EMs have penetration under 1.0; 67% of DEs have penetration under, while 67 percent of developed markets have a ratio While this slowdown was largely the result of policyabove 2.0. tightening to cool overheating economies and curb The Economic Intelligence Unit projects that banking inflation, it also reflects weaker exports and reducedassets in emerging markets will continue to grow more capital inflows. Emerging markets as a group still havethan 20 percent annually, compared to 3 percent in high- a high degree of monetary and fiscal firepower at theirincome countries (Figure 5b). This implies that emerging disposal, compared to most high-income countries,markets will contribute to 68 percent of global banking which have little or no room to cut interest rates orasset growth from 2010 to 2015 in absolute terms. increase public borrowing. However, this aggregate The insurance industry has similar potential for picture masks dramatic differences. Some governmentsexpansion. With the exception of South Africa, India, and have much more scope to loosen policy than others.Malaysia, many emerging markets still have relatively The Economist used several key monetary and fiscalundeveloped life insurance business (Figure 6a). indicators to assess 27 emerging economies’ ability toEighty-six percent of emerging markets have premium ease monetary and fiscal policy. The average of thesepenetration less than 2 percent. Similarly, for non-life monetary and fiscal measures is the overall “wiggle-insurance, there is still room to accelerate insurance room index.” China, Indonesia, and Saudi Arabia haveadoption in many emerging markets, as 82 percent of the greatest capacity to use monetary and fiscal policiesemerging markets still have premium penetration of less to support growth and respond to external shocksthan 2 percent (Figure 6b). (Figure 7). Chile, Peru, and Russia are also in a solid position. On the other hand, Egypt, India, and PolandDeveloping countries’ room to maneuver varies have the least room for stimulus. Argentina, Brazil,widely Hungary, Turkey, Pakistan, and Vietnam are also in theDespite some signs of slowing growth due to the recent “red zone.”global economic turmoil, emerging economies willcontinue to have a stronger macroeconomic outlook. The shift in global competition underscores the needHowever, attractiveness will vary significantly across for financial innovationcountries. Over the last five years, there has been a significant shift An assessment by The Economist magazine in in the competitive dynamics of global finance, influencedJanuary 2012 suggests that the downturn in the euro by the rise of global-scale institutions in the emergingzone and the uneven recovery in the United States have markets. The number of emerging-market banks inalready taken their toll on the emerging world. Setting the top 200 tripled from 22 to 66 between 2005 andChina’s economy to one side, the average growth rate in 2011, and now accounts for one-third of leading globalother developing countries is estimated to have slumped institutions (Figure 8). The rise of emerging-marketto an annual rate of less than 3 percent in the fourth competitors is even more striking within the top 100quarter of 2011, from 6.5 percent in the first quarter. Redefining the Emerging Market Opportunity | 7
    • Chapter 1: Unleashing Growth Opportunities in Emerging MarketsFigure 6: Monetary and fiscal policy wiggle room Egypt India Poland Brazil Vietnam Pakistan Turkey Argentina Hungary South Africa Taian Venezuela Czech Republic Mexico Colombia Malaysia Thailand Philippines Hong Kong Peru Russia n  Least flexible (“red zone”) Singapore n  Neutral South Korea n  Most flexible (“green zone”) Chile China Indonesia Saudi Arabia 0 20 40 60 80 100 Room to ease fiscal and monetary policy (minimum flexibility=100)Sources: The Economist, 2012.Figure 7: Number of emerging market banks in top 200 by market capitalization 80 Market Capitalization Rank 70 n  1–50 n  51–100 n  101–150 60 n  151–200 Number of banks 50 40 30 20 10 0 2005 2006 2007 2008 2009 2010 2011Source: Thomson Reuters Datastream (consulted April 2, 2012).Note: Emerging market banks in top 200 tripled their numbers in six years.8 | Redefining the Emerging Market Opportunity
    • Chapter 1: Unleashing Growth Opportunities in Emerging MarketsFigure 8: Appearance of financial development indicators Increasing GDP per capita Foreign Domestic Public debt public public debt debt services Banking Bank Bank Bank Bank deposits wholesale private claims funding credit on FIs Foreign Domestic market Capital Stock market private private debt debt Institutional investor Pension Non-life Life Mutual funds insurance insurance fundsSource: World Bank, 2012.institutions, where the number grew from nine to 33 To win and gain market share, institutions willwithin the same period. need to innovate constantly and identify “white space” In the middle of the 2000s, the emerging-market opportunities to exploit.financial institutions rising into the top ranks of global-market capitalization ranking came mostly from China. Financial institutions must steer clear of potentialMore recently, institutions from Brazil, Chile, Indonesia, macro- and micro-level risksThailand, Malaysia, Turkey, India, and South Africa have Countries need to ensure that they can respond tomade their way up the rank. global shocks, as macroeconomic conditions link closely Despite the attractive opportunities presented by to the health of the financial system. Countries that areemerging markets, competition will get more intense. in the “red zone” in terms of fiscal and monetary wiggleInstitutions will need to continue looking for creative room must manage the risk of future macroeconomicbusiness models to tap a wider range of opportunities. challenges. While government institutions such as theAs later chapters of this report will show, many Reserve Bank of India have sensibly not yet reducedemerging-market institutions have advanced by adopting interest rates in the face of a weakening economy, somehighly innovative approaches in their own markets. They others have ignored the red zone described earlier.can get around infrastructure shortcomings and address Brazil’s central bank has reduced interest rates fourthe local needs and practices of emerging-market times since last August, and it has signaled that morecustomers. They have done this through innovative cuts lie ahead. Such easing will support growth this year,distribution models, risk practices, and partnerships. but at the risk of reigniting inflation in 2013.Some institutions, for example, can effectively disburse On a micro level, there is potential for reducedfinancing to small business customers within 10 minutes returns as markets mature and competition intensifies.through electronic channels and without documentation As mentioned previously, return spread is a key driveror guarantor requirements. In developed markets, such of valuation for financial institutions. The high interesttransactions normally take days and require mailing in margins in emerging markets are expected to go downdocuments. as the market matures and competition intensifies. Redefining the Emerging Market Opportunity | 9
    • Chapter 1: Unleashing Growth Opportunities in Emerging MarketsAs market penetration increases, net interest margin A World Bank study suggests, on a macro level, that(NIM) tends to go down (Figure A3). However, margin corporate bonds emerge late in the development path.compression will not happen overnight. There is still In typical financial development, government borrowingsignificant room for development before NIM reduction emerges before basic banking services, which emergewill take place, as penetration in many emerging markets before capital markets, as the financial system developsis still low. and income levels rise (Figure 9). Institutional investors Financial providers can also overcome top-line appear at various stages of the process, reflecting policycompression by improving their efficiency to lower costs factors as well as links with other components of theand by diversifying income streams into fee revenues. development process. Pension funds typically emergeIn the early stages of financial development, interest early, before insurance and mutual funds.income dominates a financial institution’s income stream.However, as markets mature and financial activities Consumer financial services: Enabling growth bybecome more diverse, the institution can tap into reducing poverty, unleashing consumptionopportunities from non-interest income, from transaction For emerging markets, increased consumption, includingbusiness and investment banking activities. by lower-income consumers, will be critical in driving Institutions, especially credit providers, will need to economic expansion. As previously discussed, theresecure sufficient capital to continue their growth. While will be significant shifts in global spending over themany emerging markets generate high earnings that can next decade. There is a major opportunity to driverecapitalize them for future growth, external influences, consumption, especially in the lower-income segment, tosuch as pressure for high dividend payouts, can impact produce both economic and social benefits.this ability. In some emerging markets, the banking Obtaining access to financial services and adoptingspace is still dominated by state-owned institutions, disciplined savings habits are both prerequisites forwhich often face government pressure to pay high lower-income consumers to afford more goods anddividends to increase state revenue. Governments must services, including emergency expenses such asbalance fiscal revenue needs with the longer-term impact medicine and home repair. Expanding financial access ison banks’ ability to provide capital to support enterprises also a path for low-income people to escape poverty.and consumers. While there is significant demand for financial Institutions need to be able to expand beyond services, poor communities continue to be underservedcredit revenues. Credit growth should be accompanied by formal institutions. In the portfolio of the poor,by deposit growth in order to ensure sustainable and three key services are greatly in demand but oftenprofitable business. Institutions need to build capability inadequately provided: managing money on a dailyto gather deposits, including unlocking potential from basis, building long-term savings, and borrowing for“under-the-mattress” savings. The compounded effect of various needs.interest-margin reduction, as previously mentioned, will Providing insurance products will also be arequire financial institutions to diversify their sources of significant opportunity, as low-income consumers arerevenue to include fee income. the most susceptible to adverse events. Building a Finally, business environments must be open savings culture is also a requirement for supporting otherto innovation in order for their efforts to succeed. parts of financial system. For example, a savings cultureGovernments and agencies can do their part by is a prerequisite for establishing pension funds andmonitoring policies and adjusting or rejecting those that insurance, which, in turn are required for creating deepcreate market distortions, hampering innovations and capital markets.efficiencies. Policies driven by political decisions, such as Unlocking under-the-mattress savings can benefitinterest rate ceilings, dampen progress in unlocking new the larger financial system by helping governments andopportunities. global organizations deliver benefits and assistance to low-income people. Conversely, as the report will laterProviders should focus on three critical areas of highlight, government-to-person (G2P) payment alsoopportunity: consumer financial services, SME plays an important role in driving financial inclusion.financing, and corporate bonds Lowering the costs of such programs can makeThere are many financial services opportunities in them more effective. In a pilot program in Mexico, aemerging markets. Three of them are particularly critical new payment method for conditional cash transfersto supporting economic growth: consumer financial decreased transaction costs and opportunity costs forservices, financing for SMEs, and corporate bonds. beneficiaries from 30.1 pesos to 0.5 pesos, and from While the first two opportunities are relevant for 16.9 pesos to 2.2 pesos, respectively. This is equivalentmost emerging markets, developing a large and deep to a transaction cost reduction of more than 90 percentcorporate bond market should be the focus of emerging in delivering aid to low-income people.economies at the middle income level and at a moreadvanced stage of financial development. However, SME financing: Battling the credit paradoxas discussed in later chapters, there are opportunities Emerging markets face a credit paradox that hindersto support select corporate bond issuance in less small- and medium-size businesses, as well as theirdeveloped economies. banks: only one-third of SMEs, on average, have access to credit and loans, even though three-quarters of them10 | Redefining the Emerging Market Opportunity
    • Chapter 1: Unleashing Growth Opportunities in Emerging MarketsFigure 9: Credit demand and constraints across African enterprises 100 n  Received loan n  No credit demand 80 n  Credit constrained 60 Percent 40 20 0 Small enterprise Medium enterprise Large enterpriseSources: IFC, 2010; http://www.enterprisesurveys.org/Data/ExploreTopics/finance.Note: Calculations are based on surveys from Kenya, Madagascar, Senegal and Uganda. Small enterprises have <=25 employees, medium have 26-100, and large have > 100.maintain bank savings and checking accounts. Banks, of formal SMEs in emerging markets do not have accessfor their part, lack sufficient access to shared data—such to formal institutional loans or overdrafts, despite a needas tax records, credit history, and legal status—to risk for these services.lending to many SMEs. As a result, many businesses The finance gap is far larger when considering microlack much-needed cash to grow, while financial and informal enterprises. By that measure, 65-72 percentinstitutions miss the opportunity to tap the huge pool of of all SMEs in emerging markets lack access to credit.potential SME borrowers. The proportional size of the finance gap varies widely SMEs play a major role in economic development across regions and is particularly daunting in Asia andin both emerging and developed economies. SMEs Africa, especially in low-income countries. A World Bankaccount for a significant share of employment and GDP investment climate assessment survey indicates thataround the world, especially when taking into account small enterprises in Africa have much greater difficultythe informal sector. SMEs employ an average of 67 in obtaining credit access than large enterprises. Onlypercent of the formal employment in developed countries 20 percent of small enterprises in Africa get access toand around 45 percent in developing countries (Figure credit, while 41 percent are credit constrained (FigureA4a). They also contribute a sizable share to formal A5).GDP, 49 percent on average in high-income countriesand 29 percent on average in low-income countries, Corporate bonds: A foundation for long-term growthrespectively. The macroeconomic and financial dislocations that While the proportion in developing countries seems followed the crises in emerging markets in the latemodest, the informal sector—most of which comprises 1990s highlighted the importance of developing localSMEs—accounts for up to 48 percent of the total labor bond markets as an alternative source of debt financing.force and 37 percent of GDP in these countries. The Bond markets can strengthen corporate and bankcorresponding proportions for developed countries are restructuring and thus accelerate the resolution of amuch lower, at 25 percent of the total labor force and 16 crisis. At the same time, local bond issues facilitate thepercent of the GDP (Figure A4b). reduction of currency and maturity mismatches on their In addition, SMEs typically contribute more to job balance sheets and thus reduce the vulnerability of thecreation than do large firms, especially in the case of corporate sector.start-up companies. Moreover, a vibrant SME segment Well-functioning local corporate bond markets alsocan help economic development through other provide institutional investors with an instrument thatchannels, such as innovation and competition. Access satisfies their demand for fixed-income assets, especiallyto finance remains a key constraint to SME development of long maturities that match their long-term liabilities,in emerging economies. The International Finance while providing higher yields than government bonds. ForCorporation (IFC) recently estimated that 45-55 percent the same reasons, corporate bonds can also strengthen Redefining the Emerging Market Opportunity | 11
    • Chapter 1: Unleashing Growth Opportunities in Emerging Marketsthe balance sheets of pension funds and life insurance that emerging markets are able to accelerate theircompanies. financial development, support their economic potential, In many countries, assets under the management and improve the lives of their citizens.of institutional investors have been growing faster thanthe supply of local instruments in which to invest. When REFERENCESbonds are not available, such funds may invest in assets Ayyagari, M., T. Beck, and A. Demirgüç-Kunt, 2007. “Small and Medium Enterprises across the Globe.” Small Business Economics 29(4),that are a poor match for their liability structure, leading 415–34.to interest rate and other risks. CGAP (Consultative Group to Assist the Poor), The World Bank Group. To avoid such mismatches and the risks they entail, 2010. Financial Access 2010: The State of Financial Inclusiongovernments should allow institutional investors to invest Through the Crisis. Washington DC: CGAP, The World Bankinternationally. Additionally, a deep and liquid corporate Group.bond market may help prevent the development of CGFS (Committee on the Global Financial System). 2007. “Financialasset price bubbles and the associated financial Stability and Local Currency Bond Markets.” CGFS Publications 28. Basel: Bank for International Settlements.instability. Corporate bond markets also help reducethe concentration of credit and maturity risks in the Collins, D., J. Morduch, S. Rutherford, and O. Ruthven. 2009. Portfolios of the Poor: How the World’s Poor Live on $2 a Day. Princeton,banking system and free capital for banks to provide NJ: Princeton University Press.other segments, including SME financing and consumer The Economist. 2012. “Shake It All About: Which Emerging Economieslending. Have the Most Monetary and Fiscal Wiggle-Room?” The Banks become the main source of long-term Economist. January 28, 2012.local currency financing in the absence of corporate The Guardian. Credit ratings: How Fitch, Moody’s and S&P ratebond markets. Today, with the exception of Chile, each country. Datablog. http://www.guardian.co.uk/news/Malaysia, and Thailand, many emerging markets have datablog/2010/apr/30/credit-ratings-country-fitch-moodys- standard.a relatively low penetration of corporate bonds. InIndia, for example, a significant portion of infrastructure IFC (International Finance Corporation). 2010. Scaling-Up SME Access to Financial Services in the Developing World. Washington DC:projects are financed by banks, because of the limited IFC.development of the bond market. IFC and World Bank, Investment Climate Survey. Available at http:// Concentrating maturity risk in the banking system www.enterprisesurveys.org/Data/ExploreTopics/finance.is dangerous, as the lack of markets may lead to the IMF (International Monetary Fund). World Economic Outlook Database,mispricing of risk, which makes risk harder to monitor September 2011. Washington, DC: IMF.and control. Additionally, lending to large corporations — 2005. “Development of Corporate Bond Markets in Emerging —.consumes significant capital in the banking sector. With Market Countries.” Global Financial Stability Report. Washingtonso much growth opportunity in the SME and consumer DC: IMF.segments, freeing up this capital will ensure that banks Jackelen, H. and J. Zimmerman. 2011. A Third Way for Officialcan tap into these opportunities. Development Assistance: Savings and Conditional Cash Transfers to the Poor. New York and Washington DC: Growing InclusiveTHE PRIVATE SECTOR PLAYS A CRUCIAL ROLE BY Markets, United Nations Development Program, and The Global Assets Project, New America Foundation.DRIVING “LEAPFROG” INNOVATIONThe financial development path of each country is Manurung, N. and B. Moestafa. “Indonesia Regains Investment Grade at Moody’s After 14 Years.” Bloomberg. January 19, 2012.unique. There is no universal template for capacitybuilding, which must be developed over time. Relying Mukherjee, S. 2011. The impact of interest rate controls on financial inclusion: A comparative analysis. IMFR Trust blog. http://www.solely on capacity building, therefore, will not address ifmr.co.in/blog/2011/02/25/the-impact-of-interest-rate-controls-on-the urgent need to accelerate financial development in financial-inclusion-a-comparative-analysis/.emerging markets. Parkinson, J. 2011. “S&P Upgrades Turkey’s Local-Currency Rating.” This urgency is illustrated by the current near- The Wall Street Journal. September 20, 2011.standstill in certain aspects of development among Sinha, J. and N. Aggarwal. 2011. Financial Inclusion: From Obligation toemerging economies. In the areas of corporate Opportunity. Mumbai: The Boston Consulting Group.governance, legal and regulatory competence, and Swiss Re. 2011. World Insurance in 2010. Zurich: Swiss Reinsurancecontract enforcement, emerging markets have registered Company Ltd.virtually no progress over the past four years in the World The World Bank. 2012. Financial Development in Latin America and theEconomic Forum’s Financial Development Index (Figure Caribbean: The Road Ahead. Washington DC: The World Bank.A6). Financial infrastructure has improved only modestly. World Economic Forum. 2011. The Financial Development Report 2011. The lack of progress underscores the reality that New York: World Economic Forum USA Inc.traditional models often are unsuitable for seizing new — 2010. The Financial Development Report 2010. New York: World —.opportunities. Transformation and innovation are needed. Economic Forum USA Inc.While that involves risk, it also promises progress and — 2009. The Financial Development Report 2009. New York: World —.reward for those who get it right. Economic Forum USA Inc. In many countries, “leapfrog” innovation will likely — 2008. The Financial Development Report 2008. New York: World —.be the best path for accelerating financial gains. It is a Economic Forum USA Inc.form of innovation that crosses borders, platforms, andconcepts at a single bound. This kind of bold innovation,along with the policies that support it, is crucial to ensure12 | Redefining the Emerging Market Opportunity
    • Chapter 1: Unleashing Growth Opportunities in Emerging MarketsAppendix A: Supporting FiguresFigure A1: Breakdown of world GDP by country’s income level 80 n  Low and lower middle income EMs n  Upper middle income EMs 70 n  High income countries 60 GDP (nominal US$ trillions) 50 40 30 20 10 0 2006 2007 2008 2009 2010Source: IMF, World Economic Outlook Database, September 2011.Note: This table classifies all World Bank member economies and all other economies with populations of more than 30,000. For operational and analytical purposes, economies are divided among income groups according to 2010 gross national income (GNI) per capita, calculated using the World Bank Atlas method. The groups are: low income, $1,005 or less; lower middle income, $1,006–3,975; upper middle income, $3,976–12,275; and high income, $12,276 or more. Other analytical groups based on geographic regions are also used.Figure A2: Global change in financial institution market capitalization by country income group 0 Change in market cap, 2006 – 2011 –50 (US$ trillions) 119 –100 453 –150 –1,546 243 –200 High income (OECD) High income (non-OECD) Upper middle income Lower middle and low incomeSources: Thomson Reuters Datastream (consulted April 2, 2012); BCG analysis.Note: This table classifies all World Bank member economies, and all other economies with populations of more than 30,000. For operational and analytical purposes, economies are divided among income groups according to 2010 gross national income (GNI) per capita, calculated using the World Bank Atlas method. The groups are: low income, $1,005 or less; lower middle income, $1,006–3,975; upper middle income, $3,976–12,275; and high income, $12,276 or more. Other analytical groups based on geographic regions are also used. Redefining the Emerging Market Opportunity | 13
    • Chapter 1: Unleashing Growth Opportunities in Emerging MarketsFigure A3: Breakdown of world GDP by country’s income level 100 n  Low and lower middle income EMs n  Upper middle income EMs n  High income countries 80 GDP (nominal US$ trillions) 60 40 20 0 2010 2011 2012 2013 2014 2015Source: IMF, World Economic Outlook Database, September 2011.Note: This table classifies all World Bank member economies, and all other economies with populations of more than 30,000. For operational and analytical purposes, economies are divided among income groups according to 2010 gross national income (GNI) per capita, calculated using the World Bank Atlas method. The groups are: low income, $1,005 or less; lower middle income, $1,006–3,975; upper middle income, $3,976–12,275; and high income, $12,276 or more. Other analytical groups based on geographic regions are also used.Figure A4: Level of insurance penetration by country Figure A4a: 2010 Life insurance penetration Figure A4b: 2010 Non-life insurance penetration 20 10 2010 Non-life insurance premium/GDP (%) 2010 Life insurance premium/GDP (%) 4 9 3 6 2 3 1 Lower middle income Upper middle income High income 0 0 0 20 40 60 100 0 25 50 75 100 GDP per capita (US$ thousands) GDP per capita (US$ thousands)Source: Swiss Re, 2011.14 | Redefining the Emerging Market Opportunity
    • Chapter 1: Unleashing Growth Opportunities in Emerging MarketsFigure A5: Evolution of net interest margin (NIM) with expansion in banking 8 6 Turkey Indonesia NIM (percent) Thailand Russia 4 US China Singapore Malaysia 2 India South Africa South Korea Spain Canada Germany Australia France UK 0 100 200 300 400 500 600 Banking Assets/Nominal GDP (percent)Sources: BCG analysis.Notes: Indian data correspond to year ending in March 2010; for all other countries the data correspond to the calendar year 2009. The size of the circle represents the assets of the banking industry (US$ 1,000 billion)Figure A6: SME contribution to employment and GDP Figure A6a: Share of formal SMEs in formal manufacturing Figure A6b: Share of informal SMEs in labor force and GDP employment and GDP 80 50 n  Developed countries n  Developing countries 70 40 60 50 30 Percent Percent 40 20 30 20 10 10 0 0 Share of formal SMEs Share of formal SMEs Share of informal sector Share of informal sector in formal manufacturing in GDP  in labor force in GDP employmentSource: Based on Ayyagari et al., 2007.Note: The share of formal SMEs in employment corresponds to their share in formal employment in the manufacturing sector when 250 employees are taken as the cut-off for the definition of an SME. The informal sector includes all informal sector firms, irrespective of the size and sector of operation. Redefining the Emerging Market Opportunity | 15
    • Chapter 1: Unleashing Growth Opportunities in Emerging MarketsFigure A7: Development of legal, infrastructure, and business environment in emerging markets 5 n  2011 Average score (1–7, 7 being the most developed) n  2010 n  2009 4 n  2008 3 2 1 0 Corporate governance Legal & regulatory Contract enforcement InfrastructureSource: World Economic Forum, Financial Development Reports, 2008-2011.16 | Redefining the Emerging Market Opportunity
    • Chapter 2: The Opportunity in Consumer Financial ServicesCHAPTER 2 While the world’s developing economies are now growing at a faster rate than mature ones, consumer financial services have not caught up. Savings accounts,The Opportunity in insurance, loans, payments, and similar offerings—where they do exist—penetrate unevenly and often reach onlyConsumer Financial higher-income populations. As a result, the enormous potential of mass-market consumers to drive economicServices growth in emerging countries is barely tapped. By contrast, in the developed world, the ubiquity of financial services has helped transform average consumers into a credit-fuelled source of demand and stimulus, the leading driver of economic expansion. The story of consumer financial services in emerging markets is just beginning to unfold. It promises to be a powerful one, characterized by innovation and economic expansion. There is enormous room for growth that can benefit emerging countries, consumers, providers, and the global economy alike. Consumer finance can deliver broad economic and social benefits in emerging markets Consumer financial services in emerging economies can reduce poverty, improve health care, and increase the consumer’s ability to afford needed goods on a more equitable basis. The infrastructure for these services also supports and improves society’s broader efficiency in raising capital, making payment transactions, and distributing wealth. Consumer financial services, in particular, can help raise the low-income population out of poverty, while supporting the development of capital markets, helping channel government and international aid, and making subsidies more efficient. Those advances will, in turn, provide broader, international macro-economic benefits. Given the shift of developed countries to services-driven economies, consumption and spending by emerging countries will be increasingly crucial for global economic growth. Our research has shown that, for providers of consumer financial services, the most significant “white space” opportunities for emerging-market growth lie in mass-market services and products. The path to success is through innovations that expand the market. The aim of this chapter is to provide a guide to those potential opportunities and an action framework for assessing and exploiting them, including case studies of successful innovation, Providers will benefit by embracing financial inclusion of the poor Although some banking institutions are still wary of the up-front costs and challenges of fully embracing financial inclusion of the poor, it is hard to ignore the long-term benefits of such an enormous potential client market. With foresight, institutions could harness the potential to deliver not only traditional, basic products, but also a full range of risk-management mechanisms for the poor. In recent years, the penetration of consumer financial services has advanced notably in emerging markets. In India, for example, it rose to 47 percent of households in 2010 from 35 percent in 2006. Latin Redefining the Emerging Market Opportunity | 17
    • Chapter 2: The Opportunity in Consumer Financial ServicesFigure 1: Bank account penetration by income level in India, 2010 100 80 Percentage of households 60 40 n  Without a bank account 20 n  With a bank account 0 < 90,000 90,000–135,000 135,000–200,000 > 200,000 Annual income (Indian rupees)Source: BCG, 2011.Note: Number of respondents = 12,321; Household distribution by income is based on National Council of Applied Economic Research (NCAER) projections. The excluded households in the >200K income category have 7-8 members per household, and this may account for low savings.America has recorded similar advances, particularly Penetration in rural areas is particularly low. Onaided by distribution through retail chains. average, only 38 percent of rural households, across But the headline numbers fail to tell the whole story. all income levels, have bank accounts, compared to 64In India, lower-income households still have minimal percent in urban areas (see Table 1). Yet penetration isexposure to financial services, despite constituting the relatively low in urban areas, as well. Thus, there is amajority of households (Figure 1). While 91 percent of significant opportunity for providers to tap into lower-the 43 million households with annual income higher income households, whether rural or urban.than R200,000 (US$3,740) have bank accounts, only27 percent of the 112 million earning less than R90,000 Unmet consumer demand and the need for financial(US$1,680) have one. In addition, many of those with inclusion create uncharted white spaceincome below R200,000 who do have bank accounts do To become financially empowered, low-incomenot get proper services. As a result, their accounts are populations worldwide need access to:largely inactive. • Payment and remittance services: Though there are formal and informal sources for remittance in rural areas, both are costly and time-consuming. EvenTable 1: Account penetration by annual income in urban areas, many low-income customers usinglevel and resident location in India services such as postal money orders are forced to pay fees that amount to a substantial percentage Less Greater of the remittance value. Services such as mobile than Rs 90– Rs 135– than Rs 90 Rs 135 Rs 200 Rs 200 TOTAL banking and cards can provide lower-cost, more (in thousands) efficient remittance and payment services, as noted later in this chapter. Urban households with 38 45 65 96 64 bank account (percent) • Savings accounts: About 40 percent of India’s Rural households with 24 34 59 81 38 population uses no formal channel for savings, bank account (percent) often holding their money in the form of cash. Besides restricting their savings ability, this practiceNote: Data as of 2010. removes from circulation money that could support the financial sector’s funding of capital markets and public projects. It also deprives low-income families of the opportunity to manage cash flow in emergency situations.18 | Redefining the Emerging Market Opportunity
    • Chapter 2: The Opportunity in Consumer Financial ServicesFigure 2: Demand and supply of micro-insurance products Demand Supply Risk management needs prioritized by low-income people in 11 countries Individuals covered by micro-insurance products in 11 countries Health Life Property n  First priority n  Second priority Accidental death n  Third priority and disability* Job loss† 8 7 6 5 4 3 2 1 0 0 5 10 15 20 25 30 35 Number of Individuals (millions) Number of Individuals (millions)Sources: Allianz, 2010* Demand for accidental death and disability is not available.† Supply for job loss is not available. • Credit: Despite the recent hype about micro-finance, and self–employed workers and entrepreneurs who a large proportion of low-income communities still operate their own small businesses and usually have low do not have access to formal sources of credit. and variable income, in both urban and rural areas. Informal channels are the most widely used source As financial services consumers, mass-market of loans, as discussed later, despite higher interest workers have needs and priorities that differ from rates than loans from banks and micro-finance those of traditional banking customers. Many of these institutions (MFIs). consumers, for example, typically are at work during • Insurance: There is a big gap between the demand traditional branch operating hours and live far from for insurance and its supply. (Figure 2). Low-income established banking facilities. Innovating cost-effective people are concerned above all with health risks, ways to bring service channels closer to homes and followed by the risk of death and then property places of work will be one key to unlocking the mass- loss. But the supply of micro-insurance is not market opportunity. aligned with those concerns. Credit life insurance is the most widely available product, followed by accidental death and disability insurance. Health Providers must serve the specific needs of and property insurance are still rare. The mismatch mass-market consumers as well as institute between supply and demand is primarily due to larger transformations to their business models the complexity of the different products. Health Financial institutions usually find it difficult to evolve and property insurance are much more difficult to profitable services for low-income consumers directly provide than life coverage, given that claims are from their legacy businesses. Simply adjusting the harder to assess and fraud more difficult to control. traditional business model—that is, relying on capacity- building initiatives—is not enough. Because the needsTo make the most of the mass-market opportunity, and economics of low-income consumers are soproviders must know the consumer different from those of more affluent clients, successTo serve low-income, mass-market consumers, it is requires that providers innovate new channels, products,important to understand the characteristics of the and processes.population. For the purposes of this report, we define Despite these challenges, some financial institutionstwo main categories of mass-market workers who have found ways to gain progressive traction with mass-are under-served—or not served at all—by formal market consumers. They have usually succeeded byfinancial institutions: employed workers in both first meeting the express and specific needs of thoseformal and informal sectors who earn daily, monthly, customers, and only then introducing additional productsor seasonal wages, depending on their occupations; to deepen penetration. Redefining the Emerging Market Opportunity | 19
    • Chapter 2: The Opportunity in Consumer Financial ServicesFigure 3: Branch density in emerging countries 20 Developed market benchmarks Turkey France 43 USA 36 Hong Kong 21 Bank branches per 100,000 adults 15 Mexico Chile UK 21 Tunisia Columbia Argentina Brazil Philippines Uruguay Thailand Malaysia 10 India Morocco Dominican Pakistan Sri Lanka Republic El Salvador Botswana Indonesia Peru South Africa Bolivia Paraguay Namibia Kenya Ghana Algeria 5 Zambia Cambodia Vietnam Swaziland Lesotho Laos Ecuador 0 Tanzania 2 0 4 6 8 10 12 Rwanda Uganda Malawi GDP per capita (US$ thousands)Sources: IMF, 2011; CGAP and World Bank, 2010. In Brazil and Mexico, for example, retail chains have In our interviews, many financial providershad success financing consumer loans for household underscored the importance of branches as the mostappliances (white goods) and then expanding offerings effective channel for delivering comprehensive financialto insurance and savings accounts. Insurance providers, services. However, they highlighted the operatingsuch as Prudential in Vietnam, have successfully complexity and investment requirements involved inexpanded into consumer finance, leveraging the brand rapidly expanding branch networks. Many also believerecognition and customer loyalty they had established in that current branch networks in most emerging countriestheir legacy business. Wafacash started with payment are not ideally located to reach the mass market.services to Morocco’s mass market before expanding Clearly, it is critical to deploy some sort of cost-effectiveinto savings and card products. distribution model to complement traditional banking networks.Challenges to providing mass-market services The need for new business models and services:Profitably serving the mass market with traditional Traditional service models will not work. Mass-marketbanking models is difficult in emerging markets, consumers need products, services, and operatingparticularly because customer transactions are relatively processes that differ markedly from the traditionalfew and accounts are small. Three key challenges are banking designed for upper-income consumers.distribution, service needs, and risk assessment. Providers need to tailor their approach to mass-market The distribution challenge: A critical barrier to needs and characteristics, both to generate demand andusing a traditional banking model in low-income areas to manage the business economics.is distribution. Due to the expense of establishing and As a group, mass-market customers tend to haveoperating traditional branches, investment costs are likely incomes that are not only low but also highly variableto be high compared with the scale of business. and seasonal. This combination of factors shapes their While physical branches play an important role in need for financial products. Overall low income levelswinning deposits and other business, branch density restrict their savings ability, while income variabilityis low in most emerging markets (Figure 3). Branch increases their need for short-term consumption loansdensity correlates to a country’s level of development, as to tide them over during periods of limited or no income.measured by GDP per capita. More developed emerging One-off or unforeseen events such as a wedding,markets, such as Turkey, have penetration levels crop failure, or sudden illness—as well as occasionalcomparable to some developed markets, but branches purchases such as major appliances—require instantin less developed economies are less common. consumption credit, as these customers have very low savings to dip into. Establishing a savings culture during20 | Redefining the Emerging Market Opportunity
    • Chapter 2: The Opportunity in Consumer Financial Servicesincome-earning periods helps consumers manage their with these sources, as they comprise local moneycash flow during periods of less income. Emergency lenders, friends, or family members. This source isexpenses also call for purpose-specific insurance also available to them throughout the year and atproducts. any time of day. Pricing structures must also address the • Flexibility: The informal sector’s product offerings arecharacteristics of the mass market. With payment and flexible. For instance, lenders are open to changingsavings products, float-based pricing is not a profitable payment amounts and payment frequency basedmodel, because individual accounts are small. A pay- on the customer’s situation. This flexibility offersper-use model is better. For loans and insurance, convenience and value to workers receiving variablesmaller, more frequent installments are attractive to and seasonal pay. At times, the customer may wantlow-income consumers, since many do not receive to adjust the payment to suit a contingency, such as sudden illness or crop failure. There is usually nolump-sum income. Features such as payment holidays paperwork involved, and the restructuring occursprovide flexibility for emergencies that is especially useful seamlessly.to seasonal income earners. The working hours of mass-market consumers, • Ease, informality, and speed: The informal sectoralong with their frequent lack of financial literacy, make usually requires limited or no documentation. Cashtraditional banking operations, documentation needs, or loan disbursal is fast, sometimes instantaneous. This contrasts sharply with bank loan procedures,and branch procedures too lengthy and complicated often characterized by stringent documentationfor them. They need fast, simple transactions and requirements, verification procedures, andprocedures for purchasing financial products. Branch disbursement delays. Customers may need to visit alocations and operating hours, too, must be designed bank several times, to understand procedures or towith their working hours in mind. submit paperwork. Risk assessment in a data-constrained environment:Lack of consumer information for risk assessment and Some early innovators have jumped ahead inthe difficulty of efficiently adhering to required “know the emerging consumer mass marketyour customer” (KYC) standards pose another challenge This chapter explores successful innovations by financialto providers of mass-market financial services. Products institutions in overcoming the challenges and barrierssuch as loans and insurance are difficult to offer, outlined above. They include:because consumer credit databases usually do not exist • Deploying new, large-scale, lower-cost distributionin emerging economies. models requiring less capital investment; In addition, KYC standards often hinder the abilityof providers to offer savings products, due to the • Revamping and simplifying product offerings,difficulty and cost of verifying customer identities. This is communications, pricing structures, and operationalcompounded by regulations in some countries requiring models;providers to undertake detailed customer identity • Encouraging financial education through “learning-verification even for small transactions. by-using” products and services to complement traditional customer education efforts;Traditional providers can learn from the informal • Utilizing customer data from legacy businesses andsector other industries to support risk assessment for loansDespite the high fees, informal networks—including “loan and insurance products;sharks,” pawnshops, friends, and family—are prevalent inlow-income communities. Emerging-market consumers • Channelling government programs through financial services to drive scale and accelerate financialoften look favorably on these networks and, in fact, adoption; anddepend on them for survival in times of need, contraryto the customary view in financial and regulatory circles. • Creating a shared customer data repository andInformal networks often play an important role, fulfilling other supporting infrastructures, in the mediumneeds left unmet by the formal sector’s limited reach and term, to simplify risk assessment and KYC activities.flexibility and its often rigid documentation requirements. Formal financial institutions can design their Providers can drive the growth of consumer financialofferings to mimic the key factor that make the informal services in three distinct stagessector popular among mass-market customers: What follows is a guide to opportunities for innovatation, based on a framework for action divided into three • Simple products and clear communication: distinct stages (see Figure 4): A simple, “real-life” approach is needed in communicating product features. Most customers, Stage 1: Exploiting existing infrastructure and for example, do not understand the concept of capabilities. In this stage, institutions can explore interest rates. Rather, they understand simply the various partnership models to expand their reach size of payment to pay per installment period and to mass-market customers with minimal capital the total money they have taken as loan. expenditure. We discuss ways providers can improve • Proximity: Competitors from the informal sector are their capabilities around products, processes, and usually located close to the customer and thus offer risk assessment to better meet the characteristics of easy access to credit. The customer is more familiar Redefining the Emerging Market Opportunity | 21
    • Chapter 2: The Opportunity in Consumer Financial ServicesFigure 4: Roadmap to broadening reach of consumer financial services in emerging markets Exploiting existing Enhancing distribution Delivering a balanced infrastructure and capabilities to reach the mass market portfolio of services • Build partnerships to expand • Build technology-enabled • Establish credit information repository to distribution to mass-market customers channels (mobile banking, measure individual debt. (MFIs, self-help groups, retailers, post payment networks). offices, utilities). • Create consistency in regulation for bank • Launch new branch operating model to and non-bank financial institutions.* • Tailor products, pricing, processes, reduce costs and and marketing to suit mass-market deliver no-frills banking services. • Create system-wide infrastructure to demand and characteristics. improve delivery, reduce costs, and • Expedite branch network enhance customer protection.* • Bundle products to expand use of expansion through franchising financial products and enhance or partnerships. economics. • Repurpose customer data for multi-product marketing. • Channel government and aid disbursement programs to catalyze adoption of formal financial services.* Ensure regulatory environment is conducive to driving penetration of consumer financial services.*  Government-driven initiatives.the mass market. Finally, we consider the potential of agent networks perform cash-in, cash-out functions,channeling G2P payments through new channels to make small loans, and, in rare cases, enroll new clients,catalyze adoption of financial services. thus performing KYC authentication and fulfilling regulations such as anti-money laundering acts. Stage 2: Enhancing mass-market distribution There are many ways to structure a successfulchannels. In this phase, providers need cost-effective partnership or business correspondent-basedmodels to build and expand their channels. Our distribution network. Financial providers can evaluatediscussion covers both mobile channels and physical which partnership type is most suitable based on threebranches, including low-cost outlets and franchising major considerations.models. The nature of the partnership: Financial providers Stage 3: Delivering a balanced portfolio can complement their own distribution networks withof services. We discuss initiatives to establish an the partners’ networks in many ways. A financialenvironment and infrastructure that will enable financial provider must determine whether it needs manyproviders to deliver a full set of financial services more localized partnerships, one nationwide partnership, orefficiently in the long term. a combination of the two. That decision will affect the types of partner institutions it will need to engage, asSTAGE 1: EXPLOITING EXISTING INFRASTRUCTURE well as the internal operations it will need to prepare.AND CAPABILITIES For example, to minimize central operations costs,Build partnerships to expand distribution providers might want to avoid single-handedly managingPartnerships and business correspondent structures too many partner outlets. Instead, they often engageare critical enablers for financial institutions building intermediaries, such as local management companieslow-cost distribution networks for the mass market. or non-governmental organizations (NGOs) to select andTraditional branches are too expensive to build and manage small agents.maintain for serving widely dispersed, low-income The type of potential partner: Partners from differentpopulations. Formal providers, such as banks, can offer industries bring different types of channels and differenttheir products through a network of agents from the non- capabilities for financial providers to leverage. For banksfinancial services sector. and insurance companies, potential partners include: Agents typically are trained to facilitate moneytransfers, answer balance inquiries, accept payments, • MFIs: MFIs typically have closer proximity to low- income populations and are suitable partners forand generally facilitate transactions. More advanced channeling non-credit products, such as savings22 | Redefining the Emerging Market Opportunity
    • Chapter 2: The Opportunity in Consumer Financial Services and insurance. MFIs can earn substantial additional revenue from providers by partnering to deliver Case-in-Point 2.1: Delivery of financial services additional products to their customers. through supermarkets One example is the partnership between Allianz and SKS microfinance in India (Case Study 1). For most people in Mexico, going to the bank is not Together, they launched a life insurance product an everyday experience. In 2004, only 25 percent of coupled with a savings component, as well as households in Mexico City had bank accounts—a result of credit-linked life insurance that protects lenders banks’ focus on the most affluent parts of the population. against default. The products were simple, easy- The three-quarters of Mexicans who remained unbanked to-sell, and standardized. Banco Compartamos, represented a huge potential market. a Mexican bank that focuses on serving the micro Soriban has come forward to seize this opportunity. segment, has also partnered with insurance Soriban is a financial institution that offers a variety of companies to deliver life insurance (Case Study 2). in-store financial services to the more than 25 million people who visit Soriana, one of Mexico’s major retail• Retailers: Supermarkets, electronics shops, and chains, each month. Besides Soriana, the other partner other retailers can utilize their existing outlets and in this US $100 million joint venture is Banamex, Mexico’s their large traffic of mass-market customers to second-largest bank by assets. Banamex is responsible deliver financial services. for developing financial products—including small One such partnership is Soriban, a venture personal loans, automotive credit, insurance, pre-paid between Banamex and Soriana in Mexico (Case-in- cards, and remittances—that have utility for low-income Point 2.1). Soriban offers a variety of simple, easy-to- shoppers buying financial services for the first time. use financial products in supermarkets. Soriana, with its 240 outlets, provides a nationwide Banco Popular in Brazil uses subcontracted local retail channel to capture potential leads and gathers management companies to select and manage transactional data for credit assessments. To minimize default rates, Soriban emphasizes suitable outlets as business correspondents (Case- products with relatively low credit risk. One of its most in-Point 2.2). Its network includes a range of retailers popular products is a pre-paid MasterCard debit card, from bakeries to a hardware store. which customers can purchase off the shelf and refill at• Utility providers: Utility companies offer two key any Soriana outlet. benefits to financial firms. First, their monthly Soriban has wrestled with challenges that would invoicing can act as an efficient collection channel, confront any company attempting to sell financial since loan payments can be integrated with utility products to lower-income consumers in a retail setting. bills. Second, access to customers’ utility payment These include designing financial products that do not history helps formal institutions to assess the credit require significant credit risk assessment at the time of sale; training retail personnel to answer questions that an risk of previously untapped customers. inexperienced consumer of financial services might have; A successful example of this approach is and using retail-store branding that does not bring to demonstrated by Codensa, an electric utility mind traditional banking, with the negative connotations company in Colombia (Case Study 3). Codensa formal banks may have for low-income populations. provides consumer financing for electric appliance purchases by leveraging its large customer network and existing commercial infrastructure. Through References Codensa’s retail partners, customers can apply for Soriana. Soriana MasterCard FAQs. http://www1.soriana.com/ loans, which are granted and disbursed in as little site/default.aspx?p=7739. as 15 minutes. They pay back the loans through their electricity bills. Codensa was so successful — 2011. Annual Report 2011. Monterrey, Mexico: Organización —. Soriana. that its model is now replicated by Promigas, a gas company in Colombia. Lopez, G. 2007. “Soriana, Banamex Team to Launch Bank Services.” Reuters, July 25, 2007.• Self-help groups and community organizations: In many emerging markets, informal groups assemble in rural areas to address community financial needs. In India, villagers address health-care expenses by pooling funds that provide loans for medical emergencies. Allianz in India (Case Study 1) tapped into this model, collecting a portion of the monthly education campaigns. It is critical to partner with payment from the pool to cover insurance for larger community organizations that are part of a national expenses, such as hospitalization or surgery. or regional group capable of supporting education This broader coverage is attractive to and standardized administrative processes. communities, because large expenses typically deplete the pool for extended periods. For the • Production cooperatives: Like self-help groups, insurance provider, broader coverage improves production cooperatives often comprise large efficiency. It also lowers the cost of serving a new networks of mass-market members. Partnering with population within an existing physician network. these organizations, therefore, can provide efficient Small, regular visits to local doctors are still covered access to customers. by the self-help group’s pooled health fund. In India, Bajaj Allianz leveraged the hierarchical A downside to this model is lack of scalability. organization of a dairy farmers’ cooperative to Self-help groups tend to operate differently from deliver simple, flexible micro-insurance. Its products traditional insurance customers, requiring separate include life insurance with a savings component. Redefining the Emerging Market Opportunity | 23
    • Chapter 2: The Opportunity in Consumer Financial Services Case-in-Point 2.2: Delivering banking services through various retail channels Despite the growth in Brazil’s financial services sector, many enough to educate new customers; almost one-third of of the country’s poorer municipalities still have no financial those opening an account in the early days never used it. services. In 2003, however, the government issued a set of But, after losing money for a few years during its new regulations to increase all Brazilians’ access to banking. start-up phase, Banco Popular became profitable in 2008. Among the changes was a law allowing financial institutions It has benefited from the government’s support for micro- to use third-party banking correspondents. Bank kiosks financing and branchless banking, by increasing scale, and went up in supermarkets, bakeries, and drugstores, giving by its own sophisticated use of technology. hundreds of thousands of unbanked Brazilians the ability, for the first time, to make deposits and withdrawals, pay bills, and apply for loans. References At the center of this “branchless banking” is Banco Banco do Brasil. 2010. Annual Report 2010. Brasilia: Banco do Popular do Brasil, a microfinance subsidiary of Banco Brasil. do Brasil, the country’s largest bank. In Banco Popular’s — Investor Relations. www.bb.com.br. —. simplified offering, customers can open an account with nothing more than an identity card and a tax identification Benson, T. 2005. “Brazilian Banks Court the Poor.” The New York number. They get 12 free transactions per month (four Times. April 8, 2005. statement inquiries, four withdrawals, and four deposits). Business News Americas. 2008. “Banco Popular Posts US$12mn They can also buy basic life insurance coverage at BRL2,500 Loss in H1.” Business News Americas, August 17, 2008. (US$1,400) for a bi-annual premium of BRL12 (about US$7). Banco Popular’s roll-out of banking services through EXAME. 2004. “Casas Bahia e Banco Popular fecham parceria.” banking correspondents, rather than through its own EXAME.com. September 14, 2004. branches, relies on local management companies, including Kumar, A., A. Nair, A. Parsons, and E. Urdapilleta. 2006. “Expanding NetCash, a Brazilian payment services company, and micro- Bank Outreach through Retail Partnerships: Correspondent finance institutions. The retail banking correspondents host Banking in Brazil.” World Bank Working Paper No. 85. the kiosks and handle bank customers’ transactions. In Washington DC: The World Bank. return, they get a share of transaction fees and increased foot traffic to their stores. Melo, J., Palmas Institute, and Community Banks. “Innovate This outsourcing of activities has helped Banco against Poverty and Exclusion: Wakening the Popular Popular keep its overhead costs low. Despite having only Economy.” Presentation. Available at http://www.scribd.com/ 80 staff members, Banco Popular handled more than a dgcmagazine/d/31726696-Presentation-on-Banco-Palmas. million accounts within six months of launching in late 2003. Meloni, C. and S. Cohn. 2006. “Using Technology to Build Inclusive Another example of low overhead is Banco Popular’s cost of Financial Systems.” CGAP Focus Note No. 32. Washington DC: opening a new customer account—BRL0.55 compared with CGAP. BRL17 at state-owned Banco do Brasil. Banco Popular has had its growing pains. Early Wheatley, J. 2005. “Brazil: Betting on the Working Poor.” Bloomberg attempts to encourage account openings through special Businessweek. January 24, 2005. offers (such as pre-approved credit for customers’ first transactions) resulted in debt default rates as high as 29 percent. In addition, the bank’s partners did not initially do The dairy unions facilitate the transfer of knowledge • Other potential partners: Recently, financial by receiving product training from Bajaj Allianz. The providers have started to explore other potential unions then educate the farmers about the products partners. For example, Allianz has explored and collect premiums directly when milk payments partnerships with mobile operators and mini-marts are disbursed. to deliver simple, pre-packaged insurance products to mass-market customers. • Post offices: National post offices typically have very widespread networks, including rural coverage. The division of roles between financial provider Many countries have embraced the idea of and partner: There are multiple ways of structuring a delivering financial services through this channel. partnership by assigning activities based on capabilities Some post offices run their own financial operations, as in Morocco. However, in many countries, post and needs. The most common model in partnerships is offices partner with banks to provide a suite of to leverage complementary capabilities. In the examples offerings. summarized above of Allianz, Codensa, and Soriban, Banco Postal in Brazil conducts bids every few the partner provides distribution and manpower while years to select partner banks that can deliver their the provider brings oversight, products, processes, and products in post offices. Banks can also leverage information technology systems. In the case of Allianz in the postal office’s information technology system to India, its partner SKS Microfinance also provides loans simplify data transfer activities. for customers to purchase insurance products in order to drive adoption.24 | Redefining the Emerging Market Opportunity
    • Chapter 2: The Opportunity in Consumer Financial ServicesOther elements to consider in the distribution model pre-packaged and simple are now required to getIn addition to evaluating partner selection elements, insurance sales licenses for their cashiers. Becausefinancial providers must think through several other these positions have high turnover, minimarts haveconsiderations that might affect their distribution model: a limited ability to have licensed staff to sell these products. Standards for selling simplified products must • The range of products to offer: Simpler products, such as remittances and payments, are easier to be less onerous for the business correspondence model promote through partners. The mix of products to take hold. providers want to push, such as loans, deposit, Furthermore, the costs involved in setting up these insurance, and mobile recharge, will impact the networks are not inconsiderable. To make the venture structure of the distribution network. profitable, providers have to identify agents in settings Some providers have chosen to offer where a critical mass of customers can be accessed. simpler products initially before introducing more For customers to use these agents, there must be a sophisticated services. For example, Wafacash in critical mass of agents providing access. The key to Morocco began by offering remittance solutions, profitability is ensuring that the customer base and the then expanded to other banking products, such as agent network grow and engage. savings and cards (Case Study 9). To scale up and bring business correspondence to • The technology to deploy: The right technology the next level, it is critical that customer servicing points depends on the target consumer segment, product of different providers be interoperable. Interoperability offering, and geography. The choice between gives customers the flexibility to access their accounts an online or offline model will significantly affect through any channel of any provider. It thus reduces customers’ account mobility. Selection also the cost of service delivery, as the overall infrastructure depends on the connectivity of the target region requirement is shared among service providers. for the financial providers. Since technology and connectivity are evolving rapidly, service providers Interoperability also generates greater competition must choose their solutions carefully, bearing in among financial services providers and creates a level mind the direction in which technology might evolve playing field. Regulatory push and support is required in the future. to achieve interoperability, as it rarely materializes simply through private players achieving consensus. • Branding: Mass-market consumers are often However, public-sector actors must provide assurance intimidated by traditional banking services. Additionally, the services and products offered to that institutions initiating the model can recoup these customers will be largely different from those their investments before the government enforces offered to traditional bank customers. Therefore, interoperability. it is important to think about whether the new distribution model to serve will hold the same brand Tailor products, pricing, processes, and as that serving the upper-income segment. Some marketing to fit the mass market organizations have decided to distinguish the two Financial providers need to offer product, pricing, and services by using a separate brand. processes that are both economically feasible and For example, Banamex and Soriana brand attractive to the mass market. Product strategies must their supermarket banking outlets as Soriban be tailored to cater to specific target segments and (Case-in-Point 2.1). The traditional bank Attijariwafa distribution models. established its low-income branches under the name Wafacash (Case Study 9). RHB Bank For example, products offered by Allianz to Indian established Easy outletsto target mass-market self-help groups, described above, were designed to customers (Case Study 4). fit existing rural practices. Two-thirds of the premiums collected from self-help groups remain within theChallenges for the business correspondence model group to deal with minor illnesses and standard claims.There are some notable successes by providers in using One-third of the premiums goes to Bajaj Allianz forthe business correspondence model to penetrate the major medical expenses covered by Allianz’s physicianmass consumer market in emerging countries—among network.them the case studies profiled in this report. Yet, overall, Another interesting example is Srisawad in Thailand,these models have not gained traction in many emerging which provides loans secured by motorcycles, acountries. popular collateral item in emerging markets (Case Study One key barrier is that many governments still 8). In Thailand, regulation bars providers from givinghave regulations that either prohibit agent operations unsecured loans to low-income borrowers. Srisawador contain ambiguity. Without clear regulatory guidance realized that Thailand has 16 million motorcycle owners,on what they can and cannot do, formal providers often mostly in the lower-income segment. They designedhesitate to outsource activities to third parties. To enable a one-stop shopping proposition, providing instantagent banking, a clear regulatory framework is required, disbursement loans with motorcycles (and, eventually,specifying customer liability, the types of transactions other types of vehicles) as collateral.agents may perform, and consumer protection, such as On pricing, it is important to structure low paymentspricing transparency and other disclosures. for loan installments and insurance premiums, spreading Sales regulation is another barrier. For example, installments over longer periods, if necessary. Casasminimarts selling insurance products that are Bahia, a Brazilian retailer, offers financing for white goods Redefining the Emerging Market Opportunity | 25
    • Chapter 2: The Opportunity in Consumer Financial Services with small monthly installments over a longer loan period Case-in-Point 2.3: In-store credit assessment for (Case-in-Point 2.3). This contributes to Casas Bahia’s affordable consumer financing popularity and allows it to sell products at a premium, as compared with competitors. Every household, no matter how low its income, In marketing, it is important to communicate occasionally needs to buy furniture, electronics, and product benefits using real-life examples that connect home appliances—”white goods.” In many markets, most low-income households apply for loans primarily in order to the low-income customer’s everyday life. In Thailand, to buy such consumer goods. For retailers providing white for example, Srisawad’s advertisements highlight its goods, financing can improve their sales performance if speed, the simple proposition that it can provide instant they can manage the associated credit risks. approval of urgent loans, and that it allows customers to In its 50-plus years in business, São Paulo-based retain their vehicles even while these serve as collateral. Casas Bahia has mastered this calculation, as evidenced Likewise, Casas Bahia’s advertisements highlight its by its becoming the largest retail chain in Latin America, low monthly installment payments, rather than focusing with 60,000 employees and revenue of BRL13 billion (US$7 billion) in 2010. simply on low overall interest rates. In Brazil, the so-called bottom-of-pyramid (BOP) Finally, processes should also be simplified to segment, earning less than BRL1000 (US$524) per month, deliver one-stop shopping, so customers do not need accounts for more than 80 percent of the population. This to go to branches multiple times to purchase a financial is the heart of Casas Bahia’s market. Assuming they pass product. Casas Bahia, for example, uses a basic credit- a credit check conducted by the Credit Bureau of Brazil, scoring model to approve or reject loans automatically shoppers at Casas Bahia need only show evidence on the spot. It also has on-site credit analysts who can of a permanent address to receive instant credit up to BRL600. If the merchandise costs more than BRL600, provide instant approval decisions at the store, even the store’s proprietary credit-scoring system determines for those customers who are rejected by the automatic an optimal credit limit based on total income, occupation, model. As another example, Srisawad provides instant and presumed expenses—in less than a minute. Even loan disbursement by having vehicle evaluators on-site customers rejected by the system are not out of options. at branches. Customers can get cash within 30 minutes, They can talk to one of Casas Bahia’s in-store credit compared to more than three days and multiple visits at analysts, who are trained to ask a series of questions to other providers. determine customers’ creditworthiness on an individual basis. Casas Bahia’s success in working with Brazil’s BOP Bundle new financial products to promote adoption segment comes down to several tactics, including its and enhance profitability offer of a relatively large number of low-value installment Customer education is critical, given the low financial payments (up to 15 monthly payments); its use of a literacy that hinders wider adoption of formal financial proprietary credit-scoring system, which eliminates services. However, introducing new products—such as delays in approvals, as opposed to outsourcing the insurance to a micro-credit customer—requires intense function; the care that Casas Bahia takes in educating consumers about their repayment responsibilities and effort. To overcome this obstacle, providers can bundle options; and the expense it goes to in training its back- multiple products for existing customers, and thus stop credit analysts. The installment scheme, in particular, expedite adoption of new financial products through is attractive to the low-income population, who typically the “learn by using” concept. For example, bundling does not understand the concept of interest rates and life insurance with loans will not only protect credit prefer lower installment payments that better fit their providers against default in case of death, but also allow income profile. Combined, these measures have helped beneficiaries and the community to see the benefit of life Casas Bahia keep its default rate at 8.5 percent, far below the industry average of 16 percent. insurance. Indeed, the biggest impediment to Casas Bahia’s A successful case is Banco Compartamos in future growth may be the extent of its reliance on Mexico. Compartamos partners with insurance providers competent credit analysts. This is a human resources to offer life insurance to its borrowers. In case of death, challenge that could limit the scalability of Casas Bahia’s customers’ families receive funds they can use to cover business model. funeral costs. Compartomos initially had to subsidize the insurance products to drive adoption. Over time, References customers saw the benefit of life insurance, and the Casas Bahia. Website. www.casasbahia.com.br. company now earns significant insurance revenue. Compartamos now has 2 million customers, 1 million Foguel, S. and A. Wilson. 2003. Casas Bahia: Fulfilling a Dream. of whom choose to increase life insurance coverage Case Study. Ann Arbor: University of Michigan Business School. beyond the minimum loan requirements. Another example is an insurance product with a savings component that Allianz provides with SKS Microfinance in India. Customers pay a weekly premium for a period of five years. At the end of this period, they receive any unclaimed amount plus interest minus an administrative fee. Purchasing this insurance product thus educates customers about the concept of savings.26 | Redefining the Emerging Market Opportunity
    • Chapter 2: The Opportunity in Consumer Financial ServicesRepurpose customer data for multi-product Similarly, the Brazilian government channels subsidymarketing programs through bank accounts, helping Banco PostalLack of customer information is a key issue for financial in Brazil to build scale quickly and familiarizing peopleproviders in assessing the risk of potential customers. with the concept of banking through post offices in theBehavioral proxies, such as historical payment initial phase of its deployment.information, allow them to assess customers’ abilityand willingness to pay loan installments or insurance STAGE 2: ENHANCING MASS-MARKETpremiums. Codensa, a Colombian electricity company, DISTRIBUTION CHANNELSuses customers’ electrical payment history in credit Providers must establish technology-enabledassessment. channels, including mobile banking Providers who offer multiple products can also Beyond physical networks, electronic channels offerleverage transaction data from one business to assess huge potential for reaching mass-market customers. Thiscredit in another. In Vietnam, it is not possible to get is particularly true in lower-income countries with limitedcustomer information from the public domain. Prudential physical infrastructures. So far, however, the potential isuses payment history for insurance products to assess greater than the reality.credit for unsecured consumer finance (Case Study 6). If successful, electronic channels could lowerCustomers who almost never missed premium payments costs even more than business correspondence,were targeted for loan products with very attractive allowing financial providers to expand beyond traditionalrates. The model was subsequently strengthened by channels, such as branch and ATM networks, and toincorporating other information, including payrolls, reach unbanked populations. Mobile technologies havebusiness licenses, and credit card statements. generated considerable enthusiasm in the developing world. Among the nearly 2.5 billion unbanked individualsChannel government and aid programs through worldwide, 2 billion have mobile phones. For thesefinancial channels to build scale and promote customers, mobile technologies such as phones andadoption electronic cards offer a way to access banking services.Building initial scale for new distribution models is critical To date, mobile-channel transactions have focusedfor their success. To drive adoption of these innovative primarily on payments. Safaricom (M-Pesa) in Kenyaapproaches and of financial services in general, is primarily successful only in their payment business.governments and international organizations can channel This success is attributable to its dominant positionsubsidies, aid, and other payments through the formal in telecommunications, which allowed it to createbanking sector. the product, receive government approval to launch, Total G2P payments to unbanked residents in implement a wide-scale distribution network, and roll outdeveloping countries are estimated at more than US$1 service, all in a short time. However, this environmenttrillion, and channeling these payments through more may not be replicable in other markets.efficient channels, such as bank accounts, can provide Despite numerous attempts, there is still very limitedsignificant savings for governments. success in delivering loans, savings accounts, and One interesting model that has been deployed in insurance products through mobile channels. Even inLatin America is channeling international conditional the case of mobile payments, there are few successful,cash transfers (CCTs) through formal financial services profitable models in emerging markets. Access to outlets(Case Study 5). Some of these programs merely enable that can facilitate cash-related transactions also remain aformal savings by providing basic accounts, while others challenge.explicitly encourage savings through matching, bonuses, To make mobile financial services (MFS) scalableor other incentives. Pilot programs have been launched and profitable, the presence of a champion to coordinatein Mexico, Peru, and Brazil for savings-linked CCTs multiple stakeholders is required. To make this successthat provide a basic transactional account as a deposit transferrable across geographies, providers also need tofacility. take into account white differences in market structure In Mexico, Diconsa, a retail chain, acts as a retail and market development when looking at successfulagent network for BANSEFI (a government savings and models.development bank) and Oportunidades (a government To build scale, providers need to think aboutanti-poverty program), using its network of stores that combining different mobile technologies to expand thesell basic food products. Point-of-sale (POS) devices channels in which mass-market customers can conductwere installed in 230 Diconsa stores to disburse transactions. An example is the partnership betweenprogram funds to beneficiaries with an electronic card. SMART, a major mobile operator in the Philippines,Many beneficiaries use their funds to purchase items Banco de Oro, and MasterCard (Case Study 7). Thisimmediately from Diconsa, boosting sales by 20-30 partnership results in a wide network of transaction andpercent, while ensuring that government consumer cash-in, cash-out points, which is critical for the successsubsidies are being used appropriately. The Diconsa of mobile banking. The partnership offers payments,partnership model resulted in over 1 million savings- savings, and loan products by linking mobile bankingenabled accounts for participants and, in some pilot and pre-paid cards. The SMART Money platform is thelocations, in over 90 percent reduction of the cost of world’s first reloadable payment card linked to a mobiledelivering aid. Redefining the Emerging Market Opportunity | 27
    • Chapter 2: The Opportunity in Consumer Financial Services phone. It leverages an existing telecommunications Case-in-Point 2.4: Private consumer credit- infrastructure and MasterCard’s payment network. bureau service Launch new branch models to dramatically reduce The mass segment in emerging markets has a hard time costs and deliver no-frills banking gaining access to financing. Banks are unwilling to extend Beyond alternative distribution, physical branch channels loans to people with limited credit history information, and many individuals in emerging markets lack such histories, will still be important for financial providers. Many having had no previous dealings with financial institutions. financial institutions we interviewed consider branches to A study by CGAP has shown that, in emerging markets, a be among the most effective channels for delivering a full strong correlation exists between the existence of credit suite of financial products. bureaus and the level of credit access. As previously discussed, the key challenge for In Malaysia, the gap in credit bureaus is being filled expanding a physical branch network is the high capital by Credit Tip-Off Services (CTOS), which maintains a expenditure required, along with the high cost relative to database of legal and financial data on the country’s institutions and individuals. The 17-year-old service the low-ticket items associated with the mass market. maintains information about bankruptcy proceedings, Besides reducing set-up and operational unresolved lawsuits, and property auctions, among other investments, low-cost branches can expedite launch matters. CTOS complements the government’s Central times. Additionally, no-frills service can benefit providers Credit Reference Information System (CCRIS), which not only by attracting mass-market customers but also provides raw financial data from financial institutions. by freeing them to better serve their higher-income Most financial institutions in Malaysia use CTOS to some clientele. extent, often making queries to the system to determine the creditworthiness of a debtor or potential business RHB Bank in Malaysia created a revolutionary, partner. low-cost branch model that dramatically reduces set-up CTOS’s emphasis on providing raw data and and operational costs while delivering no-frills banking steering clear of scaled ratings has allowed it to come (Case Study 4). Its Easy brand comprises a network of across as impartial, creating trust in the public and in its low-cost outlets distributing simple, standard products clients. Still, CTOS has faced scrutiny when it provides and one-stop services to mass-market customers. Its negative ratings for customers that are viewed favorably network focuses on sales with no operations. by CCRIS, which gets its information from financial institutions. Easy branches are located in mass-market areas Recently, the Malaysian government has begun and offer extended and weekend hours. All customer to set up a public-record archive service to provide purchases at Easy are completed within 10 minutes. another form of credit data and to create competition This “once and done” application process uses simple, in the market. Indeed, one of the biggest challenges for biometric, paperless procedures. Easy also adopts commercial credit-bureau services in emerging markets elements such as dual screen display to promote is that their governments will introduce data offerings that transparency and to allow customers to verify their have instant credibility and, because of subsidies, are available at a lower price. personal information electronically. Setup costs for Easy’s branches are one-seventh, and operational costs one-fourth, those of traditional References branches. They also can be rolled out six times faster Alhabshi, S., A. Abd. Khalid, and B. Bardai, 2009. The than traditional branches. Easy has enabled RHB to be Development of Corporate Credit Information Database the fastest-growing bank in Malaysia. and Credit Guarantee System. Kuala Lumpur: University of Malaya, NPUMA (International Institute of Public Policy and Management). Expedite branch network expansion through franchising and partnerships Bernama. 2011. “Credit Reporting Agency Will Fully Oversee To avoid the large investment associated with branch Private Credit Reporting Agencies.” Bernama. December 14, 2011. network expansion, financial providers can also consider a franchise model. Franchising allows a financial — 2007a. “CTOS Says It Does Not Blacklist, But Provides the —. institution to leverage existing assets and capital to help Records.” Bernama. July 9, 2007. its partners quickly expand its physical network. — 2007b. “Banks to Continue Using CTOS, Says ABM.” —. In a franchise model, it is important that the financial Bernama. July 3, 2007. institution avoid keeping an excessively high number of CTOS (Credit Tip-Off Services). Website. http://www.ctos.com. franchise partners, and instead ensure that each partner my. can open and manage multiple outlets. This minimizes New Strait Times. 2007. “Bank Negara ‘Should Set up CTOS- central operations for partner management. Additionally, Style Body’.” New Strait Times. July 3, 2007. it is important to have mechanisms in place for determining outlet locations. It is also crucial to ensure proper service and compliance. A successful example of franchising to serve mass-market customers is Wafacash, a subsidiary of Attijariwafa Bank in Morocco (Case Study 9). Wafacash started by providing a remittance service to the low- income population. Over time, Wafacash used these28 | Redefining the Emerging Market Opportunity
    • Chapter 2: The Opportunity in Consumer Financial Servicesoutlets to expand their offerings to pre-paid cards and While basic consumer protection requirementssavings products. are on the books in most economies, enforcement Wafacash franchise outlets are small and efficient, mechanisms are lacking. Enforcement mechanisms,and offer flexible operating hours. These outlets are including dispute resolution, are necessary to acceleratemostly located and operated by existing small retail the development of consumer financial services in theestablishments in low-income neighborhoods that are mass market.convenient for the low-income segment. Wafacash has Consistent regulation of the non-banking sector isgrown its outlet network 20 percent a year over the last also required to provide a level playing field for bank andsix years. Around 65 percent of its outlets today are non-bank providers and to protect customers. There isfranchises. an inherent benefit in regulating the non-bank sector. For example, loan information from micro-finance institutionsSTAGE 3: DELIVERING A BALANCED PORTFOLIO OF and pawnshops will provide a better view of overallSERVICES indebtedness of the mass market for risk assessment, asIn the long term, sustainable delivery of a wide range of compared with information collected only from banks.financial services by formal providers depends on severalelements. REFERENCES Customer information repositories that measure Note: For specific references to the case studies mentioned in thispayment capabilities and overall indebtedness can chapter, please refer to the case study section in Chapter 5.significantly reduce the complexity of customer Allianz. 2010. Learning to Insure the Poor: Microinsurance Report.assessment and improve institutions’ ability to deliver Munich: Allianz SE.services to a mass-market clientele. CGAP has CGAP (Consultative Group to Assist the Poor) and The World Bankfound that countries with more comprehensive credit Group. 2010. Financial Access 2010: The State of Financial Inclusion Through the Crisis. Washington DC: CGAP, The Worldinformation systems provide more bank loans to Bank Group.individuals. — 2009. Financial Access 2009: Measuring Access to Financial —. Commercial, privately owned institutions are Services around the World. Washington DC: CGAP, The Worldimportant to complement credit reporting services Bank Group.provided by government institutions. In Malaysia, a Collins, D., J. Morduch, S. Rutherford, and O. Ruthven. 2009. Portfoliosgovernment agency is responsible for providing credit of the Poor: How the World’s Poor Live on $2 a Day. Princeton,bureau services. This institution focuses on collating raw NJ: Princeton University Press.financial data from financial institutions. To complement IMF (International Monetary Fund). World Economic Outlook Database,these sources of information, a collection service was September 2011. Washington, DC: IMF.needed to focus on legal documents, government Jackelen, H. and J. Zimmerman. 2011. A Third Way for Officialrecords, and public sources. Credit Tip-Off Services Development Assistance: Savings and Conditional Cash Transfers to the Poor. New York and Washington DC: Growing Inclusive(CTOS) is a wholly commercial and private credit bureau Markets, United Nations Development Program and The Globalsystem that collates qualitative, publicly available Assets Project, New America Foundation.information about Malaysian institutions and individuals Sinha, J. and N. Aggarwal. 2011. Financial Inclusion: From Obligation tointo a digital database (Case-in-Point 2.4). Over the last Opportunity. Mumbai: The Boston Consulting Group.17 years, CTOS has been used extensively in tandem World Economic Forum and BCG (Boston Consulting Group). 2012.with the government credit bureau CCRIS to help Galvanizing Support: The Role of Government in Advancingfinancial institutions assess risks of potential customers. Adoption of Mobile Financial Services. Geneva: World Economic Forum. Governments need to help providers reduce thecosts of delivery to the mass market. One key enabler isa national identification system. Such a system expeditesverification of customer identity, enabling new operationalmodels. For example, the paperless process at RHBEasy leverages the national identification database toquickly verify customer identity and biometric data. Indiahas launched a unique identification (UID) system thatwill cover 400 million people by the end of 2012. Governments can simplify KYC standards for small,mass-market transactions. For example, requirements foraddress verification can be difficult and costly to executerelative to the small ticket size the mass market offers. To foster adoption and sustainability, governmentsmust enforce customer protection regulations. Whencustomers are better informed about the terms andconditions of financial services, they are more likely tobegin using such services, especially in markets wherefinancial systems are not trusted for historical reasons.Transparency also stimulates competition. Redefining the Emerging Market Opportunity | 29
    • CHAPTER 3 Small- and medium-sized enterprises (SMEs) in emerging markets face a credit paradox that hobbles the companies, their banks, and the broader economy.The Opportunity in SME The paradox is this: while three-quarters of SMEs in the developing world maintain formal savings and checkingFinancing accounts, only one-third of them have access to loans or credit of any kind. Financial institutions, for their part, lack sufficient data about these smaller companies— such as tax records, credit history, and legal status—to risk lending to them. As a result, many smaller businesses lack the capital they need to grow, while financial institutions miss an opportunity to tap into the huge pool of emerging-market SME borrowers. At the same time, emerging economies suffer, because they depend heavily on SMEs for economic growth and job creation. Heightening the paradox is that, despite these difficulties, SME financing in both the developed and developing world is a profitable source of business for many leading financial institutions. Innovative approaches can overcome SME financing challenges A number of innovative institutions are working actively and creatively to topple the barriers to SME financing in emerging markets. We have conducted a global review of those efforts and present below a summary of the most successful and scalable of the initiatives. These models can be adopted or adapted by financial providers seeking to broaden their range of SME financing opportunities. The purpose of this chapter is to provide a guide to those opportunities, as well as a framework for assessing them and taking action. There is little doubt among global financial institutions that SMEs are a key source of profits now and that they will continue to be so in the future. In a 2008 survey by Beck et al. of 91 banks in 45 countries, more than 80 percent of the banks described the SME market as a large and attractive one. More than 70 percent said profitability was the top driver of their involvement. A 2010 global survey by BCG suggested that serving SMEs can be more profitable than serving large companies. The average pre-tax return on regulatory capital in emerging market banks was 44 percent for small enterprises and 41 percent for medium enterprises, compared to 33 percent for large companies (Figure 1). The SME opportunity for providers extends beyond financing. Providing credit can lead to building business in deposits and transaction fees, as well, as this chapter’s case studies highlight. Capturing that additional non-financing revenue gives providers a better return on capital. But their success in doing so varies widely. Credit can represent as little as 20 percent of overall revenue for the “transaction champions,” and up to 87 percent for “credit-heavy traditionalists” (Figure 2). Providers will need to better integrate non-credit with financing business in order to serve SMEs effectively and profitably. Despite the strong demand for funding by SMEs in emerging markets, and despite the potential profitability Redefining the Emerging Market Opportunity | 31
    • Chapter 3: The Opportunity in SME Financing Financing SMEs can be difficult because many Box 1: The Definition of an SME of them are opaque—organizationally, financially, or both. The lack of “hard,” objective, transparent data The term SME encompasses a broad spectrum of required for credit assessment can make it impossible to definitions across countries and regions. Governments, ascertain whether firms have the capacity or willingness international organizations, and financial institutions to repay loans or honor other financial commitments. deploy an array of guidelines to define what constitutes an SME—based on the number of employees, sales, assets, Relative to large firms, many SMEs in emerging or a combination of factors. markets are informal, meaning they do not rigorously The most widely used criteria seem to be number report full financial activity. They may have unrecorded of employees and sales volume, present in 50 and 41 income from non-core activities, for example, or economies, respectively. Sixteen economies use the value hidden financial obligations to employees. Informality of loans. Several countries adopt a definition of SME that compounds opaqueness, multiplying the potential covers all firms with fewer than 250 employees, thus also obstacles and risks in SME lending. The lack of clarity including micro-firms. The cut-offs used in different countries vary clouds whether a business is viable and has the capacity significantly. For example, SMEs in Zambia are those with to absorb additional capital. annual turnover of less than US$50,000, compared to Therefore, expansion of financing into the SME US$2 million in Ghana and US$5 million in Indonesia. sector needs to be accompanied by development of The issue is further complicated because individual SMEs’ business and financial capabilities, to protect banks in the same country often use different definitions providers, investors, and other stakeholders and to for their own strategic and risk management purposes. ensure that the industry is sustainable. Many emerging- For purposes of this Report, the definition of small- and medium-sized enterprises or SMEs is based on the market governments conduct SME development region and country being discussed. Readers should programs. Still, other stakeholders need to be proactive adapt the approaches highlighted in this Report to a in accelerating development of SME operational and given sector based on its own definitions. Start-ups are financial capabilities. included in this Report’s definition of SME. Traditional banking models fall short in serving References SMEs effectively and profitably Aside from risk assessment, lack of profitability poses CGAP (Consultative Group to Assist the Poor) and The World Bank Group. 2010. Financial Access 2010: The State of the biggest barrier from the provider’s perspective Financial Inclusion Through the Crisis. Washington DC: to offering credit to SMEs, especially the smallest CGAP, The World Bank Group. enterprises. Banks’ sales and service models, which are optimized for larger clients, are often uneconomical when applied to SMEs. Providers often attempt to transferof providing it, many SMEs still struggle to obtain “relationship lending” practices to SMEs, only to findworking capital financing. The problem is particularly they are too costly and difficult to scale when applied tosevere for the smaller enterprises, even when they clients of lower business value.already have banking relationships. The International Many institutions, for example, simply categorizeFinance Corporation (IFC) estimates that 70-76 percent SMEs by size when designing coverage models. Theyof formal SMEs in emerging markets already have a usually focus little attention on other characteristics,banking relationship, primarily through checking and such as service requirements, business sector, anddeposit accounts, yet only 45-55 percent of them have the potential business value. At the same time, manyaccess to credit. providers do not sufficiently differentiate coverage Data collected by Beck et al. in 2006 from 10,000 models for medium as opposed to small enterprises,firms in 80 countries suggest that 39 percent of small thus disproportionately serving the smallest clients.firms and 38 percent of medium-sized firms are likely The result is an irrational allocation of resources andto rate financing as a major obstacle. As a result, many attention, rendering business with lower-value companiesSMEs turn to informal lenders for loans, often at very unprofitable while starving higher-value clients of saleshigh interest rates. coverage and other resources.Which SMEs are qualified to receive financing? For many SMEs, credit hurdles are too complex andDuring interviews conducted in preparation for this loan terms too burdensomeReport, many experts often asked the same key From the standpoint of SMEs, a major barrier toquestion. In the words of one, “Many people say SMEs obtaining credit is that the requirements, terms, andin emerging markets are not getting sufficient access to conditions imposed by formal lenders are often sofinancing. But we should also ask if they are qualified to stringent and burdensome that they render creditget financing.” offerings unattractive or difficult to meet. Our research suggests a single answer: the Traditional credit products—and the terms formanagement capabilities, experience, business acumen, accessing them—often fail to meet SME needs andand productivity of SMEs vary widely. Not all are qualified preferences. Collateral requirements are often quite rigidfor financing. Expanding SMEs’ access to financing will or unsuitable. Many institutions in emerging marketsrequire developing their business abilities. accept only real property and some forms of equipment32 | Redefining the Emerging Market Opportunity
    • Chapter 3: The Opportunity in SME FinancingFigure 1: Return on regulatory capital for top-performing business units by segment, 2009 Average pre-tax return on regulatory capital 50 40 30 (percent) 20 10 0 Small caps (excl. micro) Medium caps Large capsSource: BCG, Global Corporate-Banking Benchmarking Database 2010.Figure 2: Revenue mix for SME banking divisions in selected emerging market economies, 2010 100 80 Revenue (percent) 60 40 n  Risk management /investment banking   Transaction fees 20 n  Deposit interest income n Credit 0 Transaction champion model Typical bank Credit-heavy traditionalistSource: BCG, Global Corporate Banking Benchmarking Database 2010.Note: Risk management includes: Foreign exchange (spot and derivatives), Fixed income (cash and derivatives), Equities (cash and derivatives), Commodities, and Other capital market and asset management revenues. Investment banking includes: Debt capital markets, Equity capital markets, and Advisory. Transaction fees includes: Transaction account fees (e.g., checking, current, and transaction accounts), Payment fees (domestic and international), and Cash management services (liquidity mgmt, value-added services, and savings or time-deposit fees). Other revenues are not shown on the bar chart.Note: Sample includes SME banking units from Indonesia, India, Panama, Mexico, Brazil, Argentina, Czech Republic, Poland, Hungary, and Turkey. Redefining the Emerging Market Opportunity | 33
    • Chapter 3: The Opportunity in SME Financingas collateral. In addition, repayment plans often lack The three stages of opportunity and action tosufficiently flexible terms, such as grace periods and improve SME financingvariable installments. Credit offerings therefore fail to There are several areas that need to be addressed thataccount for the widely differentiated income-generating providers and other stakeholders should target in ordercapacities and revenue fluctuations of SMEs in different to accelerate SME access to financing, according to ourindustries and stages of development. Moreover, finance research. They are:offerings beyond simple credit are relatively limited for • Innovate and adopt new business models thatSMEs in emerging markets. serve SMEs more appropriately and economically Even when attractive credit terms are available, by optimizing acquisition, servicing, and collectionSMEs face particular challenges passing traditional activities.risk assessment. This is especially true when trying to • Develop a range of risk-assessment models beyondwin initial approval from a new provider. The time and relationship lending to overcome issues created byresource commitment involved in credit approval is SME opaqueness and informality, thereby efficientlyalso a challenge. Most providers assess risk using a serving a broader range of SMEs.relationship-based model, which can require substantialtime and expertise of both lender and applicant to • Improve financial offerings to SMEs by creatingreach credit approval. Documentation requirements, more appropriate products with more flexible terms, faster access, and less administrative burden.in particular, can overwhelm SMEs, whose accountingand disclosure standards and related resources do • Create new financing models beyond credit, such asnot match those of corporations. Additionally, SME equity financing, to serve a wider range of SMEs.operators, especially entrepreneurs, are too busy running • Create shared national infrastructures to drivethe business to navigate the time-consuming procedures adoption of new approaches, obtain economies ofof formal lenders. scale, and lower the cost of financing. The slow pace of traditional credit assessment • Improve SMEs’ business and financial capabilitiesand loan disbursement is also an impediment. SMEs to increase their likelihood of success and improveoften need loans quickly to resolve unforeseen cash transparency to financial providers.shortages. Formal providers may take weeks to approvea loan. This chapter is intended as a guide and action A particular challenge for many SMEs is that they framework for financial institutions seeking opportunitieslack the capacity larger companies have to showcase to improve SME finance in emerging markets throughand verify their accomplishments. Formal providers innovation and action. We see those opportunities inoften require a clear business plan to approve a loan three distinct stages (Figure 3):request. Many SMEs have insufficient financial and Stage 1: Develop and improve primarybusiness knowledge to create a compelling financial institutional competencies and business modelsproposal or business plan, even if they are accomplished regarding products, services, risk management, andbusiness operators. And regulators are rarely equipped SME client segmentation.to support SMEs through the credit process or to helpthem develop the financial acumen to support business Stage 2: Transform business models anddevelopment. offerings through national-scale partnerships and collaborations with formal and informal organizations.The private sector needs alternative mechanisms to Create shared infrastructure—such as repositories ofdevelop SME capabilities SME data—and employ financial channels to deliverTraditional banks are often not the right institutions for government loans and subsidies.serving start-up companies. Financial institutions, due Stage 3: Set the stage for future growth byto their risk-management approach, typically prefer to improving the business and financial managementfinance companies with clear cash flow that are already capabilities of SMEs themselves, and thus theiroperational. Additionally, formal financial providers creditworthiness and attractiveness for investors outsideoften have scant knowledge of quickly evolving high- the banking system.technology industries and their SME business models,and are inclined to reject loans for those entrepreneurs. STAGE 1: DEVELOPING KEY INSTITUTIONALAs a result, emerging economies are deprived of COMPETENCIESthe innovation, energy, and competitive capabilities As discussed above, there can be steep challengesthat start-ups and other SMEs bring to developed for providers in financing emerging-market SMEs.economies. However, by building new capabilities within their own At the same time, alternative forms of financing organizations, providers can overcome these challenges.beyond credit remain very limited in emerging markets. One key approach is for providers to optimize theirVenture capital, private equity, and similar start-up business and coverage models to serve SMEs morefinancing operations are crucial to support new SMEs economically.trying to expand into the next stage of development.34 | Redefining the Emerging Market Opportunity
    • Chapter 3: The Opportunity in SME FinancingFigure 3: Roadmap to expanding access to SME financing in emerging markets Developing key Transforming economics Setting the stage institutional competencies through partnerships for future growth • Incorporate the complexity of • Establish scaled infrastructure • Build models and institutions that client needs in segmentation to to facilitate transactional and encourage the participation of promote efficiency in sales and asset-based lending. investors from outside the banking service. system. • Engage all stakeholders to • Develop next-generation point-of-sale create an independent repository • Expand business and financial channels that enhance convenience of SME information. management capability of SMEs. and lower costs. • Partner with informal providers • Reduce risk and acquisition costs by to improve acquisition and leveraging the supply chains of large distribution economics. corporations. • Employ a wide range of financing • Develop a risk-assessment model options when designing government based on transactional and subsidy schemes.* psychometric information. • Federalize product development to allow product customization for a variety of SME business needs. Ensure regulations and business environment are supportive and do not inhibit new business models* Government-driven initiatives.Incorporate the complexity of SME needs into client significantly with personalized treatment. Technology-segmentation strategies enhanced outreach, such as phone calls and SMS,Financial institutions should revise their SME market allows for cost-effective relationship management, assegmentation strategies to be sure their services and the study found that such remote follow-up was almostproducts take into account the complexity of SME as effective as in-person meetings with individualclients’ needs and behaviors. More accurate profiling and relationship managers.segmentation allow providers to design more efficient The use of a remote model can help institutionscoverage models, significantly improving the profitability serve more clients using the same number of staffof serving SMEs. without diminishing sales and service performance. The Many financial providers today segment SME freed-up resources can be reallocated to target andclients only by size of annual turnover or credit limit. serve high-value current and potential clients.This is an inadequate approach in emerging markets,where SMEs of similar size often vary widely in service Adapt POS networks to speed approval and deliveryneeds. The high-touch approach required to serve of SME loanssome customers is wasted on others, regardless of Many institutions in emerging markets have well-turnover size. Designing a more efficient coverage model developed electronic payment networks. These point-to serve clients based on their actual needs and their of-sale (POS) machines and ATMs serve a broad rangeactual business value can significantly lower costs while of retailers and individual customers. By adapting thesebuilding revenue. More important, customized coverage existing networks to deliver SME financing, institutionsallows banks to shift the balance of resources to high- can approve and deliver loans at a lower cost tovalue clients and sales efforts, improving overall business themselves and with the speed and convenience theirperformance. customers need. Innovative providers have deployed “remote” A successful example of using POS machines inrelationship coverage models with the use of technology SME financing is the Loan via POS program by Garanti,(Case-in-Point 3.1). That relationship approach can the second-largest bank in Turkey and operator of theallow institutions to build relationships economically with country’s largest POS network (Case Study 12). Garanti’senterprises that offer lower potential value. high-speed, customer-centric process allows clients to In a study of SME customers of ICICI Bank in apply for and receive loans directly through their ownIndia, delinquency rates and onset of delinquency fell machines in a single step, by entering loan amounts Redefining the Emerging Market Opportunity | 35
    • Chapter 3: The Opportunity in SME Financing By offering loans through POS networks, a provider Case-in-Point: 3.1: Client micro-segmentation can also strengthen its position in non-financing and use of a remote service model businesses, such as merchant and payment services. In many emerging markets, demand for banking services Use supply-chain financing to reduce risk and by SMEs is expected to rise. Tapping that growth acquisition costs potential profitably, however, is not an easy task. SMEs’ individual contributions to bank revenues are smaller than The cost of acquiring small-ticket SME clients can be those of large enterprises, making it necessary for banks significant. Financial institutions that have established to lower the cost of serving these clients. relationships with large corporations have found a The size (e.g., annual turnover or credit limit) of an cheaper and less risky way to lend to SMEs: providing SME is a common factor in determining its coverage tailored loans through large firms to the SMEs in their model. However, size is an insufficient indicator of a supply chains. This business model shifts part of the client’s revenue potential and service needs. risk assessment to the corporate client, who commits Financial needs and behaviors are additional criteria that innovative institutions incorporate into their to the SMEs’ future cash flow, helps identify qualified segmentation approach. This variable includes the client’s borrowers, and monitors their conduct throughout loan terms. • range of product and service needs, such as credit Supply-chain financing programs generate additional cards, point-of-sale services, or loans; benefits for financial providers. Using this model, for • business sector, such as agriculture or example, a provider can ensure that SMEs obtain pharmaceuticals; and technical support and training from the large corporate • transaction role, such as working capital financier, partner. In Brazil, ABN AMRO Real collaborated with one retail operator, or wholesale buyer. of Latin America’s largest pulp and paper companies, Using a combination of revenue potential and needs Votorantim Celulose e Papal (VCP), to finance eucalyptus complexity, providers can better determine the most farmers supplying the company (Case-in-Point 3.2). The efficient service model to serve their clients. For low- partnership with VCP lowered ABN AMRO’s acquisition and mid-value clients with less complex needs, banks burden and allowed it to share credit risk with VCP in can deploy a remote relationship manager to handle several ways: communications, mostly by telephone or computer. Studies have indicated that customers’ satisfaction and • Increasing the certainty and improving the timing risk profiles do not differ substantially when compared of future cash flow to farmers by guaranteeing that with a traditional relationship manager model. In fact, VCP would purchase most of the harvest. more frequent remote interactions can improve sales • Supporting the initial assessment of farmers’ performance. qualification to participate in the program. This remote model can free up manager time and other bank resources, which can be shifted to serving • Ensuring VCP would provide technical assistance high-value clients and finding high-potential prospects. to farmers while monitoring that each plantation is Sales performance can increase significantly as a result. maintained properly. As another example, financial providers can build a References transaction platform that facilitates transactions between Schoar, A. 2011. “How can Financial Institutions Improve Products corporations and their SME business partners, and and Processes to Better Serve SMEs?” First Annual Conference on Entrepreneurship and SME Development. thereby gain useful information for assessing the SMEs’ Washington DC, November 30, 2011. creditworthiness. In Thailand, Kasikorn Bank (K-Bank) developed electronic supply-chain financing (e-SCF), Phone and email interviews of selected experts conducted by author. December 2011, April 2012. an integrated portal for SMEs operating within the supply chain of large corporations to make and receive payments (Case Study 14). Facilitating transactions between corporations and their SME partners is attractive to the corporationsand terms directly into the machine via the POS menu. because it reduces the back-office costs of handlingGaranti’s automatic scoring model provides effective risk accounts receivable. For banks, the model offers anassessment and credit approval at low cost by drawing efficient channel for offering financing solutions. K-Bankborrowers’ transactional information directly from the can offer financing programs, online and simultaneously,POS system. to SME suppliers and their corporate buyers alike. The program has eased the credit crunch for a Under the e-SCF platform, K-Bank creates awide range of SMEs that need loans quickly when large database of transactions between the corporateunforeseen liquidity needs arise. No documentation, sponsors and their SME business partners. Afteradditional collateral, guarantor, or reduction in POS limit confirming the loan applications of SME buyers andare needed. Applicants receive automatic notification of suppliers based on information from the corporatethe credit decision within five minutes via SMS, and can sponsors, K-Bank disburses collateral-free loans toaccess the loan through the POS machine. the SMEs’ accounts within three working days and at reduced interest rates. e-SCF also offers a simple36 | Redefining the Emerging Market Opportunity
    • Chapter 3: The Opportunity in SME Financingpayment procedure for both the sponsors and their SMEpartners. Case-in-Point: 3.2: Tailored supply-chain K-Bank is currently the number-one market player financing programsin Thailand in supply-chain financing, with THB40 billion(~US$1.3 billion) of loans to more than 60 supply-chain To financial institutions, one of the things that can reduce the attractiveness of the SME segment is the high cost ofbusinesses. acquiring customers, especially small-ticket ones at the top of the supply chain. To get around this obstacle, ABNDevelop risk-assessment approaches beyond the AMRO Real, in Brazil, teamed up with a financially stablerelationship-lending model downstream customer.Relationship lending has traditionally been the main The opportunity arose in 2005, when one of Latincredit -assessment model of most financial providers America’s largest pulp and paper companies, Votorantimin emerging markets. Relationship-lending procedures Celulose e Papal (VCP), was looking to substantially grow its position as a supplier of eucalyptus. Havingare based significantly on “soft,” qualitative information set its sights high—VCP hopes to become the world’sgathered through contact, over time, with the SME biggest supplier of eucalyptus pulp—VCP needed a wayand, often, with its owner and members of the local to build up, and gain some control over, local eucalyptuscommunity. Relevant data may include the character suppliers.and reliability of the SME’s owner, payment and receipt Eucalyptus farmers were considered a high risk duehistory of the SME’s past loans, and perceptions of the to the seven-year planting-to-harvest cycle before harvestSME’s future prospects collected in communications income can be realized. ABN Amro developed a tailored credit scheme to help manage risk and ensure that it iswith suppliers, customers, and neighboring businesses. suitable to these farmers’ cash flow. Additionally, ABN “Soft” information is often proprietary to the loan Amro involves VCP in the selection of farmers who qualifyofficer and may not be easily verified or transmitted to for the program. VCP is in charge of training the farmersothers within the financial institution. The strength of on technical skills.the lender-borrower relationship often affectss contract The farmers who joined the program, and whoelements such as interest rates, collateral, and credit became eligible for loans through what is known aslimits. Because of these characteristics, the relationship- the Poupança Florestal (Forest Savings Account), had to agree to a few conditions. They had to agree to selllending model has drawbacks. First, it is difficult to VCP at least 95 percent of their eucalyptus output at ascale, since it is useful only for existing customers and predetermined price, adjusted for inflation. They had toprominent SMEs. Second, the fieldwork time involved have plots of a certain minimum size, and they had tocan make it costly and labor-intensive. The higher costs live on the land they were cultivating. They had to agreeare likely passed on to borrowers in the form of higher to undergo training—very few of them had experiencerates or fees. In a highly competitive environment, higher in eucalyptus harvesting—and to have their progresscosts will result in margin compression. monitored by Brazil’s agricultural extension service. A maximum of 30 percent of the farmers’ land could be It is therefore important for financial providers to dedicated to eucalyptus, in order to keep the farmersexpand their capabilities in lending to SMEs. This can from becoming too dependent on income from this crop.be accomplished through transactional lending models, As of September 2007, more than 400 eucalyptuswhich are primarily based on “hard,” quantitative data producers, with land in excess of 8,000 hectares, hadthat may be observed and verified at, or close to, the entered into agreements with VCP. Loans are expected totime of credit origination. Hard data may include: reach US$30 million by the end of 2012, with benefits for 20,000 producing families. • financial ratios, such as profit margins, calculated The ABN Amro-VCP collaboration has several of the from audited financial statements; prerequisites of a successful supply-chain loan program, including in-depth knowledge of the industry under • credit scores assembled from data on the payment development and the presence of a financially stable histories of the SME and its owner provided by corporate partner. It can serve as a model to others for credit bureaus; and its smart approach to risk management and its sharing of • information from transparent, high-quality buyers operational costs. about accounts receivable being pledged as collateral by the SME or sold to the financial institution. References Boechat, C., and R.M.Paro. 2008. Votorantim Celulose e Papel Much of this information can be collected, verified, (VCP) in Brazil: Planting Eucalyptus in Partnership withand assessed through communications channels within the Rural Poor. New York: United Nations Developmentthe financial institution, saving time and cost. Programme. Sutton, C. N., and B. Jenkins. 2007. The Role of Financial ServiceProviders should consider transactional models, Sector in Expanding Economic Opportunity. Cambridge,including asset-based lending MA: Kennedy School of Government, Harvard University.There are different types of transactional lending modelsthat financial services providers can consider. Asset-based lending—including factoring—is often relevantin emerging markets. In asset-based lending, lenderslook for short-term assets, such as accounts receivable, Redefining the Emerging Market Opportunity | 37
    • Chapter 3: The Opportunity in SME Financinginventory, and equipment, and make credit assessments SMEs with short-term funding. This is particularly thebased on the liquidation value of these assets. case when timing is tight, as credit assessment and Asset-based lending is unique because it views the invoice processing take time.collateral as a primary source of repayment, as opposed Reverse factoring resolves this problem. Into a secondary source, as in other lending models. The traditional factoring, credit assessment is conducted foramount of credit extended under an asset-based loan is all buyers of a particular supplier. In reverse factoring, theexplicitly linked to the liquidation value of the asset used lender focuses on one large buyer and finances manyas collateral. This is continually monitored, to ensure that SME suppliers of that large buyer, thus simplifying creditthe value of the asset always exceeds the amount of the assessment and processing.loan. Reverse factoring offers a range of benefits. The Asset-based lending offers several key benefits lender benefits from lower information costs and creditin emerging markets. It overcomes opaqueness, as risk. The high-risk SME sellers benefit from accessrepayment capability is assessed based on collateral to less costly short-term working capital. The largevalue as opposed to a company’s cash-generating buyer benefits from outsourcing accounts receivableability. An SME’s riskiness is also not a barrier to management and negotiating better terms with suppliers,financing if its underlying assets have sufficient liquidity allowing them to extend the payment period.value. Therefore, this lending model is well suited to K-Bank’s e-SCF platform, described earlier in thishigh-risk SMEs. chapter (Case Study 14), is an example of successful Asset-based lending generates information about factoring. In K-Bank’s supplier financing program,borrower performance through the monitoring of the factoring is one of the main offerings. SME suppliersunderlying asset. It thus plays a critical role in bringing provide their invoices to corporate buyers as the basissmall businesses into the formal financial system, as it for receiving loans through the platform.helps them to build a history of financial transactions Providers can strengthen the proposition of theirthey can use in securing future financing. electronic transaction platforms by offering additional One form of asset-based lending is equipment services usually provided by accounting softwareleasing. Leasing enables small enterprises that have no companies. These include bank account reconciliation,underlying collateral to purchase equipment and use its invoice financing, and payment services. Usingvalue to leverage an initial cash deposit. For example, in information obtained from factoring transactions,farming, where lack of credit often constrains business, providers can also assess risk for other supply-chainleasing plans can help enterprises finance initial financing services, such as purchase-order financing.operations. Ultimately, factoring networks can be developed at the national level (see below, in the Second Stage).Factoring and reverse factoring offer an alternativeto traditional financing Transactional and psychometric credit-scoringFactoring is a specific type of asset-based financing. In models can be used to assess SME risktraditional factoring, a borrower’s accounts receivable— Credit scoring and similar quantitative techniques havethat is, payments due from customers—are used as the been widely used in consumer finance. More recently,underlying asset securing a loan. The lender—known they have been adopted by a growing number ofas the factor—purchases the accounts receivable at institutions to assess the risk of small enterprises.a discount. The amount of credit is thus linked to the These statistical models quantify a borrower’samount of receivables. default probability using various potential input variables. Factoring is particularly useful in emerging markets, The types of input for a credit-scoring model can varybecause the credit decision is based primarily on from current account and transaction information to verythe quality of the underlying accounts—often large specific industry-related information. The scoring modelcorporations—not on the quality of the SME borrower. and its assumptions can be adjusted based on theThis overcomes the problem of opaqueness, because growth and risk appetite of the lending institution.an informal SME’s corporate partner is relatively easy The use of a transactional credit-scoring model canto assess. Accounts receivable provide convenient and be complemented by the use of psychometric testing toavailable collateral for SMEs, since trading is part of most assess an SME’s willingness to pay and ability to absorbSMEs’ daily business operations. the loan. Psychometric testing uses the score from a For the factor, too, there are several important series of questions to assess risk. The test measuresbenefits. It can reap significant economies of scale in attributes such as the entrepreneur’s psychologicalboth lending and collections by performing them for profile, ethics and integrity, intelligence, and businessmultiple clients over a large number of transactions. In skills.addition, it can create proprietary databases by gathering Recently, Standard Bank Group launched a newaccount-payment performance information. The largest lending program that uses a psychometric assessmentand most experienced factors essentially become the to provide unsecured loans of up to US$30,000 to SMEsequivalent of large credit-information exchanges, offering in Africa, where businesses are largely in the informalan alternative to credit bureaus and registries. sector. The program, which was launched in Kenya, Yet traditional factoring, while convenient, is not Ghana, Nigeria, and Tanzania over the last year, adaptsalways a cost-effective or viable means of providing the psychometric test to the local market and SME38 | Redefining the Emerging Market Opportunity
    • Chapter 3: The Opportunity in SME Financing Case-in-Point 3.3: Transaction-based credit scoring Standard Chartered Bank is a global institution with a customer service. The assumptions of the bank’s scoring strategic focus on building small and medium enterprises model must constantly be updated, based on their record of (SMEs) in the emerging countries of Asia, Africa, and the accuracy. Assessment criteria are tightened or loosened to Middle East. The bank has successfully increased its balance loss-adjusted returns, overall business needs, and loan business in recent years—despite the absence of the bank’s growth appetite in specific markets. traditional risk-assessment data—with an innovative credit- Standard Chartered works constantly to build scoring model based on the details of applicants’ business efficiencies into the system. To reduce processing time and transactions and banking current-account data. costs, it encourages applicants to assume responsibility for To assess the health, liquidity, and repayment ability of gathering data, much of which they can provide online. Once loan applicants, Standard Chartered looks at checking and clients have completed several loan payments, Standard savings account balances, deposits, cash flow, and cash- Chartered can more accurately assess their ability to repay generating capabilities. and is more willing to extend additional credit lines. The bank checks information—when available—from Still, there is room for improvement. Standard credit bureaus, company registers, and tax filings to Chartered does not yet have a system to track how eliminate risky enterprises and those with multiple accounts. borrowers use their loans, for example. Therefore, in addition Standard Chartered has succeeded in expanding loans to its transaction-based credit scoring model, the bank to a range of high-quality clients using its non-traditional is also implementing psychometric testing that assesses approach. In China, the bank is recording 8 percent to 9 a customer’s ability to repay and to absorb the loan. And percent in loss-adjusted returns, higher than it said it had Standard Chartered continues to improve its ability to forecast. Twenty-three of the bank’s markets now deliver nurture relationships beyond the initial loan phase, to make overall income of more than US$100 million. sure SME clients continue to bring more business to the Turnaround time is Standard Chartered’s key bank as they continue to grow. differentiating factor. The bank has created standardized credit-assessment procedures based on its transactional scoring that allow it to return a loan decision to most References applicants within 48 hours. The bank is aided by its growing Furness, C. 2011. Phone interview by author with Chris Furness, transaction business, which channels client cash flow Managing Director, Standard Chartered, December, 2011. through its books. Hsu, C. 2011. “Standard Chartered Plans to Increase Lending to Still, harvesting transactional information for credit SMEs.” Taipei Times. March 22, 2011. assessment is a relatively manual process that can be time consuming and costly. It is kept as a manual process, in IFC (International Finance Corporation). 2010. Scaling-Up SME part, because of the individual analysis required in avoiding Access to Financial Services in the Developing World. the risk of customers’ gaming the system by creating Washington DC: IFC. artificial flows. Credit applicants not using Standard Jenkins, P. 2011. “Former GE Man’s Lightning Touch.” Financial Chartered as their main transaction bank can provide their Times. October 10, 2011. account statements from other banks to apply for a loan, though the process is slower. John, I. 2011. “Standard Chartered Unveils New SME Initiative.” In competitive markets, products and processes are Khaleej Times. April 12, 2011. quickly copied. For Standard Chartered, that means staying Khare, S.V. 2011. “India Powers Stanchart Profit.” Financial Chronicle. focused on honing back-end processing capabilities that March 2, 2011. support the competitive advantage of fast and efficienttrading conditions. This approach shortened Standard Chartered current account customers, if they provideBank‘s loan disbursement process from several weeks their bank statements.to less than three days and reduced application forms Institutions can also leverage information such asfrom 19 pages to two. tax and utility bill payment records to enhance their Credit scoring for SMEs can be more complex than transactional credit-assessment models. For example,for consumer finance, as considerable weight is given electricity consumption can help estimate factory sizeto an entrepreneur’s credit and financial history. The and production volumes for companies in the steelmain challenge is to identify what information to use in manufacturing industry.the model. Since most SMEs have bank relationships One key challenge in this approach is that leveragingthrough deposit or current accounts, banks have data to transactional information for credit assessment is abuild a credit-scoring model for SMEs. relatively manual process, and therefore can be time Standard Chartered Bank has adopted such consuming and costly, depending on data availability.data to develop credit scoring in emerging markets This is particularly true for providers that do not have(Case-in-Point 3.3). Standard Chartered looks at a strong transactional business, and most of whosea borrower’s current account balance, inflow, and clients do not use them as their main transaction bank.outflow as additional input to assess the SME’s health To reduce processing time and costs, institutionsand repayment ability in advance of credible-rating need to place the responsibility for data gatheringinformation. This approach is also used for non-Standard on the customers as much as possible. Institutions Redefining the Emerging Market Opportunity | 39
    • Chapter 3: The Opportunity in SME FinancingFigure 4: Factoring penetration by country 20 Cyprus United Kingdom Domestic factoring volume (percent of GDP) l  Emerging economies l  Developing economies Portugal 10 Chile Spain Taiwan Italy Belgium Belgium Turkey Croatia France Finland Greece South Africa Sweden 5 Australia Netherlands Norway Poland Czech Republic Germany Brazil Hungary Hong Kong SAR China Peru Mexico Japan Austria Denmark India Bulgaria Lebanon Singapore Slovenia Morocco Russia Switzerland Malaysia Korea Canada Thailand New Zealand United Arab Emirates Israel 0 Vietnam Argentina 0 Romania 20 40 60 100 GDP per capita (US$ thousands)Source: Factor Chain Internationalthat use psychometric testing typically make the test were ready to go public, BOC acted as promoter andself-administered on a computer without any banker underwriter of the initial public offering.supervision, thus lowering assessment costs. On a more macro level, providers can build various industry-specific packages, like the approach usedImprove the ability to deliver flexible offerings that by Garanti Bank. Garanti offers 17 sector-specificmeet specific SME needs loan packages to SMEs from industries as diverse asAs discussed previously, terms and conditions offered agriculture, manufacturing, tourism, pharmacy, furniture,by formal financial providers often do not cater to SMEs’ food wholesalers, and logistics. Loan terms—includingbusiness needs. Financial providers need to build their payment schedules and types of collateral— reflect eachcapability to gather customer inputs and design a wide sector’s business cycle and stage of growth.range of flexible offerings that cater to the specific needs Finally, providers will need to tailor their productsof many SME segments. to support supply-chain financing programs, discussed One approach adopted by Bank of China (BOC) above. In ABN AMRO’s partnership with VPS (Case-in-is to decentralize insight generation and product Point 3.2), eucalyptus timber production served as andevelopment to regional teams (Case Study 11). BOC alternative form of collateral, allowing farmers who doadopted a regional product strategy, decentralizing not own their land to get a loan. To minimize risk, ABNproduct development functions to first-tier branches and AMRO specified the maximum proportion of land thatexecution to sub-branches, including consumer insights could be planted with eucalyptus.generation and product tailoring. It also relies partially Providers can expand supply-chain financingon local market knowledge and non-financial information operations by partnering with franchisers and lendingto assess risks. Other loan operation functions, such as associations to offer services to those partners’marketing, loan management, and monitoring, remain members and affiliates.centralized. BOC also adopted simplified proceduresthat reduced loan approval to five days. Finally, it built STAGE 2: TRANSFORMING ECONOMICS THROUGHan automated, industry-specific SME risk-management PARTNERSHIPSsystem. Beyond transforming the capabilities of financial The program resulted in over 200 credit products providers to serve the SME segment better and moreand services, each tailored to meet the specific efficiently, stakeholders will benefit from establishingcharacteristics of SMEs by region, industry stage of national-scale infrastructure, partnerships, and sharedgrowth, and business conditions. BOC disbursed services.RMB140 billion (~US$22 billion) of loans through thisprogram by mid-2011, reaching over 22,000 SMEs. For Establish scaled infrastructure to facilitateexample, financing for a film and television SME used transactional and asset-based lendingintellectual property as collateral. For SME clients that As discussed earlier, factoring and reverse factoring can be powerful models for SME financing. Factoring40 | Redefining the Emerging Market Opportunity
    • Chapter 3: The Opportunity in SME Financinghas been substantially promoted in recent years, butthere is still significant opportunity to broaden its use Case-in-Point 3.4: Creating liquidity for SMEsin many emerging markets. Figure 4 shows factoring through an electronic credit networkpenetration by country. Many emerging economies, andsome developed ones, are not listed because they have SMEs make a significant contribution to economic growth around the world, but often struggle with working-capitalyet to adopt factoring as a viable financing model on a problems. Mismatched credit periods mean SMEs havemeaning scale. to pay their suppliers on a certain date but may not get Building a national infrastructure to promote reverse cash flow from buyers until 30 or 60 days later. The lackfactoring has proven successful in Mexico (Case Study of working capital makes it hard to grow.15). Nacional Financiera (Nafin) offers national-scale Several Latin American nations have piloted a creditonline factoring services to SME suppliers. Nafin acts network developed by the Social Trade Organization, aas a receivables broker for over 20 domestic lenders. Dutch research and development NGO. The network, called the Commercial Credit Circuit (C3), allows virtualAfter collecting transaction information over time, Nafin credit to be used in lieu of conventional currency. Uruguayexpanded into purchase-order financing. Nafin’s success is in the lead on this initiative; its C3 credit program wascan be attributed to the fact that it operates on an introduced nationally in mid-2010 and is expected toefficient electronic platform to provide online factoring reach as many as 10,000 Uruguayan SMEs by 2013.services, improving turnaround time and security while The primary goal of Uruguay’s network is to increasereducing costs. Nafin also promotes competition among liquidity among SMEs. Uruguay’s C3 program allows itslenders, helping SMEs to obtain better rates. NAFIN participants to pay each other using C3 credits rather than conventional currency. After opening an accountmanages risk of fraud by requiring buyers to submit with the C3 clearinghouse, a business owner get itsreceivables to be factored. The program continues to receivables insured by certified insurance companies,show healthy growth and is now the largest source of converts the predetermined amount into C3 credits,financing in Mexico. and can then use those credits to pay her suppliers. At Another recent example of national-scale factoring maturity, the holder cashes our C3 credit at no cost.infrastructure is a virtual money-trading ecosystem In the case of cashing out before the credits are due,developed by Commercial Credit Circuit (C3) in Uruguay interest for the outstanding period must be paid, plus banking fees. These virtual loans are cheaper and(Case-in-Point 3.4). Circulation of virtual credit allows faster than traditional bank loans, accelerating businessparticipants in the network to pay each other using C3 transactions and the economy. Indeed, one of thecredit rather than conventional currency, thus lowering reasons Uruguay’s program is relatively advanced is thattransaction costs and expediting disbursement. it was a product of necessity, having come into existence To support factoring and reverse factoring at a time (2002-2003) when Uruguay was emerging fromoperations on a large scale, governments must create a banking crisis and needed a way to alleviate nationala supportive tax, legal, and regulatory environment. currency shortages. Currency networks have their challenges. ForFactoring transactions must receive fair and favorable tax instance, because they require participants to use thetreatment. Electronic security laws must assure factors same currency, they are of limited value to SMEs thatand borrowers that their transactions are recognized, rely heavily on export/import activities. The nature of theconfidential, and secure. The commercial code must system also requires significant government planningtreat factoring as both a purchase and sale, as well as a and oversight to create a central clearinghouse to trackfinancial service. Regulators, buyers, and suppliers must transfers of credits; invest in information technology;be educated about the benefits of factoring and reverse and, often, set up a guarantee fund to encourage use of the system. In Uruguay, the central bank, state-ownedfactoring transactions. SMEs will often need support enterprises, and the national pension fund all play a role inin bringing their back-office systems up to the required C3 in one way or another.standards of the program. Similarly, to ensure that asset-based lending ingeneral can be adopted on a large scale, regulators Referencesneed to build a clearly defined and predictable set of Allen, M. 2009. “Cash Substitute Greases Business Wheels.”laws and regulations governing these transactions, and SwissInfo.ch, October 21, 2009.improve the tax regime and supervisory framework. For C3 Uruguay. Website. http://www.c3uruguay.com.uy/..example, although leasing does not need to be granted Lietaer, B. 2009. “Commercial Credit Circuit (C3): A Financialany tax or regulatory advantage to develop, regulations Innovation to Structurally Address Unemployment.”must provide a level playing field for both leasing and Submission to online forum. World Academy of Art &traditional lending. Without specific regulations, leasing is Science, November 15, 2009. http://www.worldacademy.at a disadvantage compared to traditional loans, which org/forum/commercial-credit-circuit-c3.are better understood by the judicial, financial, and Qoin. Commercial Credit Circuit. http://qoin.org/commercial-commercial system. credit-circuit/. Flintoff, J.-P. 2012. “Stock Swap.” CNBC Business, January-Engage all stakeholders to create independent February 2012. http://www.cnbcmagazine.com/story/stock-repositories of SME information swap/1523/1/.Credit-repository and rating agencies are critical toexpand financing to SMEs. Credit-rating agenciesmitigate information asymmetry between lenders and Redefining the Emerging Market Opportunity | 41
    • Chapter 3: The Opportunity in SME Financing borrowers by providing an objective assessment of the Case-in-Point 3.5: Commercial SME credit borrowers’ creditworthiness, including their financial rating services viability, ability to honor financial obligations, and business risk exposure. Given the difficulties and high costs associated with In our interviews, many experts in financial SME credit assessment, commercial banks and financial institutions suggested that access to centralized institutions sometimes shy away from serving this sector. In India, only 13 percent of registered SMEs have access information would significantly improve institutions’ ability to finance from formal sources, according to a 2010 to conduct risk assessment and thus to extend financing report from the country’s reserve bank. to more SMEs. However, many markets do not have Although the involvement of government entities centralized SME credit-rating or repository agencies. increases the credibility of SME ratings, bureaucracy can In developed markets, several commercial undermine the efficiency of program execution. Private, entities (e.g., Dun & Bradstreet) specialize in building commercially driven credit rating agencies can accelerate and providing enterprise databases used for credit progress in covering SMEs in emerging markets. Over the last few years, India has made progress assessment. It is critical in emerging markets to initiate in developing a robust and competitive SME credit the involvement of the private sector to build a shared rating sector. Its biggest credit ratings company, CRISIL infrastructure for credit data. Ratings, is majority owned by Standard & Poor’s. CRISIL In India, SME credit rating is robust and competitive has credit specialists in a diverse set of industries, with multiple players. CRISIL Ratings, whose majority including automotive, pharmaceuticals, textiles, and shareholder is Standard & Poor’s, is India’s largest telecommunications. This makes it possible for ratings to ratings agency (Case-in-Point 3.5). It offers a full be issued quickly and accurately. CRISIL also revisit their ratings regularly. CRISIL’s SME ratings are generally good spectrum of rating services, covering entities from large for a year, but the service will update a rating if its analysts to micro. CRISIL provides financial and non-financial become aware of a material change in a company’s information on SMEs, with specialized information by financial health. In issuing its ratings, CRISIL goes beyond sector to allow for peer benchmarking. The rating agency an analysis of corporate financial data, factoring in charges revenue-based fees in an effort to make SME considerations such as management experience, pricing rating affordable to companies of any size. power, and the stability of a company’s customer and One key challenge for credit rating agencies supplier bases. Another CRISIL service, Dealer and Evaluation in emerging markets is that many micro and small Services, helps corporate entities and banks benchmark enterprises lack properly constructed, audited financial SME creditworthiness through the strengths of their statements. Parallel government efforts should be in current suppliers and customers. The inputs for place to train SMEs to undertake proper financial record determining creditworthiness include management keeping and presentation. discussions and feedback from bankers and other relevant sources. The results allow entities to put SMEs Partner with informal providers to improve into tiers and to evaluate them as potential business partners, thereby de-risking their supply chains. acquisition and distribution A good credit rating, of course, has major financial Informal channels provide SMEs with a quick and easy benefits, as well. SMEs that receive one get interest rates channel to mitigate their funding shortages. Through that are 0.25 percent to 1.5 percent below what they pawnshops, loans can be disbursed quickly, often would otherwise be. within days, rather than the weeks required to process CRISIL offer revenue-based rating fees in order traditional bank loans. However, pawnshops generally to make a credit rating affordable regardless of an charge interest rates 6-7 times higher than do banks. In enterprise’s size. In addition, the National Small Industries Corporation offers a subsidy to SMEs, covering up to 75 China, for example, the interest rates charged for loans percent of the fees involved in the ratings process. To backed by real estate and movable assets can be as date, CRISIL has done ratings of some 25,000 SMEs. high as 38 percent and 56 percent per year, respectively, compared to the 6 percent per year charged by banks. Partnerships between a bank and an informal References financial institution such as a pawnshop can improve Chadha, S. 2011. “Benefits of Credit Rating for SMEs.” The overall economics for SME financing. For example, Economic Times. June 20, 2011. customers can still benefit from fast access to loans CRISIL Limited. 2011. Annual Report 2011. Mumbai: CRISIL and flexibility in collateral, as offered by pawnshops, but Limited. subsequently, obtain the lower rates offered by banks. — Website. http://www.crisil.com/index.jsp. —. One example of such a partnership is the Bank- Pawn-Expressway program in China (Case Study Thakur, N.,and G. Seetharaman. 2011. “Crisil Expects to Grow Its SME Ratings Business Ten-Fold.” DNA Daily News and 13). The partnership is based on Huaxia Pawnshop’s Analysis. April 20, 2011. capacity to store, maintain, and perform quick and accurate due diligence on collaterals. This simplifies the partner banks’ credit assessment procedures and reduces their cost of acquiring and serving SME customers. Loans can be disbursed within two days. In return, Huaxia Pawnshop receives bank financing for its business expansion.42 | Redefining the Emerging Market Opportunity
    • Chapter 3: The Opportunity in SME Financing For this model to work, banking and non-bankingindustries need to be aligned. The traditional pawnshop Case-in-Point 3.6: Hybrid direct loan and creditindustry is loosely regulated in many emerging markets. guarantee programs for SMEsGovernments may need to regulate and restructure thissector to facilitate partnerships and reduce banking Khula Enterprise Finance was founded in 1996 as a government-financed loan wholesaler focused on SMEsrisks. in South Africa. Working through intermediaries such as commercial banks and retail financial institutions, itEmploy a wide range of financial options when sought to bridge the funding gap and reach segmentsdesigning government loans and subsidies of the SME market not served by commercial financialGovernments around the world have implemented a institutions, primarily through a credit guarantee program.number of programs to promote lending to SMEs. One However, after the financial crisis of 2008, bankscommon type of program involves subsidized loans, cut back on lending, especially to small enterprises, and it became apparent that the wholesale model was fallingloan guarantees, and special lines of credit—usually short in assisting SMEs. In 2010, Khula guaranteed fewerchanneled through public banks and usually benefiting than one-third as many loans as in previous years.specific economic sectors. To make up for financial institutions’ unwillingness South Africa established Khula Enterprise Finance to to loan, Khula began offering credit directly to lower-endbroaden the reach of financing to more SMEs (Case-in- SMEs in underserved areas. Its Khula Direct programPoint 3.6). Khula guaranteed loans by commercial banks offers loans of less than R500,000 (US$61,400), whichand other financial institutions. However, when the global banks and other retail financial institutions are often unwilling to approve. Loans are disbursed through Khula’sfinancial crisis hit in 2008, banks cut back on lending, 11 regional offices. In the future, Khula expects to getespecially to small enterprises, and Khula’s guarantees some retail financial institutions to participate in the directfell drastically. Khula then launched a direct financing lending program and help the program grow.model to complement the guarantee scheme. It targeted Loans to small-scale SMEs are risky because of aits direct loans at lower-end SMEs in underserved areas, lack of reliable financial data. In addition, the inexperienceespecially those that banks were unwilling to approve. of SME managers can result in high default rates. ForKhula also offered mentorship and information collection this reason, Khula offers post-loan mentorship to SMEs through the Institute of Business Advisers of South Africaservices to help SMEs develop their business and and through the Small Enterprise Development Agency.financial skills. South Africa’s experience underscores It counts on field officers it has hired to gather thethe fact that a direct lending program may be required information necessary for loan applications.to complement a credit guarantee scheme, especiallyduring times of economic uncertainty. A second type of government subsidy promotes Referencesdevelopment of alternative types of SME financing within Khula Enterprise Finance Ltd. Website. www.khula.org.za.the private sector. — 2011. Annual Report 2010/2011. Sunnyside, South Africa: —. As previously mentioned, Nafin built a national Khula Enterprise Finance Ltd.factoring program in Mexico. The government initially Terblanche, B. 2011. “Government Launches Direct Lending forprovided funds to set up the national electronic Small Businesses.” Mail & Guardian Online. October 14,infrastructure and offered credit guarantees to drive initial 2011.buy-in for the program. — 2010. “Khula’s Grand Helping-Hand Plan Fizzles Out.” Times —. Another example is the Yozma Fund in Israel (Case Live, October 3, 2010.Study 16), which promotes venture capital financing forthe high-tech sector. The government recognized that,to succeed, SME start-ups needed help not only withraising funds, but also with learning strong managementskills, acquiring business know-how, and gaining access 2000 and US$5.9 billion in 2008. As of 2008, Israel’sto foreign investors. venture capital industry was second only to that of Yozma started with the government investing the United States, with 80 active funds and more thanUS$100 million in two fund types, both focused on US$10 billion under management.high-tech SME start-ups. While 20 percent of the funds A third type of government program supports thewere invested directly in high-tech SMEs, 80 percent technical development of SMEs. For example, initiativeswere invested in 10 new private venture capital funds, to simplify and standardize SME financial data havein partnership with leading foreign venture capital proven useful in cultivating more SMEs that can qualifyinvestors. Yozma gives investors the option to purchase for private-sector loans.the government’s stake should the venture capital fundbecome successful, thus providing both a risk-sharing STAGE 3: SETTING THE STAGE FOR FUTUREcomponent and an attractive upside to interest investors. GROWTHAt the same time, it ensures that local SMEs can tap As discussed previously, financing schemes such asinto the capabilities of international venture capitalists to venture capital and equity financing are needed tosupport their growth. complement the banking system, especially to provide Yozma has been highly successful in promoting a financing to those SMEs in the early stages of businessprivate venture capital sector. It raised US$3.2 billion in development. Redefining the Emerging Market Opportunity | 43
    • Chapter 3: The Opportunity in SME Financing Case-in-Point 3.7: Diagnostic tools for building productivity and financial access Despite Latin America’s recent economic growth record, FINPYME’s model relies heavily on local partners, the region’s small and medium-sized enterprises (SMEs) are which are better able to develop deep connections with hindered by low productivity. Latin American SMEs account the private sector and understand local businesses. Local for roughly 90 percent of companies and 61 percent of partnering also decreases FINPYME’s expense in building employment, but only 28 percent of GDP. Improving SMEs’ new capacity. business capabilities can increase their chances of obtaining Standardization of the diagnostic tool makes it finance. efficient to fund smaller enterprises, providing a common The Inter-American Development Bank (IDB) began to framework to compare risks, rewards, and challenges. to support SMEs in Latin America in 1989. The program, On the other hand, the program adopts a tailor-made now called FINPYME, partners with local agents from capacity-building strategy, giving agents the latitude to academic and trade associations to develop the key prescribe different solutions depending on the context. diagnostic tools for providing consulting assistance to SMEs. This is supported by FINPYME’s commitment to using a The agents then identify viable SMEs, provide them with comprehensive methodology, looking at a full spectrum unique, tailored technical assistance, and implement the of indicators measuring the strength of an SME. Meeting findings of competitiveness evaluations. Partner banking the needs of diverse SME clients also requires a long-term institutions make a commitment to commitment and a willingness to use pilot programs and evaluate the creditworthiness of SMEs that longer implementation periods to allow for feedback and have participated in FINPYME and occasionally provide methodological refinement. enterprise financing. FINPYME’s standardized tools, criteria, and assistance FINPYME provides a range of services: can be accessed online. Disseminating knowledge and tools online facilitates uptake and lowers implementation costs. • FINPYME Diagnostics: evaluates the firm’s industry attractiveness, competitive position, intellectual capital, innovativeness, and environmental situation, as well as References its major projects, resources, and financial situation. ECLAC (Economic Commission for Latin America and the Determines technical assistance priorities to Caribbean), OAS (Organization of American States) and IDB raise competitiveness and the firm’s suitability (Inter-American Development Bank). 2011. Innovating, Gaining for financing. Market Share and Fostering Social Inclusion: Success Stories • FINPYME Technical Assistance: provides consulting in SME Development. Washington DC: ECLAC. services ranging from environmental regulation ECLAC. 2010. Time for Equality: Closing Gaps, Opening Trails. compliance to financial analysis and market evaluations. ECLAC Session Report. Washington DC: ECLAC. • FINPYME ExportPlus: helps SMEs diversify their markets Ferraro, C. and G. Stumpo. 2011. “Las pymes en el laberinto de las and products by facilitating access to international políticas.” ECLAC Conference on Policies to Support SMEs in markets. It addresses three key steps: acquiring quality Latin America. Montevideo, Uruguay, July 15. standard certification, managing productivity deficiencies, IFC (International Finance Corporation). 2010. Scaling-Up SME and improving management skills. Access to Financial Services in the Developing World. • FINPYME Family Business: focuses on improving Washington DC: IFC. corporate governance of family enterprises, with specific IIC (Inter-American Investment Corporation). FINPYME. emphasis on operating protocols and succession planning. — Technical Assistance. http://www.iic.org/about-us/technical- —. assistance. • FINPYME Integrity: aims to foster business transparency by advising SMEs on best practices regarding — FINPYME Caribbean: A Diagnostic Tool for SMEs. Brochure. —. compliance, fraud prevention, and reporting to Washington DC: IIC. shareholders — 2010. 2010 Annual Report. Washington DC: IIC. —. • GREENPYME: encourages energy efficiency and clean — 2008. FINPYME Training and Methodology Manual. Washington —. technologies through training, awareness workshops, DC: IIC. and energy audits. — IIC and IDB (Inter-American Development Bank) Group. 2011. —. Over the last year, hundreds of firms have used Aid-for-Trade: Case Story: FINPYME Export Plus. Paris: OECD FINPYME diagnostics, received technical help, attended (Organisation for Economic Cooperation and Development). workshops, and received a total of $1.6 million in loans through financial partners. FINPYME is expected to be deployed in 17 countries by the end of 2012.44 | Redefining the Emerging Market Opportunity
    • Chapter 3: The Opportunity in SME Financing Additionally, systematic programs involving the the GDP contribution per labor unit. To improve theirprivate sector are needed to develop SMEs and ensure chances of obtaining financing, SMEs need to build theirthat more of them are capable of absorbing additional business and financial capabilities and, in turn, theircapital. It would be difficult to support many SMEs in productivity.emerging markets by relying on government programs A creative example of developing SMEs’alone. Involving the private sector in development capacity is FINPYME, launched by the Inter-Americaninitiatives can accelerate progress. Development Bank (Case-in-Point 3.7). The program provides diagnostic tools and involves local agents andBuild models and institutions that attract and serve academics in screening and providing support to SMEs.non-banking investors FINPYME works with the local partners to identify SMEs.When barriers to SME financing exist within the After a diagnostic, the agent specifies managementbanking sector, a path forward may be cleared through challenges and provides unique, tailored technicaldevelopment of equity financing, such as private equity. assistance. The agent also determines the SME’sEquity funding of SMEs is catching on among investors, suitability for financing from partner financial institutions.who are finding ways to assist the companies in their The standardized tools, criteria, and assistance can bemanagement and technical challenges in return for accessed through an online channel.access to early financial returns. In addition to the approaches identified in this In African countries such as Kenya—which are chapter, governments also need to continue to driveemerging from economic recession, massive defaults, initiatives to improve the institutional environment. Thisand a high volume of non-performing loans—banks will be essential, particularly during global economichave become excessively conservative. They often slowdowns. Strong macroeconomic conditions arerely on stringent and sometimes unattainable collateral critical for the SME sector, as smaller companies tendrequirements. In such an environment, non-debt to be more affected by economic downturns than largefinancing instruments can play an important role in corporations.funding SME growth. A country’s legal institutions shape access to Private equity firms such as Aureos Capital and external financing, as well as firm growth. In countriesfund management companies such as Business with better institutional environments, SMEs face fewerPartners International (BPI) have jumped into the breach financing obstacles, obtain more external financing,(Case Study 10). They provide examples of SME equity and grow faster. More important, recent research usingfinancing different from those in developed markets. firm-level data show that SMEs seem to benefit the mostBoth Aureos and BPI deploy equity and quasi-equity from improvements in the institutional environment.to help SMEs bridge the financing gap.1 They manageinvestment risk through selection criteria, deal structure, NOTEtechnical assistance, and portfolio diversification. They 1 Quasi-equity investments are debt instruments that are counted toward equity for shareholder-reporting purposes.structure their investments in the form of either largeminority stakes ranging from 30-40 percent, or revenue- REFERENCESsharing arrangements. Afribiz. 2011. “Standard Bank Applies Psychometric Lending Criteria to Both Aureos and BPI provide support, guidance, African SMEs.” Afribiz. November 25, 2011.and governance advice to help target companies Bakker, M., L. Klapper, and G. Udell. 2004. Financing Small andabsorb the funds’ investment and capitalize on market Medium-size Enterprises with Factoring: Global Growth inopportunities. Both investment groups rely on networks Factoring—and its Potential in Eastern Europe. Warsaw: The Worldof regionally based experts to provide technical Bank.assistance and a knowledge network to SMEs. BCG (Boston Consulting Group). Global Corporate Benchmarking Aureos has completed 250 transactions. Its first- Database 2010.generation portfolio has realized gains of US$141 million, Beck, T., A. Demirguc-Kunt, L. Laeven, and V. Maksimovic. 2006. “Thewith a 2-times cash multiple and 30 percent internal rate Determinants of Financing Obstacles.” Journal of International Money and Finance 25(6): 932-52.of return. BPI Kenya has disbursed US$7.3 million ofinvestments in 62 projects. These companies’ success Beck, T., L. Klapper, and J.C. Mendoza. 2008. “The Typology of Partial Credit Guarantee Funds around the World.” Policy Researchhas attracted other investors to establish eight new Working Paper Series 4771. Washington DC: The World Bank.Africa SME funds totaling US$400 million. Beck, T., A. Demirguc-Kunt, M. Pería. 2008. “Bank Financing for SMEs around the World: Lending Practices, Business Models, DriversImprove the business and financial management and Obstacles.” Policy Research Working Paper Series4785.capability of SMEs Washington DC: The World Bank.Among the concerns of financial providers regarding Berger, A. and G. Udell. 2004. “A More Complete Conceptualemerging-market SMEs, worries about the business and Framework for SME Finance.” Presentation at the World Bank Conference on Small and Medium Enterprises, Washington DC,financial capabilities of these companies rank at the top. October 14-15.SMEs are often plagued by low productivity as well as CGAP (Consultative Group to Assist the Poor) and The World Banklack of financing. Latin American SMEs, for example, are Group. 2010. Financial Access 2010: The State of Financialonly 16-30 percent as productive as larger enterprises. Inclusion Through the Crisis. Washington DC: CGAP, The World In the developed world, SMEs usually achieve Bank Group.productivity between 63-83 percent, measured as Redefining the Emerging Market Opportunity | 45
    • Chapter 3: The Opportunity in SME Financingde la Torre, A., J.C. Gozzi, and S. Schmukler. 2006. “Innovative Experiences in Access to Finance: Market Friendly Roles for the Visible Hand?” Policy Research Working Paper Series 4326. Washington DC: The World Bank.ECLAC (Economic Commission for Latin America and the Caribbean). 2010. Time for Equality: Closing Gaps, Opening Trails. ECLAC Session Report. Washington DC: ECLAC.Factor Chain International. Current factoring turnover by country. http:// www.fci.nl/about-fci/statistics/current-factoring-turnover-by- country.Freund. C. 2011. Small and medium enterprises: Not a silver bullet for growth and job creation. Voices and Views: Middle East and North Africa. The World Bank. http://menablog.worldbank.org/ small-medium-sized-enterprises-not-silver-bullet-growth-and-job- creation.GPFI (Global Partnership for Financial Inclusion) and IFC (International Finance Corporation). 2011. SME Finance Policy Guide. Washington DC: IFC.IFC. 2010. Scaling-Up SME Access to Financial Services in the Developing World. Washington DC: IFC.Kallberg, J. and G. Udell. 2003. “Private Business Information Exchange in the United States.” In Credit Reporting Systems and the International Economy, ed. M. Miller. Cambridge, MA: The MIT Press.Klapper, L. 2006. The Role of “Reverse Factoring” in Supplier Financing of Small and Medium Sized Enterprises. Washington DC: The World Bank.Kotei, M. 2010. “Creating Value with Leasing in Emerging Markets.” The World Bank Access Finance 33.Schoar, A. 2011. “How can Financial Institutions Improve Products and Processes to Better Serve SMEs?” Presentation at the IPA SME Initiative and the Inter-American Development Bank Conference on Entrepreneurship and SME Development, Washington DC, November 30.The World Bank. 2008. Finance for All? Policies and Pitfalls in Expanding Access. Washington DC: The World Bank.Zavatta, R. 2008. Financing Technology Entrepreneurs & SMEs in Developing Countries: Challenges and Opportunities. Washington DC: infoDev, World Bank.46 | Redefining the Emerging Market Opportunity
    • CHAPTER 4 Corporate bond markets provide many advantages, both subtle and systemic, in the nations where they thrive. Economies, companies, and investors all receive clearThe Opportunity in and measurable benefits when corporations compete transparently to raise funds by selling debt.Corporate Bonds In emerging countries, domestic corporate bond markets provide a number of powerful systemic benefits. They help diversify economies, reduce systemic risk, and mitigate exposure to currency swings. As economies evolve, local companies grow larger, too, and develop more complex funding needs, such as handling larger investments and managing liquidity, interest-rate, and foreign currency risks. Bank credit alone cannot meet these requirements. Corporate bonds provide a valuable alternative debt instrument. Other benefits include: • More efficient distribution of resources: Local corporate bond markets help allocate capital more efficiently because they fill the gap left by banks in providing large-scale, long-term financing. For example, some projects need funding over a 10- to 20-year period. Banks are constrained from lending in these circumstances because the life span of their deposit accounts is usually 5-10 years. • Greater corporate and market transparency: Issuing bonds requires public companies to disclose financial and operations data, increasing the transparency of company finances and management strategies. Moreover, in principle, corporate bond disclosures help educate investors, generating more informed investment decisions across the market. • More efficient risk pricing: Corporate bond markets increase transparency as well as competition among financial providers, producing more effective pricing of risk. One result is lower funding costs for borrowers with demonstrably higher-quality credit. Also, a liquid corporate debt market—by increasing competition among providers—lowers funding costs for issuers, while expanding investment options for investors. Despite these benefits, few emerging economies have succeeded in establishing substantial corporate debt markets. The notable exceptions include Malaysia, Thailand, and Chile, which have a relatively large primary bond market. Even there, corporate issuances lack liquidity and secondary markets are weak. As illustrated in Figure 1, outstanding bond issuance by non-financial companies was typically below 5 percent of GDP in emerging countries in 2010, compared to 10-15 percent in developed economies. There were a few notable exceptions. Corporate bond issuance was 36 percent, 18 percent, and 15 percent of GDP in Malaysia, Thailand, and Chile, respectively. Because of the generally low level of issuance, emerging economies have considerable room to develop domestic corporate bond markets. Further heightening the opportunity, corporate credit demand—for both bonds and bank lending—is expected to escalate over the next decade. According to a 2010 report by the World Economic Forum, roughly US$28 trillion of new bank lending will be required in Asia (excluding Japan) Redefining the Emerging Market Opportunity | 47
    • Chapter 4: The Opportunity in Corporate BondsFigure 1: Penetration of non-financial company corporate bonds by country 25 Emerging markets High income countries Non-FI corporate domestic debt outstanding, 2010 South Korea Malaysia United States 20 Thailand Italy Japan Taiwan Netherlands 15 (% GDP) Chile Austria France Canada Germany 10 South Africa China Norway Sweden Hong Kong Switzerland 5 Belgium Philippines Mexico Australia Colombia Singapore Indonesia India 0 Turkey Spain Brazil Hungary Argentina 0 1,000 2,000 3,000 15,000 GDP (US$ billions)Sources: BIS, 2012; IMF, World Economic Outlook Database, September 2011.by 2020 if economies were to remain reliant on banks. government bond market lies between US$50 billionAs banks’ capital requirements become more stringent, and US$100 billion in outstanding bonds. Belowthe need to access other debt instruments, such as this bracket, sustaining a liquid sovereign bond marketcorporate bonds, become more urgent. is difficult. The size of a country’s economy also determinesTwo pillars support corporate bond markets: its ability to service a debt load. Reinhart and Rogoffeconomic size and level of development calculate that the optimum debt level for emergingThe ability of countries to develop a corporate bond economies is 30-60 percent of GDP. When grossmarket varies widely. It is largely determined by two external debt surpasses 60 percent, annual growthfactors: the size of a country’s economy and its level of declines by approximately 2 percent. Given that aeconomic development. country needs at least US$50 billion in outstanding Economic size is important because a sizable and bonds in order to sustain an active bond market, andstrong economy is required to sustain a liquid sovereign that this amount must not exceed 60 percent of GDPbond market, and such a bond market is a prerequisite in order to avoid a destabilizing external debt load, thefor creating a corporate bond market. country will need a GDP of at least US$83 billion. A government bond market serves as a crucial Big economies also directly promote the viabilitystepping stone to corporate issuance in several ways. of corporate bond markets. Their scope allowsGovernment bonds provide valuable price and yield more companies to grow large and flourish. Smallerbenchmarks for corporate debt. They help corporate economies have few corporations large enough toissuers set prices and timing, and assist investors issue bonds of sufficient issuance size to attractin analyzing and comparing potential fixed-income investors. Bonds issued in the relatively successfulopportunities. Regular issuance of government bonds corporate debt markets of emerging economies suchhelps create a benchmark yield curve that serves as a as Malaysia, Mexico, and Thailand have a minimum facefoundation for a corporate debt market. value in the range of US$20 million, and most surpass Furthermore, studies show that the liquidity of US$50 million.the sovereign debt market correlates to the amount Bond size is important because of the scale effectof government debt issued. The larger the quantity of in the cost to issue them. A US$10-$20 million corporateoutstanding, publicly issued, central government debt, bond can cost twice as much to issue, relative to its facethe higher the turnover of that debt, as measured by value, as a $100 million bond. The International Monetarythe bid-ask spread of benchmark 10-year issues. Fund (IMF) in 2005 reported, for example, that it costAccording to McCauley and Remolona, the minimum 4.6 percent of face value to issue a US$17 million bond,issuance threshold for creating a self-sustaining compared with 2.4 percent for a $100 million issue. Yet,48 | Redefining the Emerging Market Opportunity
    • Chapter 4: The Opportunity in Corporate BondsFigure 2: Key barriers to developing deep corporate bond markets in emerging economies Demand-side challenges Supply-side challenges from issuers: from investors: • High bond issuance costs • Under-developed institutional investor • Long bond issuance turnaround time base • Lack of price benchmarks, especially in • Weakness in the country’s legal and markets with less developed government business environments, including investor bond markets protection Liquidity challenges: • Undiversified investor base with buy-and-hold behavior • Herd behavior from institutional investorsfew companies in most emerging countries are large such as savings, payments, and credit, provides aenough to support even a US$20 million issuance. necessary foundation for corporate debt markets. For Some emerging market countries are attempting example, expanded consumer financial services developto pursue regional integration of their capital markets a savings culture, which, in turn, builds the institutionalin an effort to achieve economies of scale. They hope investor base required to support a bond market.to overcome size limitations, reduce trading costs, andexpand depth and liquidity while broadening the base of Primary vs. secondary marketinvestors. To date, implementing financial integration has It is important to set realistic expectations regarding abeen challenging. Burundi, Kenya, Rwanda, Tanzania, country’s potential to create a sizable secondary bondand Uganda have formed the East African Community market. Corporate bonds are by nature less liquid thanin an effort to create a regionally integrated capital equity and government bonds. Establishing a secondarymarket. It is still a work in progress. In Latin America, bond market can be difficult even in developeddespite numerous proposals, market integration has not economies.materialized. In the United States in 2006, corporate and A country’s level of development is also important government bond turnover ratios were 0.7 andin determining what additional measures are required 35.7, respectively, highlighting the relative liquidityto develop a domestic debt market, much more so of government bonds compared to corporate debt.than in the case of the other main areas of opportunity A similar contrast in turnover ratios exists in Asia’sdescribed in this Report, developed economies, though it is not always so For middle-income emerging economies, the pronounced. For instance, in 2010, corporate andestablishment of a local bond market will depend government bond turnover rates were 0.07 and 1.15 inon achieving a minimum level of capacity. The least Japan; 0.18 and 1.16 in South Korea; and 0.06 and 49.61developed countries, on the other hand, may be able in Hong Kong.to offer corporate bonds only on an opportunistic orsporadic basis. In these economies, only the largest and There are considerable barriers to corporate bondmost reputable firms may be capable of issuing debt. development in emerging economies As discussed in Chapter 1, low-income countries Developing corporate bond markets in emergingshould focus on building corporate bond markets in the economies is a complex task requiring a systematiclater stages of the financial development process. The approach. Initiatives to improve liquidity are requiredreason is that developing more basic financial services, in order to attract a wide range of investors. There Redefining the Emerging Market Opportunity | 49
    • Chapter 4: The Opportunity in Corporate BondsFigure 3: Pension funds’ global assets under management 120 Emerging markets Developed markets Pension fund assets under management, 2010 100 80 (% GDP) 60 40 20 0 Chile South Africa Malaysia Thailand Brazil Poland Mexico Turkey United United Hong Kong Kingdom States SARSource: Towers Watson, 2012; Laboul, 2011.are several key barriers that need to be overcome to countries’ business and legal environments. Investorestablish a deep and liquid corporate bond market, as protection and legal rights in general tend to be limitedillustrated in Figure 2: in low-income countries. According to the World Bank’s Shortage of sustained investor demand: Institutional Doing Business project, sub-Saharan Africa scoresinvestors such as pension funds, insurance companies, only 4.5 out of 10 in its investor protection index,and mutual funds provide the crucial investor base compared with an average 6.0 for high-income countriesfor a corporate bond market. Corporate bonds offer in the Organisation for Economic Co-operation andinvestment vehicles that match the liability and maturity Development (OECD).needs of these investors. Without corporate bonds, Cost to issuers: The economics of bond issuancenon-bank financial institutions may be forced to invest in is a key consideration for corporations. In emergingassets that do not match the maturity structure of their markets, the high costs of issuing corporate bondsliabilities. This creates interest rate and liquidity risks. In dissuades companies from pursuing this financingaddition, corporate bonds are attractive to institutional instrument, and encourages them to opt for bankinvestors because they often provide higher yields than loans, instead. This is particularly true in marketsgovernment securities. where bank loans are still widely available at low rates. While a handful of emerging economies—notably A relatively large portion of bond issuance costs areChile, Malaysia, South Africa, and Thailand—have fixed, and therefore costs are proportionately lower forrelatively well-developed pension and insurance markets, larger issuances, as noted above. These costs can bemost emerging economies do not. Figure 3 shows classified into five categories:that pension fund assets remain quite small in many • Management fees: These fees cover adviceemerging economies. In the United Kingdom and the in structuring the transaction, preparation ofUnited States, pension fund assets under management documentation for credit rating agencies, registration,are 101 percent and 73 percent of GDP, respectively. and underwriting. Management fees are often theThis contrasts starkly with some emerging markets, such largest cost associated with a corporate bond issue.as Brazil and Turkey, where pension fund assets under • Registration, listing, and legal fees: These feesmanagement are just 15 percent and 2 percent of GDP. cover services that provide common standards forLife insurance penetration is also low in many emerging business descriptions, financial statements, termsmarkets, and therefore a parallel push to expand the and conditions, and public disclosures to bothinsurance industry is also required to support corporate issuers and investors. They provide market and legalbond market development. safeguards through increased transparency, and Weak business and legal environments: Another allow investors to assess the comparative merits ofproblem for investors is structural weakness in many bond issues.50 | Redefining the Emerging Market Opportunity
    • Chapter 4: The Opportunity in Corporate BondsTable 1: Corporate bond issuance costs in Latin American countries Brazil Chile Mexico Face Value (US$) 17 million 100 million 15 million 100 million 18 million 91 million Local bonds total cost (% of face value) 4.6 2.4 4.6 2.7 2 1.2 Composition of total cost (% of total cost) Management fees 65 86.6 45.6 36.6 50.3 67.7 Registration listing and legal fees 8.8 3.9 10.8 2.7 33.2 23.6 Credit ratings 14.3 5.8 4.3 1.3 12.7 7.4 Marketing costs 11.8 3.7 2.6 0.6 3.8 1.3 Taxes - - 36.7 58.8 - -Source: IMF, 2005. • Credit ratings: The cost of credit rating is based on Additionally, because legal, regulatory, corporate several factors, the most relevant of which is the issue governance and accounting frameworks are often weak amount. Frequent issuers have a cost advantage, in emerging economies, it is often difficult for traditional since most rating agencies charge an up-front fee companies, such as family-owned businesses, to meet to recover the incremental costs associated with disclosure requirements for public offerings. preparation of the initial credit ratings. Illiquid government bond markets: As discussed • Marketing costs: Marketing costs depend on a previously, a liquid government bond market is number of elements, including the location of the required to support development of a corporate bond investor base, regulatory standards, investors’ market in advance of strong infrastructure such as needs, and frequency of issuance. Marketing costs credit rating agencies, particularly to create price or vary considerably with the scale of a country’s yield curve benchmarks. Yet, many emerging economies corporate debt market. lack a large and active government bond market. In • Taxes: Issuance taxes, which are sometimes quite Asian emerging markets, for example, government significant, affect the overall economics of issuance bond liquidity is significantly lower than in developed in some countries. Removing these taxes in the markets. In 2010, government bond turnover was initial phase of bond market development can approximately 19.0 in the United States, 6.2 in the accelerate progress. United Kingdom and 49.6 Hong Kong, as compared Table 1 provides the breakdown of costs in with 0.27 in Indonesia, 0.65 in the Philippines, andseveral markets under different issuance sizes. Beyond 0.96 in China.management fees and taxes, costs can be as high as 50 Illiquid corporate bond markets: A deep and liquidpercent for smaller issuances and 30 percent for larger corporate bond market—sometimes difficult even inones. Initiatives to lower these costs can incentivize developed economies—is a requirement for attractingissuance and expand the potential issuer base. a wide range of investors and for increasing market Time and complexity: Disclosure requirements for efficiency. Active secondary markets provide morebond issuance, especially for public offerings, can be effective mechanisms for price setting to further expandburdensome for new issuers. Yet many countries focus the bond market, and allow companies to better assesson developing public offerings rather than enabling their financing options.efficient private placements. The illiquid nature of corporate bond markets can be Stand-alone public offerings of corporate bonds partially explained by the desire of institutional investors,are particularly cumbersome and time consuming in such as insurance companies and pension funds, toemerging markets. Significant disclosure requirements pursue a buy-and-hold strategy that effectively matchesand lengthy pre- and post-launch periods are assets and liabilities. Since most institutional investorscharacteristic of public corporate bond markets in many do not need to keep a large part of their portfolio liquid,developing economies. Issuing a bond in the pre-launch assets that they hold for liquidity purposes can beperiod in emerging economies can take several months small. If institutional investors are able to achieve theiror longer. The time required for prospectus review objectives without trading, corporate bond turnover willand acceptance can be unpredictable, translating to be limited.additional costs that could discourage companies from Because institutional asset managers are evaluatedissuing bonds. In China, for example, the issuance on a short-term basis, there is little incentive for themprocess takes 13-14 months. That compares to just two to deviate from their peers’ buy-and-hold behavior. Asmonths in the Eurobond market for a public offering by a a result, they tend to herd in their investment strategies,new or infrequent issuer. Some emerging markets have particularly with respect to corporate bonds. Thisstreamlined this process. For example, Malaysia reduced exaggerates the effects of the buy-and-hold strategy.the issuance process from 9-12 months to no more than Herd behavior is problematic because it creates15 days. price asymmetries, reduces efficiency, and increases Redefining the Emerging Market Opportunity | 51
    • Chapter 4: The Opportunity in Corporate BondsFigure 4: Deepening the domestic corporate bond market in emerging countries Building scale for corporate Enhancing liquidity Laying the foundation bond markets and deepen markets • Explore the full spectrum of partners • Establish financial intermediaries to • Attract international investors through and promote simpler issuance address the potential mismatch with tax relief and foreign exchange reform.* mechanisms to address barriers in investor maturity. high-risk countries. • Enhance the platform and provide • Develop simpler disclosure incentives for trading.* • Build the domestic institutional requirements for issuances targeting a investor base.* small number of investors. • Enhance regulations to improve • Create a conducive regulatory and tax flexibility for bond investments.* environment to drive corporate bond issuance and investment.* • Launch a regular calendar of government bond issuances.* Develop an investor syndicate for repeat issuers and establish a distribution network to attract retail investors. • Enhance the liquidity of the government bond market through a main dealer network and inter-dealer Engage multilaterals to establish regional bond fund trading.* pools and accelerate market reform.* Government-driven initiatives.market risk, especially in corporate bonds, as they are Stage 2: Building scale for corporate bond marketstraded less frequently than government bonds and The second phase is characterized by a sound primaryequity. In order to overcome the liquidity problems market with a fairly stable macro-political environment.created by the buy-and-hold strategy, emerging markets The budding capital market includes several high-qualityneed to have a more diversified investor base—one that issuers, although it continues to be hindered by a smallincludes both international and retail investors, in addition investor base and a limited benchmark yield. The focusto institutional asset managers. of initiatives during this stage is to: • develop simpler disclosure requirements and reduceThe sequential path of development for corporate the cost of issuances;bond marketsDeveloping a corporate bond market is a relatively • establish financial intermediaries to address maturitycomplex process requiring a sequential approach. Based mismatches; andon our research for this Report, we have divided the • remove market impediments by enacting adevelopment process into three distinct phases. The conducive regulatory and tax environment.stages and associated initiatives are shown in Figure 4. Stage 3: Enhancing liquidity and deepening marketsStage 1: Laying the foundation The third stage of corporate bond market developmentIn the first phase of corporate bond market development, is characterized by the growth of an active secondarythe market is very small and unsophisticated. Bond market. During this phase, primary issuance is active.issues and investors are few, and the sovereign The focus of initiatives is to:bond market is underdeveloped. Transactions occur • attract a wider range of issuers and enhance thesporadically and usually by private placement. The focus platform;of initiatives is to: • broaden and internationalize the investor base; and • overcome infrastructure gaps, enabling a few companies to begin issuing bonds; • tighten disclosure rules to ensure transparency. • build the institutional investor base; and STAGE 1: LAYING THE FOUNDATION • enhance the liquidity and functioning of the The process of developing corporate bond markets government bond market. in emerging economies begins with creating issuance mechanisms and building related infrastructure. This52 | Redefining the Emerging Market Opportunity
    • Chapter 4: The Opportunity in Corporate Bondsincludes developing a base of institutional investors while In general, some regulatory measures should beenhancing the liquidity of the government bond market. enforced in order to support private placement and institutional offerings. First, in the case of fraud andIn the early stages of development, build alternative material misrepresentation or omission in a privatepartnerships and simple issuance mechanisms placement, the issuer and intermediary should be heldIn less developed markets, infrastructure and regulation liable.for bond issuance are often under-developed. In Second, once a simple, clear, and consistentthese circumstances, simpler issuance mechanisms set of rules is in place, issuers should be allowed tosuch as private placements are more suitable. Private place bonds without receiving informal clearance orplacements can be advantageous, particularly for consultation with a regulator. In order to ensure thatinitial issuers, because costs are low, deal execution investors fully understand the merits and risks of theis quick, transactions are confidential, and bond terms securities, privately placed securities should be availableare renegotiable. Confidentiality is particularly important only to qualified investors.because it reduces information asymmetry between the Third, the requirements and process for privateinvestor and the issuer. In addition, agency costs are placements to small sets of investors need to bereduced in private placements, because the investor simplified. An example of process simplification is inmonitors the issuer’s performance and usually imposes Morocco, where the government streamlined disclosuretailored covenants on the issuer, unlike public offerings, requirements for issues under $60 million targeting fewerwhich require filing a full prospectus with regulators. than 10 investors (Case Study 19). These issues no As another option, large and well-connected longer require a visa from the Deontologic Council forcorporations can unilaterally issue bonds, Securities (CDVM), a market watchdog organization.notwithstanding infrastructure and regulatoryshortcomings, by involving multiple stakeholders. A Build a domestic institutional investor base andsuccessful example of bond issuance in advance improve investment flexibilityof required capital market infrastructure is Palestine In order to establish a primary domestic investor baseDevelopment and Investment Limited (PADICO), a limited to support demand for corporate bonds, it is necessarypublic shareholding company registered in Liberia and to establish pension fund and insurance industries. Thistraded on the Palestinian Securities Exchange. PADICO process may require several steps, as demonstratedprivately placed US$85 million of five-year bonds with by the case of Chile (Case Study 18). Over the years,14 Palestinian and Jordanian banks in May 2011 (Case the Chilean government has made considerable effortsStudy 20). to establish a primary investor base, which has driven The placement was the first corporate bond demand to build the country’s bond market.issuance in Palestine. It was a considerable achievement, Chile’s pension fund reform efforts began ingiven the tumultuous nature of Palestine’s political 1980, when a state-operated pay-as-you-go pensionenvironment and the fact that Palestinian financing is system was replaced with a fully funded capitalizationdominated by bank lending. The bonds are secured by program, based on individual accounts and operatedstock in Palestine Telecommunication Group (PALTEL) a by the private sector. All dependent employed workers,telecommunications company in which PADICO took a including civil servants, were required to contribute to the31 percent share to mitigate investors’ risk concerns. retirement system. Tax incentives were provided, quickly Private placement allowed PADICO to negotiate driving adoption of company pension funds. In 2008, therequired collaterals and an issuance structure that government expanded pension coverage to the widerattracted investors. To overcome structural, legal, and population—particularly the self-employed, youth, andregulatory barriers, PADICO took the following steps: women—through programs such as monthly subsidies in exchange for pension contributions. • It developed a relationship with the government and supervisory authority that oversees bond issuance During this period, Chile also expanded the in order to negotiate, obtain approval, and set up country’s insurance industry, allowing the banking sector regulatory requirements in an efficient manner. to participate. Insurance companies also benefited from the growth of pension funds, since retiring workers • It used Jordan’s bond issuance requirements and would use the funds in their individual capitalization regulations, and leveraged Jordan’s benchmark accounts to purchase annuities sold by insurance yield, since no government bond market existed locally. companies. In 2001, Chile relaxed rules on investment assets, • It retained law firms from the United States and further expanding the market for corporate bonds. The United Kingdom to sort through compliance and new policy allowed insurance companies to invest up regulatory procedures in Liberia, where PADICO is to 25 percent of their portfolios in corporate bonds registered. rated above BBB and up to 5 percent in riskier bonds, • It involved AB Invest and Ithmar Invest as advisors increasing demand for more types of corporate bonds. from the beginning to structure and facilitate the The government also eliminated a 15 percent capital issuance, including determining rates and collaterals gains tax, giving investors additional incentive to invest that would be attractive for investors. and trade in corporate bonds. Redefining the Emerging Market Opportunity | 53
    • Chapter 4: The Opportunity in Corporate BondsDeepen the government bond market by creating a STAGE 2: BUILDING SCALE FOR CORPORATE BONDcalendar of scheduled issuances MARKETSRegular issuance of government bonds, along with Once the basic infrastructure has been established, it isenhanced market liquidity, is essential to establishing necessary to focus on reducing the cost of issuancesprice benchmarks for corporate bond issuances. and to address maturity mismatches and other marketBoosting liquidity is difficult in the initial development impediments.phase, especially in smaller economies. But market-making activity can help, as Morocco’s example shows Engage multilaterals to establish regional bond fund(Case Study 19). pools and accelerate market reform In 1993, Morocco began taking steps to develop Regional bond funds that directly involve central banksits government bond market. The government sought to as investors allow those banks and regulators to betterimplement a transparent and clear issuance mechanism understand and overcome market obstacles. In thatby making the central bank the designated intermediary way, they can actively develop practical solutions, asbetween the Treasury and investors. The central bank well as provide initial funds. The regional initiative canworked closely with a network of four dealers, called also promote peer sharing and harmonization acrossIVTs, which were the only investors initially allowed to countries.participate in auctions of government debt. In 1994, A good example of a regional bond initiative is thethe bidding process was opened to non-IVT issuers. Asian Bond Fund, a joint venture of the central banksSubsequent measures that facilitated development of a of ASEAN + 3 economies, that is, China, Hong Kong,liquid government bond market included: Indonesia, Korea, Malaysia, the Philippines, Singapore, and Thailand (Case Study 17). The initiative aims to raise • legal recognition of mutual funds; investor awareness and interest in Asian bond funds, • formal legalization of the repurchase agreement mitigate impediments to investors, and improve liquidity (repo) market; in the major government and corporate bond markets. • a decision to allow banks to begin proprietary Holding approximately US$1 billion, the first Asian trading activities; and Bond Fund (ABF1) invests in a basket of US dollar- denominated bonds issued by the eight participating • establishment of a futures market based on treasury economies. A second Asian Bond Fund (ABF2) bonds. was launched in 2004 where central banks invest Because of these measures, liquidity in Morocco’s approximately US$2 billion in the eight countries’ localsecondary markets has more than doubled to 65 currency bond markets. ABF2, which consists of apercent of the outstanding market (180 million Moroccan Pan-Asian Bond Index Fund (PAIF) and a Fund of Bondsdirhams) in 2010 from 32 percent (MAD 63 million) in Fund (FoBF), was established to invest approximately2003. The repo market has grown from MAD 2.8 billion $2 billion in eight local currency bond markets. PAIFin 2003 to 4.3 billion in 2006. invests in local currency bonds issued in China, Hong Morocco succeeded in using its relatively small Kong, Indonesia, Korea, Malaysia, Philippines, Singaporegovernment bond market to establish a benchmark yield and Thailand. FoBF, on the other hand, invests incurve for corporate bond issuances. It did so by focusing eight single-market funds, each of which will invest inits sovereign issuances on maturities relevant to the local currency bonds issued in individual markets. Ascorporate bond market and defined the curve with just a investors in ABF2, central banks were able to identify keyfew benchmark points, rather than a full set. development requirements and take practical steps to While government bond markets provide crucial build them.support, they sometimes compete with corporate For example, in ABF2, large private-sectorbonds for the attention and money of investors. This is brokerage-dealers played a critical role in the creationparticularly true in early stages of market development, of benchmark indices. These indices are important forwhen the investor base is still small. The problem is several reasons. On the one hand, they provide assetaggravated when banks and other institutions are managers with a point of reference in their portfoliorequired to buy government bonds, which often occurs construction. On the other, benchmark indices alsoduring the initial phase of market evolution. This can allow investors to compare the performance of passivelystifle the demand for corporate bonds and stall market managed portfolios against those portfolios that aredevelopment. actively managed. For example, in Palestine, where banks are theprimary investor base for bonds, regulation limits bank Develop investor syndicates and establishinvestment in bonds to 10 percent of capital. This has distribution networks to attract retail investorscreated competition between government and corporate Investor syndicates such as bond debenture clubs canbond issuances. This limitation will be alleviated as the help frequent bond issuers retain previous investors,investor base grows and becomes more diversified. reducing administrative and marketing costs. Two examples of this strategy are PTT Global Chemical Public Company Limited and Siam Cement Group (SCG) in Thailand. Both have formed bond debenture clubs for their regular investors (Case-in-Point 4.1).54 | Redefining the Emerging Market Opportunity
    • Chapter 4: The Opportunity in Corporate Bonds The purpose of the club is to build loyalty amongmembers, encouraging them to continue investing in Case-in-Point 4.1: Bond investor clubs fornew bonds as they are issued. Members of the club— primary bond issuanceinsurance firms, pension funds, mutual funds, and high-net-worth individuals—participate in investment clinics, For all its potential advantages, issuing bonds is often an inefficient way to raise capital in emerging markets,overseas trips, and other events. Club members receive because it requires companies to invest prohibitiveearly access and are pre-qualified to invest, reducing amounts in registration, listing, and marketing activities.marketing and documentation requirements. One option for companies is to create bond debenture clubs, which give them a ready-made and pre-qualifiedEstablish financial intermediaries to address market for their corporate debt.potential mismatch with investor maturity Two Thai companies, PTT Global Chemical andMechanisms to address maturity mismatches between Siam Cement Group (SCG), provide an example of how bond debenture clubs can work. Members of theinvestor appetite and issuers’ needs are important two companies’ clubs include insurance firms, pensionfor supporting longer-term corporate bonds. This is funds, mutual funds, and high-net-worth individuals. Theparticularly true in illiquid markets. Despite the need existence of these interested and pre-qualified investorsfor long-term financing, most corporate bonds issued allows PTT and SCG to issue bonds with relatively littlein emerging economies are short term. Having an marketing and little time or money to find new investors.intermediary that can repackage various corporate For their part, bond club investors benefit frombonds and resell them to investors, allowing long-term having first access to the debt offerings of two well- known Thai companies.issuances to be funded by shorter-term investment PTT and SCG have strong track records andfunds, can go a long way to attract a wider range of reputations. PTT is Thailand’s largest petroleum producer.investors. SCG, which has been around for nearly a century, The difficulty of attempting to do this is illustrated by comprises 100 companies with 24,000 employees.infrastructure financing in India. The Indian government Indeed, both companies have become benchmarks forestablished the India Infrastructure Finance Company the Thai bond market. Emerging-market companiesLimited (IIFCL), a non-banking financial company, to that do not have similarly well-known track records and brands might have trouble creating such clubs.provide long-term financial assistance to infrastructure Both PTT and SCG regularly organize activities forprojects carried out by companies from both the investors, including face-to-face meetings, investmentpublic and the private sectors (Case-in-Point 4.2). clinics, and overseas trips. These efforts have increasedIIFCL repurchases infrastructure loans from project the companies’ success in raising debt capital. SCGlenders and distributes them to third-party investors or issues domestic corporate bonds twice a year, mostlyrepackages them as asset-backed securities to be sold with three- to five-year maturities. And in November 2010,to investors such as insurance companies and pension PTT issued the first century bond in Thailand’s history. (A century bond has a 100-year maturity). Demand forfunds. Under the program, IIFCL hopes to reduce the the century bond was so strong that the offering wastenure of financing from 15-30 years to 5-15 years. increased to 4 billion Thai baht (US$129.5 million) fromHowever, the project still faces implementation issues, as THB 3 billion.the terms and features of its scheme are not attractiveto project lenders. A robust model for refinancingand repackaging of debt securities still needs to be Referencesdeveloped. PTT Global Chemical Public Company Limited. Website. http://www.pttgcgroup.com/.Provide additional government supports to build a SCG (Siam Cement Group). Website. http://www.siamcement.well-functioning primary bond market com/en/.Other government actions can accelerate corporate Phone interviews by author of selected experts, September 2011.bond development in emerging economies. Onecrucial step is creating an efficient tax environment.As illustrated earlier, issuance taxes can make up asignificant portion of bond issuance costs. Reductionor removal of this tax can significantly improve the and attract higher-quality issuers. Stakeholders shouldattractiveness of issuing corporate bonds. Another broaden the investor base and tighten disclosure rules tocritical step is development of efficient credit rating ensure transparency.agencies. This is critical to supporting the issuanceprocess, especially in public offerings. Agencies enable Engage multilaterals to establish regional bond funda wide range of investors to assess risks with associated pools and accelerate market reformbond investments. As discussed earlier, regional cooperation can help accelerate development of corporate bond markets. ThisSTAGE 3: ENHANCING LIQUIDITY AND DEEPENING can be extended further in the next phase of marketMARKETS reform to help improve depth and liquidity.As the market develops, stakeholders should take on the In the latter stage of ABF2, the ASEAN + 3 marketschallenge of improving its depth by enhancing liquidity. see the need to expand the investor base to attractThis is a requirement for the market to function effectively foreign investors (Case Study 17). One initiative that Redefining the Emerging Market Opportunity | 55
    • Chapter 4: The Opportunity in Corporate Bonds Case-in-Point 4.2: Takeout financing for infrastructure projects One of the attractions of bonds, in both developed and Despite the challenge to create a scheme that will emerging markets, is that they give companies access to drive financiers’ interests, effort to develop sustainable long-term financing. In emerging markets, however, investors refinancing and takeout financing models must continue to often balk at buying long-term bonds because of liquidity drive diversification and expansion of investor base for long issues, as well as real and perceived risk. Similar issues term bonds. apply to infrastructure projects, which by their nature take years to build. Their funding must, likewise, last for years. This tension is evident in India, a fast-growing country References that has struggled to get financing for its infrastructure Business Line. 2011. “IIFCL to Free Banks from Takeout Financing projects. India’s roads, railways, and seaports need financing Fee.” Business Line. August 17, 2011. over a 10- or 20- year period, but many private investors The Economic Times. 2011. “IIFCL, LIC, IDFC Enter into MoU for have shied away because of a maturity mismatch with their Takeout Financing.” The Economic Times. November 19, 2011. investment horizon, leaving to banks the job of making loans. Indian banks have increased their exposure on infrastructure The Hindu. 2011a. “3 Institutions Sign MoU for Takeout Finance projects, but this rapid expansion was not sustainable due to Scheme.” The Hindu. September 17, 2011. a growing concentration of asset-liability maturity mismatch — 2011b. “How the Mechanism Works.” The Hindu. September 17, —. on banks’ balance sheets, since most of their deposits 2011. are for five or 10 years. Many other institutions—such as insurance companies and pension funds—require high credit India Infrastructure Finance Company Limited (IIFCL). Website. www. ratings, all but unheard of in the initial years of a private iifcl.org. infrastructure project in India. Lall, R.B. and R. Anand. 2009. “Financing Infrastructure.” In 2006, with the country’s infrastructure investments IDFC Occasional Paper Series 3. Mumbai: Infrastructure stuck at about 5 percent of GDP (by comparison, China’s Development Finance Company Limited. were at 14.4 percent), India established a specialized government-supported institution called the India LiveMint.com. 2011. “IIFCL to Buy Rs2,000 cr Infra Loans by Infrastructure Finance Company Limited (IIFCL) to provide March.” LiveMint.com. February 6, 2011. www.livemint. long-term financial assistance to infrastructure projects in com/2011/02/06123007/IIFCL-to-buy-Rs2000-cr-infra.html. both the public and the private sectors. Ramesh, M. 2011. “IIFCL Lines up Rs 3,600-cr Proposals for Take- IIFCL is responsible for implementing the Takeout Out Financing.” The Hindu Businessline. November 1, 2011. Finance Scheme (TFS), which allows infrastructure loans to be repackaged as asset-backed securities and sold to other Tiwari , D. and D. Sikarwar. 2011. “Borrowers Allowed to Approach investors, including non-bank institutions. This gets the loans IIFCL.” The Economic Times. December 6, 2011. off project lenders’ balance sheets, freeing more capital for Tiwari, D. 2010. “IIFCL Gets Nod for Takeout Financing.” The future infrastructure projects. TFS can help build a healthy Economic Times. April 20, 2010. financing ecosystem for projects with a diversified investor base. Under the scheme, IIFCL can take debt liability of up to 20 percent of the total project cost, once the project becomes commercially viable. This has helped reduce the tenure of financing from 15-30 years to 5-15 years. However, the initial efforts on TFS failed to gain traction due to unattractive features to lenders. Disbursements fell far short of plan: INR700 million (US$13.3 million), compared with the objective of INR80 billion. IIFCL subsequently modified TFS terms and hopes to finance INR250 billion in projects over the next three years. Some of these modifications include shortening the timing of loan sell- off, increasing the loan takeout limit, employing a more transparent mechanism for interest-rate pricing, and opening access to non-financial institutions.emerged in the region was exemption of non-residents strong initially, but leveled out after only a few years.from withholding taxes to attract foreign investors. By Clearly, multi-country funds can help attract internationalreducing investment yield, withholding taxes undermine investments and promote standardization across thethe attractiveness of local currency securities for non- different markets in the region.residents. Removal of such impediments should, in A downside of attracting foreign investment istheory, make local currency bonds more attractive. that it may lead to a surge of capital inflows, which However, the success of ABF2 in attracting foreign may result in macroeconomic volatility. For example,investors is mixed. Foreign investment in one sub-fund Thailand reinstituted withholding taxes in October 2010that invests in local currency bonds of the eight ASEAN as a response to potentially destabilizing capital inflows.+ 3 economies has increased steadily since inception. Korea also reinstituted a withholding tax on the interestOn the other hand, foreign investment in a second sub- payments of foreign investors’ holdings on governmentfund, which comprises eight single-market funds, was bonds and monetary stabilization bonds in January 2011.56 | Redefining the Emerging Market Opportunity
    • Chapter 4: The Opportunity in Corporate Bonds Development of repo markets is another critical BIS (Bank for International Settlements). 2012. “Table 16B: Domestic Debt Securities.” BIS Quarterly Review, March 2012.element to drive liquidity. A developed repo marketcan enhance liquidity in the bond markets, including Chan, E., M. Chui, F. Packer, and E. Remolona. 2011. Local Currency Bond Markets and the Asian Bond Fund 2 Initiative. Report forcorporate bonds, by allowing short positions through Bank for International Settlements.securities lending and by providing a market in Chan, E., M.F.H. Ahmad, and P. Wooldridge. 2007. Liquidity in anwhich market makers can finance their positions. Emerging Bond Market: A Case Study of Corporate Bonds inThis is demonstrated by the case of Morocco where Malaysia. Draft report for Bank for International Settlements.government bond liquidity increases with the introduction de la Torre, A. and S. L. Schmukler. 2007. Emerging Capital Markets andof a repo market. Globalization: The Latin American Experience. Washington DC: While ABF2 economies have expanded domestic The World Bank Group, Stanford University Press.debt markets, their ability to develop repo markets has Department of Finance Canada. 2011. Debt Management Report 2010-been limited. Chan et al. identified the following sources 2011. Ottawa: Department of Finance Canada.of weakness in the ABF2 repo markets: Endo, T. 2008. “Broadening the Offering Choice of Corporate Bonds in Emerging Markets: Cost-Effective Access to Debt Capital.” Policy • Lack of appropriate legal apparatus: Failing Research Working Paper 4655. Washington DC: The World Bank to ensure that the lender will be able to take Group. possession of the collateral in the event of default IMF (International Monetary Fund). 2011. World Economic Outlook creates a sense of mistrust, which disincentivizes Database, September 2011. Washington, DC: IMF. investors. — 2005. “Development of Corporate Bond Markets in Emerging —. • Lack of suitable collateral: Although government Market Countries.” Global Financial Stability Report: Market bonds are considered the collateral of choice, Developments and Issues. Washington DC: IMF. in some markets there is not enough of such Laboul, A. 2011. “Pension Fund Assets Climb Back to Pre-Crisis Levels collateral to go around. In order to address these but Full Recovery Still Uncertain.” Pension Markets in Focus shortcomings, regional cooperation such as ABF2 8. Paris: OECD (Organisation for Economic Co-operation and Development). could enter into a tri-party repo agreement. Under this approach, a clearing bank will serve as a McCauley, R. and E. Remolona. 2000. “Special Feature: Size and centralized custodian of collateral, thus becoming Liquidity of Government Bonds.” BIS Quarterly Review, November 2000. a third party between a lender and a borrower. The success of this approach is predicated on the fact Reinhart, C.M. and K.S. Rogoff. 2010. “Growth in a Time of Debt.” that any form of collateral the clearing bank is willing American Economic Review 100(2): 573–78. to hold is eligible for repo transactions. Towers Watson. 2012. Global Pensions Assets Study 2012. New York: Towers Watson.Develop investor syndicates and establish The World Bank and IFC (International Finance Corporation). 2011.distribution networks to attract retail investors Doing Business 2012: Doing Business in a More Transparent World. Washington DC: The World Bank.Beyond institutional investors, investor syndicatescan also be expanded to include past retail investors. World Economic Forum. 2011. The Financial Development Report 2011. New York: World Economic Forum USA.Additionally, investors can promote issued bondsthrough bank channels, such as branches. In the case of — 2010. More Credit with Fewer Crises: Responsibly Meeting the —. World’s Growing Demand for Credit. Geneva: World EconomicPTT Global and SCG in Thailand, both firms also provide Forum.priority access to previous retail investors, thereby Yabara, M. 2012. “Capital Market Integration: Progress Ahead of theincreasing interest in purchasing the companies’ bonds East African Community Monetary Union.” IMF Working Paper(Case-in-Point 4.1). WP/12/18. Washington DC: IMF.Provide ongoing government supportIn addition to the initiatives discussed earlier in thischapter, there are other government policies thatcan deepen corporate bond markets in emergingeconomies. Aside from removing withholding taxes,governments should evaluate foreign exchangepolicies and improve access to domestic currenciesin order to attract international investors. They shouldharmonize public credit registries with other countriesin the region to allow international investors to betterassess risk across borders. Finally, they should createretail trading platforms for corporate bonds, such asthose established in Singapore and South Korea, tosignificantly increase participation by retail investors andimprove liquidity.REFERENCESADB (Asian Development Bank). Bonds turnover ratio. AsianBondsOnline. http://asianbondsonline.adb.org/regional/data/ bondmarket.php?code=Bond_turn_ratio. Redefining the Emerging Market Opportunity | 57
    • Part 2Case Studies
    • List of Case StudiesCase Study 1: Community Partnership Models........................ 63 Case Study 11: Federalizing Product Development..................103 for Efficient Product Delivery to Tailor Loan Products to SMEsCase Study 2: Bundling Products to Encourage.......................67 Case Study 12: Adapting POS Networks..................................107 Experienced-Based Learning to Deliver SME LoansCase Study 3: Delivering Consumer Loans to...........................71 Case Study 13: Using a Pawnshop-Bank Partnership.............. 111 Low-Income Consumers through to Improve Propositions for Customers Utility Company Infrastructure and ProvidersCase Study 4: Rationalizing the Branch-Banking......................75 Case Study 14: Using an Electronic Platform to Provide........... 115 Model to Deliver ‘No Frill’ Services Supply-Chain Financing for SMEsCase Study 5: Savings-Linked Conditional Cash......................79 Case Study 15: Finance SME Suppliers through....................... 119 Transfer Programs National Reverse Factoring InfrastructureCase Study 6: Using Legacy Payment Data............................. 83 Case Study 16: Developing the Venture Capital........................123 and Infrastructure to Expand into Industry through Co-Investment Consumer Loans with Foreign InvestorsCase Study 7: Developing the Broader Ecosystem...................87 Case Study 17: Forging Central Bank Partnerships to..............127 for Technology-Enabled Channels Build the Market for a Region’s BondsCase Study 8: Instant Disbursement of.....................................91 Case Study 18: Building a Bond Investor Base through............131 Vehicle-Based Financing Pension Fund and Insurance ReformCase Study 9: Adopting a Franchise Model to......................... 95 Case Study 19: Building Liquidity in Government Bonds..........135 Expand Low-Income Financial Services to Pave the Way for Corporate IssuancesCase Study 10: Using Equity to Finance SMEs in...................... 99 Case Study 20: Overcoming Institutional Voids to.....................139 Credit-Constrained Markets Issue Corporate Debt Redefining Opportunities in Emerging Markets | 61
    • Case Study 1: Community Partnership Models for Efficient Product DeliveryCASE STUDY 1Community Partnership Models for Efficient ProductDeliveryFinancial institutions can deliver products to poor communities by tailoring partnershipmodels to engage with organizations with commercially oriented distribution.ALLIANZ, ASIA and AFRICAMarket Opportunity services to reach low-income communities. In order toMicro-insurance programs allow low-income communities provide these services, Allianz has partnered with NGOsto manage risk, secure investment capital, and and other community-based organizations.accumulate savings. They help build a pathway frompoverty. Yet more than 90 percent of people in the world’s100 poorest countries still lack access to insurance, even Business Model Overviewthough more than 1.5 billion of these people can afford it. Historically, most of Allianz’s emerging-markets insuranceThe mismatch between supply and demand is due to the partners have been micro-finance institutions (MFIs) andgeographical dispersion of low-income populations and commercial banks. More recently, Allianz embarked on ahigh delivery costs. As a result, the communities most new strategy, partnering with “social aggregators”—vulnerable to external shocks are the least likely to have membership groups such as cooperatives. These groupsinsurance protection. generally believe micro-insurance benefits their members but lack resources and regulatory approval to underwriteHealth insurance, in particular, is in high demand in risk themselves. Cooperating with Allianz providesemerging markets, yet access to it is rare. In India, just 10 coverage not possible otherwise, particularly in ruralpercent of the population has health insurance, and more areas. The benefit for Allianz is that it can leverage thethan 70 percent of health expenses are paid out of cooperatives’ organizations and staff, thereby makingpocket. Medical costs are responsible for over half the collection and premiums processing more efficient.cases of people declining into poverty. In Africa, less than Additionaly, cooperatives self-police against fraud, late3 percent of the population living under US$2 per day is payments, and risky participants.covered by insurance of any type. A key element of Allianz’s new strategy is partnering with regional non-governmental organizations (NGOs), whichStakeholder Overview in turn help Allianz connect with the social aggregators.Allianz Group is an integrated financial-services firm thatoffers insurance, banking, and asset-management Micro-insurance distribution in rural and otherproducts and services worldwide. Allianz serves 78 million underserved regions is based on a partner-agent model.customers in more than 70 countries. In emerging As the partner, Allianz provides the insurance product,economies, Allianz is also trying to expand its insurance assumes the risk, pays claims, and shares back-office work. The agent acts as distributor, explaining and Redefining the Emerging Market Opportunity | 63
    • Case Study 1: Community Partnership Models for Efficient Product DeliveryA life micro-insurance product with a savings component Year 0 Year 5 NATURAL DEATH ACCIDENTAL DEATH UNCLAIMED CLAIM CLAIM ACCOUNT VALUE Weekly premium payments of €0.60 Payment in case of Payment in case of Account value refund natural death (account accidental death consisting premium paid value + €220) (account value + €565) plus accumulated interest minus administration feeSelected Allianz’s micro-insurance coverage in emerging markets Egypt India Indonesia Credit Life Insurance • Mutual Health, Personal Credit Life Insurance • Distribution with Accident, Group Term • Distribution through PlaNet Guarantee Life and Life local MFIs and minimarts Endowment Insurance • Distribution through Care International, SKS Microfinance, dairy cooperatives and others Senegal Ivory Coast Cameroon Madagascar Credit Life Insurance • Funeral Insurance Credit Life Insurance Credit Life Insurance • Distribution with • Distribution through the • Distribution with • Distribution with PlaNet Guarantee cooperative UNACOOPEC PlaNet Guarantee PlaNet GuaranteeSource: Allianz, 2012.64 | Redefining the Emerging Market Opportunity
    • Case Study 1: Community Partnership Models for Efficient Product Deliveryproviding the products to the client and collecting Potential Implementation Challengespayments. • Providing financial education to participants is crucial for the success of micro-insurance programs becauseIn India, the firm’s local business unit, Bajaj Allianz, of the lack of financial experience and literacy in poorpartnered with SKS Microfinance, one of the fastest- communities. Less conventional methods, such asgrowing and most prominent MFIs in India, to offer life role-playing, must supplement education campaignsinsurance policies. To build trust and participation, Allianz to communicate a clear and understandable valuedesigns simple, easy-to-sell products tailored to local proposition.needs. Central to the model are product standardization,customer-centric processes, and specialized training • While micro-insurance provides clear social benefits,modules for staff members. SKS also provides loans that these alone are not sufficient incentive for distributorsenable customers to build savings and pay for their to sell and market the products effectively. MFIs andinsurance premiums in the initial 25 weeks. NGOs need to understand that a monetary incentive is important and profitability is critical for theBajaj Allianz created a micro-insurance program for dairy sustainability of the model.farmers by partnering with their union cooperative. BajajAllianz developed a simple yet flexible product consisting • Achieving scale is crucial because micro-insuranceof both life insurance and savings. Union representatives programs are generally low-margin. Allianz terminatedreceive product training from Bajaj Allianz and, in turn, a mutual health insurance pilot program in Indiaeducate the farmers. Union chapters can customize their because the participating groups were too dissimilar togroup plan for preferred risk coverage, premium and allow Allianz to scale the program efficiently. Scale ispayment terms, and benefits. more easily achieved with organizations that have strong local presence and deep community ties, suchIn Africa, Allianz provides consumer education about as cooperatives and religious groups.insurance products to build trust, and tailors products tolocal needs and customs. It primarily provides credit life • Micro-insurance demand is often market-specific.insurance and funeral expense insurance and is Local products must be tailored to local needs. Indeveloping a livelihood component, allowing claimants to South Africa, demand for life insurance is high. Incover lost income in case of disability. Indonesia, where discussing death is considered taboo, demand is low.In Senegal, Allianz collaborates with CAURIE, a micro-credit organization providing credit to 21,000 women in275 village banks. Within each village bank, solidarity KEY LESSONS LEARNEDgroups are created and CAURIE educates the women 1. Micro-insurance providers can expand coverage toabout savings and credit. CAURIE requires solidarity mass populations in low-income communities, in agroups to purchase credit life insurance to offset the cost-effective way, by customizing partnerships withburden that a member’s death would impose. socially oriented organizations.International organizations such as PlaNet Guaranteeprovide educational materials for loan officers. 2. The ability to achieve efficient scale can be realized by partnering with well-managed central organizations, regional coverage, and proper incentives at the retailImpact distribution level.• In 2011, Allianz operated micro-insurance in 11 markets, covering 3.85 million low-income people and 3. Education and trust are key drivers of acceptance and generating €57 million in premiums. participation and can be gained by processing payouts quickly and efficiently and by selecting trustworthy• In Africa, Allianz and its partner, PlaNet Guarantee, partners. have helped cover 53,000 clients and insured US$11.8 million of loans since 2009. Allianz has also created 4. Products, pricing, and policies should be tailored and new products to meet unique local needs. In 2011, it simplified depending on the types of partnerships and sold 65,000 funeral expense policies that were local needs, through an iterative approach if necessary. designed to offset the exceptionally high cost of funeral 5. Fraud can be reduced by harnessing community- rites in Ivory Coast. group dynamics and implementing simple policies• In Indonesia, Allianz works with a network of over 50 such as co-payments and first-claim waiting periods. MFIs that help to distribute micro-credit life and micro-education insurance policies. In 2011, Allianz References Indonesia covered 40,000 low-income customers and Allianz Group. Website. http://www.allianz.com/sustainability. generated €370,000 in premiums. Since the introduction of micro-insurance in 2006, the business —. 2012. Microinsurance at Allianz Group. Munich: Allianz SE. has grown by over 100 percent on average per year. —. 2010a. Learning to Insure the Poor: Microinsurance Report. Munich: Allianz SE. Redefining the Emerging Market Opportunity | 65
    • Case Study 1: Community Partnership Models for Efficient Product Delivery—. 2010b. “Social Responsibility Meets Profitability in Indonesia.” Press Release.—. 2009. “Allianz—Micro-insurance Partnership: Care for India.”—. 2006. “Allianz and CARE Partner for Micro-Insurance in India.” Press Release.Asia Insurance Review. 2011. “Microinsurance Focus – Asia Leads the Way of Allianz’s Microinsurance Market.” July 2011.Goyal, K. 2011. Phone interview by author with Kamesh Goyal, Head of Group Planning and Controlling, Allianz SE, July 2011.Hintz, M. 2012. Phone interview by author with Martin Hintz, Head of Micro-insurance, Allianz Group, March 2012.Kunzemann, T. 2009. “Care for India.” Press Release.LeapFrog Investments. Website. http://www.leapfroginvest.com/lf.Palmer, A. 2010. “Microinsurance: The Market of Tomorrow.” Euromoney Institutional Investor.66 | Redefining the Emerging Market Opportunity
    • Case Study 2: Bundling Products to Encourage Experienced-Based LearningCASE STUDY 2Bundling Products to Encourage Experienced-BasedLearningFinancial institutions can accelerate adoption of new services by bundling products toencourage financially inexperienced customers to “learn by using.”BANCO COMPARTAMOS, MEXICOMarket Opportunity economic, and human value into the lives of its clients andBanking services available to the mass-market segment stakeholders.in emerging economies often begin and end withmicro-lending. Non-loan financial products and services Compartamos commenced operations in 1990 as anhave scant penetration. Even micro-finance customers non-governmental organization (NGO) financed partly bywith a record of repayment usually lack access to savings the Inter-American Development Bank (IDB). In 2000, itaccounts, insurance plans, and other bank offerings that was licensed to operate as a regulated finance company,can bridge uneven income streams, reduce and received a line of credit from the International Financeindebtedness, and soften the impact of calamitous Corporation (IFC), one of its shareholders, in 2001. Inevents. 2006, Compartamos was transformed into a bank.Among hurdles slowing access to new banking resourcesis the limited financial experience of the communities Business Model Overviewthemselves. One way to build financial competence with The primary product in Compartamos’s loan portfolio isfresh offerings is to introduce them bundled with the Crédito Mujer, an individual loan of 1,500-27,000 pesosfamiliar, allowing customers to adopt new resources and (US$107-$1,928), delivered through women’s groupsbuild financial literacy through experience. consisting of 12-50 people with a group guarantee. Disbursements and collections are channeled through theBundling new and traditional products benefits financial groups, a proven model of ensuring timely payment,firms, as well. Banks can expand product lines and obtain lowering default rates, and reducing transaction costs.new revenue sources through new customer bases andnew channels. In recent years, Compartamos has made significant efforts to introduce a savings culture, as well as insurance products, to its customers.Stakeholder OverviewBanco Compartamos is Mexico’s largest micro-lender, • To introduce a savings culture, Compartamos requireswith over 2.3 million clients and coverage in every state in that each group member place 10 percent of the loanthe country. The bank’s mission is to generate social, amount prior to disbursement. This savings account is established and operated by commercial banks. Each week during the loan repayment period, the group Redefining the Emerging Market Opportunity | 67
    • Case Study 2: Bundling Products to Encourage Experienced-Based LearningBundling of savings and insurance products into loans Crédito Mujer loan • Groups consist of 12–50 women • Individual loans of 1,500-27,000 pesos with group guarantee Savings Life insurance • Loans disbursed through an • Basic life insurance individual payment order coverage bundled with loan • Customers are asked to save at no extra cost 10% of the disbursed loan amount • In addition to coverage, in a savings account Compartamos writes-off • Group discusses additional outstanding loan upon death amount savings each week Option to increase insurance coverage • Option of increasing coverage beyond minimum requirements • Customers can choose between up-front premium payment or finance it through weekly premium installments68 | Redefining the Emerging Market Opportunity
    • Case Study 2: Bundling Products to Encourage Experienced-Based Learning meets and discusses additional savings it would like to policy it sells to ensure that the risk assessment generate for the period. The group returns the deposit function remains with partner institution. after the 16-week repayment period. During that time, the group can access its savings account and conduct transactions, as long as a pre-determined minimum Impact number of group members are present. • Almost 50 percent of Crédito Mujer’s clients—around 1 million customers—bought additional life insurance• From 2005 to 2010, Compartamos partnered with coverage, double the initial 25 percent target set by Seguros Banamex to offer basic life insurance. Since Compartamos. The program accounts for 10 percent 2010, Compartamos has partnered with a Spanish of all insurance policies sold in Mexico. insurance provider, MAPFRE. The life insurance product provides coverage of up to 15,000 pesos • Compartamos’s client retention rate has increased to (US$1,071) in case of a customer’s death. On top of 92 percent from 88 percent since it began offering free this, Compartamos writes off the customer’s basic life insurance bundled with all micro-credit in outstanding loan balance. In the event of death, the 2005. insurance beneficiary needs to provide only the client’s • Income from insurance fees now accounts for 6 proof of death, Compartamos identification, and percent of Compartamos’s revenues, and is projected transaction record. Customers may opt to purchase to grow. additional coverage of up to 150,000 pesos (US$10,713), either by paying a premium at the beginning of coverage or by financing coverage Potential Implementation Challenges through a weekly premium payment. There is no • Brand familiarity, trust, and low prices are required to restriction on age or health condition for customers build rapid adoption of new offerings. Compartamos who wish to obtain the insurance product. Half of has been lending to clients for over 21 years. Clients Crédito Mujer’s clients choose this extended coverage. are now comfortable buying additional products if they are initially offered at a low price.The success of Compartamos is due to several factors: • A wide and convenient network is required to drive• Focus on a long-term customer relationship: savings product adoption. By building a correspondent Compartamos’s approach aims at building a long-term agent network and adopting mobile technologies, relationship with clients, thereby creating a base of institutions can tap into savings and transaction customers open to purchasing additional products and businesses. services. • It can be challenging to simplify products and to• Proximity to customers: Each Compartamos branch minimize disputes with customers. For example, for covers customers within a 2-hour radius. Additionally, natural disaster damage insurance, providers need to Compartamos is embarking on initiatives to improve find a trigger (e.g., a government’s national warning) access to customers by building a wider that is a reliable estimate of home damage, in order to correspondent agent network to cover mom-and-pop avoid having to conduct site visits. retail stores. This is critical to driving adoption of savings products in particular. KEY LESSONS LEARNED• Loan write-offs to drive product adoption: 1. Bundling new financial products into existing offerings Compartamos writes off loans in case of death to can accelerate the customer education process, build demand for insurance products. improve client retention, and help providers grow new• Product simplicity to improve uptake and reduce revenue streams with minimal investment. costs: New products must be simple to understand 2. Simplified, bundled products can be created through and execute. In the case of life insurance, for example, appropriate partnerships with other providers. a death certificate, Compartamos identification, and transaction history are the sole requirements for a 3. Branding, product simplicity, and initial subsidies are beneficiary to receive payment. This simplifies key factors driving adoption of new products by operations and reduces costs while alleviating low-income communities. customers’ concerns.• Efficient operations: Compartamos delivers References insurance-claim payments within two working days, Banco Compartamos. 2010. Annual Report 2010. Colonia Escandón, fostering a smooth and efficient customer experience. Mexico: Compartamos, S.A.B. de C.V. Cardoletti, G. 2008. “Life Insurance Keeps Customers at Mexico’s• Partnering with other providers to expand offerings: Banco Compartamos.” Dow Jones Newswires. Compartamos encourages loan customers to deposit their savings with partner banks. For insurance, Compartamos collects only a fee for each insurance Redefining the Emerging Market Opportunity | 69
    • Case Study 2: Bundling Products to Encourage Experienced-Based LearningMoctezuma, R. 2010. “8 empresas que crecieron en la crisis.” CNN Expansión. December 31, 2010.Schatz, W. 2009. “Compartamos’ Income from Insurance Product Rises 400%.” Business News Americas. October 21, 2009. .Toca, F.A. Phone interview conducted by author with Fernando Toca, Chief Executive Officer, Banco Compartamos. November 18, 2011.Ugarte, J. 2011. “Compartamos va por el Mercado de Peru.” CNN Expansión. April 4, 2011.Velazco Bernal, C. Phone interview conducted with Carolina Velazco Bernal, Investor Relations Officer, Banco Compartamos. May 7, 2012.Xanic, A. and U. Hernandez. 2009. “Un banco que empezó como ONG.” CNN Expansion. June 27, 2009.Phone interview with Compartamos customer service representative conducted by author. December 5, 2011.70 | Redefining the Emerging Market Opportunity
    • Case Study 3: Delivering Consumer Loans to Low-Income ConsumersCASE STUDY 3Delivering Consumer Loans to Low-IncomeConsumers through Utility Company InfrastructureUtility companies’ payment information and ready-made billing infrastructure providea strong platform to extend credit to unbanked population.CODENSA CRÉDITO FÁCIL, COLOMBIAMarket Opportunity own customer service, invoicing, and loan recoveryIn 2004, 55 percent of Colombians were living below the operations, but Multibanca Colpatria has taken overpoverty line. Only 41 percent of households reported responsibility for credit assessment and loan monitoring,having a bank account, and only 23 percent of Colombia’s and has begun offering Codensa’s customers a range of46 million inhabitants had access to bank credit. To be new products.sure, part of the issue was commercial banks’ reluctanceto serve a low-income, high-risk segment of thepopulation. But a lack of financial literacy on the part of Business Model OverviewColombians themselves added to the problem. Codensa Crédito Fácil provides consumer financing for the purchase of electric appliances, as well as forThe lower-income population lacked such basics as home-improvement products, insurance, and otherofficial identification cards, income statements, and credit goods and services offered by Codensa’s almost 300histories. These consumers made purchases in cash or business partners, which include retailers such asused small loans received through cooperatives. Most Carrefour and Exito. Customers apply for credit throughconsumers used electricity, however, and this turned out the business partners; Codensa Crédito Fácil approvesto be an opportunity for improvement. the credit; and the customers pay back the loans through their electricity bills. In addition to making financial credit more available to lower-income segments, the processStakeholder Overview allows many customers to establish a credit history for theAs Colombia’s largest electric utility company, Codensa first time. Since the program’s inception, Codensa alsosells and distributes electricity to more than two million has begun to offer financing through credit cards.customers, meeting a quarter of the nation’s electricityneeds. This is the statutory limit for a utility company Codensa Crédito Fácil has been successful because ofbecause of antitrust laws, and as Codensa approached how it leverages Codensa’s existing infrastructure.this ceiling in the last decade, it began searching for new Codensa’s 2.2 million electricity users are a naturalsources of long-term growth. It launched a financial prospect list for Codensa Crédito Fácil; this minimizesservices business in 2001. acquisition costs. Existing Codensa customers see advertisements for Crédito Fácil on their monthly utilityIn 2009, Codensa sold a stake in its financial services bills, in Codensa catalogs, and in materials distributed bybusiness to Multibanca Colpatria. Codensa still runs its Codensa’s retail and other partners. Loan payments are Redefining the Emerging Market Opportunity | 71
    • Case Study 3: Delivering Consumer Loans to Low-Income ConsumersCodensa: Consumer loan through utility network Step 1 Step 2 Step 3 Step 4 Unbanked Customer Credit assessment Codensa pays appliance Customer repays Codensa purchases electrical process outsourced retailer on behalf of together with his electricity appliance through over to Datacrédito, which Customer. bill payment. 280 partnered retailers and calculates credit based on: applies for installment loan. • Data from financial and CODENSA Electricity Loan real sector; and fee repayment exito • Customer’s utility Carrefour payment history. Alkosto Electricity bill Credit scoring is completed Momecenter Retailer Retailer Retailer within 15 minutes. CODENSAmade as part of customers’ monthly utility bills, but the lowest-income class (stratum 1 and 2), and two-thirdsloans are initially disbursed, and products delivered, of them are unbanked.through the partners’ own outlets. • Despite the fact that Codensa is not allowed to cut offCodensa outsources credit risk assessment to electricity because of late payment, Codensa CréditoDatacrédito, an established private credit-reporting Fácil has a very low default rate—just 5 percent.company, which scores consumers based on data from avariety of sources, including financial institutions, credit • In 2008, Codensa’s non-energy services contributedcard issuers, merchants, mobile phone companies, and 12 percent of revenue in 2008 at COP315,970 million, aother utility companies. In many cases, Codensa can also 35 percent average annual growth rate since 2004.add its own utility bill payment history to the credit Codensa’s sales of its credit business to Multibancaassessment. Turnaround on a credit request is often as Colpatria in 2009 was valued at US$529 million.fast as 15 minutes. Consumers can apply for loans of up • The success of Codensa Crédito Fácil has broughtto four times their salary and pay annual interest rates of competition to the market. The Colombian gas utility25-32 percent, the maximum allowed under Colombia’s Promigas now provides loans to more than 200,000usury laws, with loan repayment periods of up to 48 Colombians on electronics and home-improvementmonths. products.Impact Potential Implementation Challenges• Codensa Crédito Fácil has become very successful as • Unsecured loans granted in a short period of time are a financing scheme for low-income consumers and necessarily risky. A large pool of credit data must be has grown rapidly. The unit now offers financing for 90 cross-checked and triangulated with other available different brands of electronic products through 250 credit information if the right decisions are to be made. outlets nationwide. In the capital of Bogotá, Codensa covers 31 percent of the market for electronic • Scale matters. Institutions must have access to a large appliances. customer base and operational infrastructure in order to cost-effectively deliver and collect on loans.• Codensa Crédito Fácil had 730,000 customers as of Codensa had these advantages; not every company 2008, from a start of a few hundred in 2001. Over 60 will. percent of these customers come from low-middle or72 | Redefining the Emerging Market Opportunity
    • Case Study 3: Delivering Consumer Loans to Low-Income Consumers• Non-bank institutions looking to make loans to low-income consumers will have to find a funding source. Partnerships with banks are one possibility to explore. In the early days of Codensa Crédito Fácil (prior to Multibanca Colpatria’s involvement), Codensa made heavy use of the corporate bond market.KEY LESSONS LEARNED1. The well-developed retail payment network of a utility company can be a good foundation for a loan system targeting lower-income populations.2. Use of payment information to extend consumer finance can help build a credit history database that is critical to enable consumer financing in the lower- income segment.3. Financing of small-ticket consumer products can be an effective way to introduce a lower-income group to more advanced financial services.4. Commerical incentive is required to motivate companies from non-financial sectors, such as utility companies, to pursue and sustain interest in delivering financial services to their customers.ReferencesBueno, M. 2007. “The Codensa Case: Electricity and Related Services for the BOP in Colombia.” Next Billion 2.0. http://www.nextbillion. net/blogpost.aspx?blogid=874.CGAP (Consultative Group to Assist the Poor). 2010. Update on Regulation of Branchless Banking in Colombia. Washington DC: CGAP.Codensa. Codensa Crédito Fácil. http://www.codensa.com.co/ publicaciones.aspx?cat_id=90.——. General information. http://www.codensa.com.co/publicaciones. — aspx?cat_id=118.——. 2010. Annual Report 2010. Bogotá: Codensa. —Endesa. 2009. “Codensa, Endesa’s Subsidiary in Colombia, Sells its Consumer Lending Programme to Multibanca Colpatria.” Press Release.Obermann, T.P. 2006. A Revolution in Consumer Banking: Developments in Consumer Banking in Latin America. Atlanta: Federal Reserve Bank of Atlanta.Western Hemisphere Credit and Loan Reporting Initiative. 2005. Credit and Loan Reporting Systems in Colombia. Durango, Mexico: Centre for Latin American Monetary Studies (CEMLA), World Bank, and FIRST Initiative. Redefining the Emerging Market Opportunity | 73
    • Case Study 4: Rationalizing the Branch-Banking ModelCASE STUDY 4Rationalizing the Branch-Banking Model toDeliver ‘No Frill’ ServicesA fast-growing chain of low-cost outlets brings mass-market banking to Malaysia,offering pre-packaged products, self service, and a focus on simplicity, convenience,and value.EASY BY RHB, MALAYSIAMarket Opportunity RHB’s branch network is significantly smaller than thoseTraditional branch models adopted by banks in Malaysia of the three market leaders. In 2008, it had fewer than halfhave allowed them to serve affluent clients profitably. In the branches of Malaysia’s largest bank. Catching up todoing so, they created a service model with stringent competitors appeared to require significant time andminimum-balance requirements that effectively excluded investment capital to expand RHB’s physical network andthe country’s lower-income majority population from to staff new branches.banking services. Under this model, there is little profitpotential in Malaysia’s mass market, where 70 percent ofhouseholds have monthly income between RM1,000 and Business Model OverviewRM5,000 (US$120-$600). In late 2009, RHB launched Easy by RHB. The new bank was envisioned as a game-changing model that wouldAs a result, average consumers account for a small provide low-cost, no-frills financial services to Malaysia’sportion of deposit accounts and other formal banking mass-market consumers.activity, leaving the field open to providers who inventprofitable models to serve such customers. This unmet RHB Easy—now referred to as just “Easy”—comprises aneed for financing is currently served by informal network of small-footprint, sales-focused outletsproviders. Malaysian bank competition is a battle of equipped with self-service terminals. These outletsbranches: a bank’s market share of deposits and loans distribute a simple menu of five pre-packaged financialcorrelates to the size of its brick-and-mortar network. products. Easy offers quick and consistent service,Tapping the mass market, therefore, requires a cost- simple interest rates, transparent processes and pricingeffective physical distribution model. with no hidden charges. Easy’s focus on simplicity, convenience, and valueStakeholder Overview transformed Malaysia’s traditional bank-branch model.RHB Bank is Malaysia’s fifth-largest financial services Customers were quickly drawn to its efficient service,group. As a retail bank, it is known for products ranging absence of long queues, and loan processing that takesfrom insurance and wealth management to credit cardsand loans. Redefining the Emerging Market Opportunity | 75
    • Case Study 4: Rationalizing the Branch-Banking ModelBranch look and formatWarm and cheerful stores focused on sales with self-service terminals.Paperless, straight-through processing with dual-screen technology76 | Redefining the Emerging Market Opportunity
    • Case Study 4: Rationalizing the Branch-Banking ModelPaperless banking transactions Customer C uses Mykad reader to verify identity Receipt printed for C upon C selects transaction to perform successful transaction, on screen and verifies information e.g., account opening, deposit, or personal loan application Use of electronic signature Additional data typed eliminates signature cards into electronic form and paper forms10 minutes from start to finish. Easy is now Malaysia’s • Products: Key differentiators, in addition to speedyfastest-growing bank. approval and disbursement, include flexible loan terms and installments, acceptance of small depositIts no-frills service, outlet model, and focus on sales with accounts, and prize drawings rewarding high-usevirtually no paper-based operations greatly reduced customers.typical branch set-up and operating costs. That strategyhas made Easy scalable, allowing RHB to expand the new • Customer experience: A new blueprint of customernetwork quickly and inexpensively. experience at branches is characterized by simplicity, consistency, and speed. Outlets are physically distinctRHB launched Easy as a separate sub-brand to from RHB’s traditional branch in look, feel, anddistinguish it from traditional banking. Easy differentiated functionality, featuring an open and non-intimidatingitself with customer experience designed to meet the environment with informal layout and flow, as well asneeds of the mass market: bold colors and graphics. Products and prices are clearly displayed on panel signs similar to those at• Simplicity: A straightforward menu of just five fast-food restaurants. transparently-priced products at launch, including two loans, two deposit accounts, and one insurance • Technology: Innovative technologies have been offering; speedy 10-minute purchasing times; and adopted to create lean processes with fast turnaround, simple application procedures using paperless including completely paperless banking based on biometric technology, such as electronic identification biometric and straight-through techniques. To promote cards. The “once and done” experience of a retail store transparency, Easy uses a dual screen display for means customers do not have to leave the kiosk and transactions, which also allows customers to check return with documentation. This not only simplifies the their information on the spot. experience for customers, it also ensures better sales by reducing the likelihood that customers will shop • Risk management: A strong risk-management around or have second thoughts. approach harnesses technology to mass-market credit models. Operational procedures focus on mitigating• Convenience: Kiosks located in mass-market and fraud, errors, and theft, including low cash at outlet, no high-traffic areas, with extended and weekend opening cash-outs at outlet, function segregation, and hours; self-service access, including ATMs, cash biometric verification of data. deposit terminals, and interactive voice response. • People: Easy focuses on human resources and• Value: Innovative features, quick turnaround time, and staffing, with selective recruiting, rigorous training, and almost no fees or charges. highly incentivized compensation. Staff are offered an entrepreneurial and fun culture with flexibility in workThe RHB Easy model transformed Malaysian banking in schedule and career path.several fundamental dimensions: Redefining the Emerging Market Opportunity | 77
    • Case Study 4: Rationalizing the Branch-Banking Model Impact • Identifying priority outlet locations requires careful • RHB has become Malaysia’s fastest-growing bank, planning, especially in countries with a high penetration with 17 percent loan growth, almost double the of traditional branches in key cities. industry average. For one of the loan products that Easy offered, market share increased from nine percent to over 20 percent in two years. KEY LESSONS LEARNED 1. The branch banking model must be fundamentally • Easy’s low-cost, high-profitability model has driven redesigned to accommodate mass segment buying overall improvements: behavior, lower ticket size. ——Cost-to-income ratio is estimated to be in the range 2. Creating a new sub-brand can eliminate the of 30-35%. constraints of operating under a legacy identity. The sub-brand leverages the main bank’s reputation while ——Outlet setup cost is one-seventh, and operational differentiating its service from traditional banking. costs one-quarter, those of traditional branches. 3. Simplicity, convenience, transparency, speed, and • Assisted by Easy’s strong performance, RHB’s stock value are key features the operational model must market capitalization rose to US$16 billion from deliver to attract mass-market customers. RM10.9 billion in 2009 to RM15.6 billion in 2010. As of Q2 2012, RHB’s stock market capitalization was RM17.0 billion. References Bank Negara Malaysia. Statistics. http://www.bnm.gov.my/index. • Rollouts are six times faster than for typical branches, php?ch=12. with much higher sales productivity: Credit Bureau, Bank Negara Malaysia. Credit Bureau. http:// creditbureau.bnm.gov.my/index.php?lang=en. ——Up to eight times the productivity of traditional Credit Suisse. 2011. RHB Capital: Equity Research Report. Hong Kong: branches for top loan products. Credit Suisse. ——Ramp-up time is one-quarter that of traditional RHB Bank. 2010. Annual Report 2010. Kuala Lumpur, Malaysia: RHB Bank Berhad. branches, allowing Easy to establish 250 outlets within two years. Phone interviews of selected experts conducted by author. December 2011, April 2012. • Received the Best Process Innovation Award from the Share/Guide Association of Malaysia, a nonprofit association of information technology (IT) users. Potential Implementation Challenges • The efficiency and success of RHB Easy were greatly supported by infrastructure and IT enablers designed and implemented by the Malaysian government. Similar bank launches without such support would be significantly more difficult. A major constraint to implementation would exist without IT infrastructure enabling the use of electronic identification cards, digital signatures, and information management systems. In addition, in order to quickly and accurately make decisions on credit applications, financial institutions require accurate, up-to-date information on their prospective borrowers. In Malaysia, the national credit bureau (CCRIS) database stores credit information on borrowers from lending institutions and flags default events, thus helping banks determine appropriate credit limits. • Successful adoption rate depends on the level of education and financial literacy of the population in each country. In addition, self-service terminal models in the financial industry encounter skepticism unless security and reliability issues are transparently resolved.78 | Redefining the Emerging Market Opportunity
    • Case Study 5: Savings-Linked Conditional Cash Transfer ProgramsCASE STUDY 5Savings-Linked Conditional Cash Transfer ProgramsChanneling aid to low-income citizens through savings accounts can catalyze adoptionof financial services, while reducing costs of delivery for governments and internationalagencies.Oportunidades, Mexico; Personal Capitalization Accounts, Peru; Bolsa Familia, BrazilMarket Opportunity Stakeholder OverviewsEfficient delivery of financial aid is becoming increasingly Oportunidades is the principal anti-poverty program ofimportant to improve social conditions in emerging the Mexican government. It focuses on helping poormarkets. Governments are seeking ways to enhance the families invest in improving their children’s education,effectiveness of financial aid and its delivery. Traditional health, and nutrition. Having started with only 300,000methods of aid delivery suffer from complexity and a lack households in 2002, it now reaches more than 5 millionof transparency and accountability. In addition, aid households and has a US$3.6 billion budget. In 2008,programs often have faults in their design, especially with Oportunidades started a pilot CCT program with Diconsa,respect to specifying targets and measuring results. a publicly owned and managed company that is the biggest retail chain in Mexico.One newer type of aid that is showing promise isconditional cash transfer programs (CCTs). CCTs are Since 2004, Edge Finance S.A. has been running a pilotanti-poverty social-policy programs that direct funds CCT program in Peru called Personal Capitalizationtoward recipients based on specified behaviors, such as Accounts. The program, which targets rural areas,children’s attendance at school or doctors’ visits. The improves individual access of very poor people, especiallyprograms, though still young, are becoming more women, to deposit services in formal institutions.sophisticated. Brazil’s Bolsa Familia CCT program began in the 1990sFor instance, some CCTs are now linked to savings with an electronic benefit card from which recipientsaccounts, thus boosting financial inclusion and asset could withdraw grant funds, but to which they could notbuilding. By partnering with these CCTs, financial deposit money. The program now reaches almost 13institutions and retail SMEs can offer their products to a million households, a quarter of the Brazilian population.vast array of new customers. In Mexico, Peru, and Brazil, Over the last few years, Caixa Economica, a government-there are already pilots underway for savings-linked CCTs owned bank, has been moving recipients from the card tothat provide a basic transactional account as a deposit a basic banking account and using retail merchants asfacility. agents. Redefining the Emerging Market Opportunity | 79
    • Case Study 5: Savings-Linked Conditional Cash Transfer ProgramsSavings-linked conditional cash transfer programs to deliver official development assistance Mexico’s Oportunidades pilot with Diconsa BANSEFI provides free basic account. Diconsa Mother Mother ensures provides retail withdraws children attend network for program funds school, doctors’ BANSEFI and and buys food at visits. Oportunidades. Diconsa. Oportunidades deposits funds directly into account. Peru’s Personal Capitalization Account pilot process Day 1 Day 10 Intermittently throughout End of Year 1–3 Personal Capitalization Woman W opens a W develops discipline W exits program. Account promoted personal savings in regular savings W’s savings enable through financial account at Bank B and is again rewarded her to invest in education workshops. and receives matching with matching funds. personal assets or grant as a reward. productive assets.80 | Redefining the Emerging Market Opportunity
    • Case Study 5: Savings-Linked Conditional Cash Transfer ProgramsBusiness Model Overviews ImpactMexico: Oportunidades Pilot with Diconsa Mexico: Oportunidades Pilot with DiconsaFor Oportunidades, one of the attractions of Diconsa has • Pilot Diconsa stores have increased sales 20-30been its proximity to aid recipients. Diconsa sells basic percent as compared with control Diconsa stores.food products from its 23,000 stores, of which 13,000 arewithin 4 kilometers of 1 million unbanked Oportunidades • Over 1 million savings-enabled accounts have beenbeneficiaries. Originally, 230 Diconsa stores were set up created for participants.with a point-of-service (POS) device to disburse program • The use of electronic payments has proven extremelyfunds to beneficiaries with an electronic card. popular with the initial test group. A survey of 260If beneficiaries meet program conditions, Oportunidades beneficiaries demonstrated a near-unanimousdeposits cash in accounts set up for them by BANSEFI, preference for electronic payments over cashthe government savings and development bank. payments.BANSEFI is also expanding correspondence networks to • Initial results suggest that the cost of channelingmake the program more attractive to end customers. The payments and aid in pilot outlets is reduced by over 90beneficiaries can withdraw cash at Diconsa stores that percent.that have the POS devices, where clerks are also trainedin the devices’ use. Many beneficiaries use their funds topurchase items immediately from Diconsa, boosting the Peru: Personal Capitalization Account Pilotretailer’s sales. Through careful management, Diconsa • Women in the program have saved 6.6 percent of theirstores have never run out of cash. households’ median income through Personal Capitalization Accounts.Peru: Personal Capitalization Accounts Pilot • In three years, 10,000 very poor women saved thePeru’s Personal Capitalization Accounts (PCA) pilot equivalent of US$2 million.financially rewards poor rural women through a system ofsubsidized savings for a period of 12-36 months. As • The early savings rate suggests that, if the program iswomen meet certain requirements—opening personal conducted on a larger scale, hundreds of millions ofsavings accounts at formal banks, demonstrating dollars could be injected into local financial institutions.discipline in regular savings, and becoming familiar withformal financial institutions—matching grants are Brazil: Bolsa Familiadeposited directly into their accounts. The PCA is • More than two million families have opened bankpromoted in small financial education workshops. Women accounts.receive intensive training on money management, on theimportance of savings, and on the possibilities for • The cost of administering the program has beenpersonal investment projects made possible by savings. reduced by 12 percent.Brazil: Bolsa Familia Partners with Caixa Potential Implementation ChallengesIn 2003, Caixa Economica, a government-owned bank, • If retailers are to be used with CCT programs, countriesbegan offering free simplified accounts to increase may need to clarify and streamline their regulatoryfinancial inclusion. Bolsa Familia recipients are being frameworks. In Brazil, the Central Bank, labor laws,moved to these accounts to receive benefits. So far, more and the National Health Surveillance Agency, whichthan 2 million accounts have been opened. regulates pharmacies, all have jurisdiction over retailRetail “correspondents,” contracted by the banks and correspondents.authorized by Caixa, can open the accounts. Eighty-five • In order to develop a robust and dispersed agentpercent of fund withdrawals occur at retail network and enrollment system, it is essential to pickcorrespondents. strong partners and provide sufficient training for theirThe accounts include a Visa-branded debit card that can clerks and other staff members.be used at more than 20,000 ATMs, stores, and retail • In a well-managed CCT program, it is necessary tocorrespondents acting as bank agents. Recipients can authenticate the identities of potential aid recipients.pay bills, make deposits, and withdraw funds using their This could be a stumbling block in countries whereaccounts. Caixa has experimented with insurance, potential users may lack required identification or proofdeveloped financial literacy programs, and considered of residency.microloans for account holders. • The push to encourage savings—the next step after merely enabling it—could inhibit consumption and investment. It may seem unlikely that a CCT program’s own success could lead to problems, but countries will have to watch for this possibility. Redefining the Emerging Market Opportunity | 81
    • Case Study 5: Savings-Linked Conditional Cash Transfer Programs • All CCT programs have an education component. Beneficiaries must be taught how to resolve financial and technological literacy issues. KEY LESSONS LEARNED 1. Channeling government payments and foreign aid through savings-enabled accounts can catalyze adoption of financial services in the low-income population. 2. Partnerships with banks and retailers provide an efficient, inexpensive way to reach poor rural populations, while ensuring low income people spend aid money on the most important goods and services. References CGAP (Consultative Group to Assist the Poor). 2009. Banking the Poor via G2P Payments. Washington DC: CGAP. The Economist. 2010. “How to Get Children out of Jobs and into School.” The Economist. July 29, 2010. New America Foundation. 2011. Savings-Linked Conditional Cash Transfers: Lessons, Challenges & Directions. Washington DC: New America Foundation. —— and UNDP (United Nations Development Programme). 2011. — A Third Way for Official Development Assistance: Savings and Conditional CashTransfers to the Poor. New York and Washington DC: UNDP, New America Foundation. Proyecto Capital. Website. http://www.proyectocapital.org/.82 | Redefining the Emerging Market Opportunity
    • Case Study 6: Using Legacy Payment Data and Infrastructure to Expand into Consumer LoansCASE STUDY 6Using Legacy Payment Data and Infrastructure toExpand into Consumer LoansFinancial institutions can expand from insurance to consumer lending—even lackingaccess to traditional credit data—by improvising risk-assessment tools and marketingchannels based on their legacy customer payment information.PRUDENTIAL FINANCE, VIETNAMMarket Opportunity needs to invest in Vietnam. In 2005, Prudential InsuranceVietnam is among Asia’s fastest-growing economies and established a fund management business and quicklyfinancial markets. The long-term outlook for consumer became the largest institutional fund manager. By 2007,finance in particular is promising, given the country’s Prudential had about US$1.3 billion of assets underyoung population and expanding middle class. More than management and one of the largest holders of sovereign50 percent of Vietnamese are under 30, and an equal debt.portion have monthly income between $250 and $500.Despite this potential, the Vietnamese public has been Business Model Overviewunder-served by banks, which lack access to shared As Prudential began looking for additional long-term,risk-assessment data and often focus on lending to diversified, higher-yield investment opportunities,state-owned industries. According to a 2010 study by the expanding into consumer finance seemed a logicalConsultative Group to Assist the Poor, consumer deposit choice. In 2007, Prudential obtained a license to createand loan penetration in Vietnam is among the lowest in Prudential Finance Vietnam, offering unsecuredAsia. consumer loans, personal loans, residential mortgages, and credit cards.Stakeholder Overview At the outset, Prudential Consumer Finance had littlePrudential is a global financial services firm. It operates a infrastructure and insufficient data for full-scale creditsignificant business in Asia, with 15 million customers in scoring. But it did have other assets of its legacy business13 countries. Prudential first entered Vietnam in 1999 and to deploy. These included a base of loyal insurancequickly became a dominant provider of private insurance, customers, a highly trusted brand with an awarenesswith 41 percent market share, 1.3 million policy holders, rating of over 90 percent in Vietnam, back-office andover 200 branches and GA offices, 1,600 staff, and nearly marketing operations, and initial capital.40,000 independent insurance agents. It is one of thelargest foreign taxpayer in Vietnam. Prudential launched the business using its insurance customer information as credit data, offering loans only toAs Vietnam’s largest life insurance provider, Prudential the best of those legacy clients—people who had rarelyaccumulated the significant long-term liquidity that it missed a premium payment. This approach allows Redefining the Emerging Market Opportunity | 83
    • Case Study 6: Using Legacy Payment Data and Infrastructure to Expand into Consumer LoansConsumer finance credit-assessment process for insurance customers Customer applies for consumer finance. Information about customer’s insurance premium payments is extracted from system. Insurance payment and/or other information is entered into credit assessment tools. Qualified customers enjoy Insurance clients with loans at lower rates poor premium payment history with faster approval process. do not qualify for financing.84 | Redefining the Emerging Market Opportunity
    • Case Study 6: Using Legacy Payment Data and Infrastructure to Expand into Consumer LoansPrudential to identify worthy clients outside the high- • Prudential’s loan business has very high brand- andincome segment that banks traditionally compete for in spontaneous-awareness levels. Thirty percent ofemerging economies. Within two years, the firm potential consumer-finance clients identified Prudentialexpanded credit-check capabilities to non-insurance as the top provider when asked which organizationscustomers, capturing data from payrolls, credit-card they would consider for loan services.records, labor contracts, and business licenses.Prudential also tapped the back-office, recruiting, Potential Implementation Challengeshuman-resources, information-technology, and marketing • Financial providers seeking to branch out fromresources of its insurance unit to build the loan business, insurance into emerging-markets consumer finance,while its regulatory and communications teams cleared without access to traditional personal-credit data,regulatory and communications hurdles. must actively collect and assess behavioral and customer information to build reliable credit-scoringAt the same time, Prudential established separate sales models. They should proactively build and refine theseand distribution channels for the new business in order to databases and their credit modeling as the businessavoid distracting insurance agents from their own grows.business. It set up a consumer-finance call center and hasbuilt a multi-channel direct distribution platform centred • Firms seeking to emulate Prudential’s consumeron Ho Chi Minh City and Hanoi, Vietnam’s most affluent finance model must ensure they have widespreadprovinces. The finance company now fully supports its brand recognition. That, along with customer trust,own channels and operations, including a telemarketing was key to Prudential’s quick growth and its appeal tocenter that also serves its insurance business. high-value clients, who often avoid unfamiliar providers.Prudential Finance’s knowledge of its Vietnam insuranceclientele allowed it to structure attractive and profitable • Traditional banks accustomed to the credit-loan programs for the local market. Prudential’s Insurance assessment and premium-payment data available inSurrogate Income Program (ISIP) in particular was upper-income markets may find competition fordesigned for insurance clients. It created medium-term middle-market customers difficult in emergingloans for salaried and self-employed insurance clients, economies. By partnering with insurance companieswith less-restrictive credit checks. It also offered to gain access to data supporting credit assessmentunsecured loans with no guarantor requirements—a and client selection, those banks may win ahighly competitive product in Vietnam, where collateral competitive edge.requirements are the rule.Prudential’s competitive rates also distinguished it from KEY LESSONS LEARNEDother providers. As of 2011, with high deposit rates in 1. Institutional investors, such as Prudential, can generateVietnam about 14 percent amid 20 percent year-on-year long-term, high-yield returns in emerging markets byinflation rate, banks usually charge 25-30 percent for expanding from insurance into consumer finance.collateralized loans and 50-60 percent for unsecuredloans. However, Prudential charged 25-30 percent for 2. Properly managed, the hard and soft assets of anuncollateralized loans, the lowest rate in the market. For insurance business—including customer data,existing insurance customers, Prudential offered rate marketing channels, back-office infrastructure, anddiscounts and high-speed loan approvals. brand reputation—can create a strong platform for branching into consumer finance.Impact 3. Financial institutions can use legacy payment data and• As of December 2010, Prudential has extended new client lists to conduct credit assessments and create a loans of US$190 million to more than 100,000 target client base, allowing financial institutions to build customers in under three years. It started with scale rapidly and to reduce customer acquisition costs. stronger-than-expected growth the first year, in the 4. Existing back-office functions—such as information absence of other consumer finance competitors, giving technology, distribution, and human resources—can Prudential a first-mover advantage. be repurposed to support new financial products,• Credit extended to Prudential’s insurance clients has services, and businesses, accelerating launch time resulted in very few non-performing loans (NPLs), and reducing initial investment costs. producing one of the lowest NPL percentages in the country. Redefining the Emerging Market Opportunity | 85
    • Case Study 6: Using Legacy Payment Data and Infrastructure to Expand into Consumer Loans References Life Insurance International. 2008. “Prudential Enters Vietnam’s Consumer Finance Market.” News Digest. May 1, 2008. Park, B. and J. Howell. 2011. Phone interview by author with Brian Park, CEO, Prudential Vietnam Finance Company, and Jack Howell, CEO, Prudential Vietnam Insurance, December 2011. Prudential Finance. 2011. Leveraging Insurance in Building Consumer Finance in Emerging Market. Internal Presentation Document. Stowe, B. 2011. Phone interview by author with Barry Stowe, Chief Executive Asia, Prudential Plc, August 2011. Tucker, S. 2007. “Prudential Eyes Vietnam Growth.” Financial Times. October 8, 2007. Vietnam News Briefs. 2010. “Finance: Prudential Finance Vietnam Lends VND 1.9T So Far.” Vietnam News Briefs. November 2010.86 | Redefining the Emerging Market Opportunity
    • CASE STUDY 7Developing the Broader Ecosystem forTechnology-Enabled ChannelsTechnology-enabled channels must be complemented by broad cash-in / cash-out andmerchant payment networks.SMART Money, PhilippinesMarket Opportunity Unibank (BDO), the country’s largest bank, to launchBefore mobile banking came to the Philippines, account Smart Money, a service available to SMART’s 47 millionofficers spent almost two-thirds of their time collecting subscribers nationwide.microloans in rural areas, where much of the populationdoes not have bank accounts. The high costs associatedwith account handling and bank transactions constrained Business Model Overviewbank branch expansion and kept many low-income Smart Money is an electronic wallet, similar to a bankFilipinos from accessing financial services. account, that allows customers to pay bills over their mobile phones, shop at point-of-service machines andThe lack of infrastructure also had a big impact on online, transfer money to each other, and receiveremittances, the money sent back home by overseas remittances at a dramatically reduced cost—less than 1workers. Remittances are a significant part of the percent of the value of the transfer, versus 2.5-10 percenteconomy of the Philippines, amounting to US$20.1 billion previously. All the SMART subscriber needs are a mobilein 2011. Traditionally, however, a large portion of phone, a SMART Money account number, and a six-digitremittance inflows has been lost to money-transfer fees. numerical code to use as a password.In recent years, a solution to these twin problems has Part of Smart Money’s success lies in its use of Smartarrived in the form of mobile banking via text messaging. Money Mastercard, which doubles as both a reloadableMore than 75 percent of Filipinos are mobile phone debit MasterCard and an ATM card. Account holders loadsubscribers; collectively, they send a billion text messages cash into their accounts in order to have access to thea day. Clearly, there is potential to use mobile phones and funds later. This brings an alternative financial service toother electronic platforms to widen access to financial lower-income populations in rural areas and stimulatesservices among the low-income population. the growth of savings and microfinancing. Smart Money customers can also deposit and withdrawStakeholder Overview cash at 100 SMART wireless centers, at 10,000 BDOSmart Communications (SMART), the Philippines’ leading ATMs and branches, and at more than 4,000 so-calledwireless services provider, is a wholly-owned subsidiary Money-In, Money-Out Centers. This extensive coverageof the Philippine Long Distance Telephone Company, the (there are also 95,000 partner agents worldwide) givescountry’s largest telecommunications carrier. In 2000, the unbanked Filipinos access to financial services no mattersubsidiary teamed with Mastercard and Banco De Oro how much they earn and where they live. Redefining the Emerging Market Opportunity | 87
    • Case Study 7: Developing the Broader Ecosystem for Technology-Enabled ChannelsSMART Money services Registration Getting a SMART money card Registration of 1. Complete form SMART money 2. Photocopy ID account online 3. Pay fees SMART SMART Wireless money Center Confirmation SMART card Reload SMART money account SMART money transfer Wallet-to-wallet transfer SMART money SMART Wireless Center Send SMART money SMART balance Deposit cash via SMS increases Banco de Oro SMART balance increases Mobile banking service reload SMART Money Center Send SMS request Inform the bank (accredited outlets) SMART money SMART balance Confirm acceptance decreases Withdrawal of SMART money (cash-out) Transaction via Master Card network Over-the-counter Purchase via POS machine of partnered vendor SMART SMART balance decrease Wireless PIN + SMART card Center Banco de Oro Receive cash SMART Confirmation of purchase Vendor Money Center ATM Online purchase PIN + SMART card Activation PIN PIN + card info SMART ATM money Receive cash Vendor Mobile payment Confirmation via SMS88 | Redefining the Emerging Market Opportunity
    • Case Study 7: Developing the Broader Ecosystem for Technology-Enabled ChannelsOther reasons for the program’s success are the • Mobile banking requires communication andinvolvement of Mastercard, which lets Smart Money collaboration among multiple stakeholders. Thesubscribers make purchases or payments anywhere government should be involved, both to regulate theMasterCard is accepted; Smart Money’s reputation for emerging industry and to ensure that mobilesecurity; the simplicity of its interface; and its use of transactions happen in a secure environment.familiar mobile phone services, such as SMS textnotifications on every completed transaction. SmartMoney makes its revenue through service fees that are KEY LESSONS LEARNEDsmall enough not to deter subscribers. For instance, it 1. Combining multiple electronic platforms, such ascosts PHP25 (US$0.06) or less to do a balance inquiry telecommunications infrastructure, with a paymentand PHP12 (US $0.03) or less to withdraw money from network can increase scale, improve convenience andthe bank. There is a 1 percent transaction charge to efficiency, and bring a wide range of financial servicesreload money onto a card. to the mass segment. 2. A broader cash-in / cash-out and payment networksImpact can be attained through wider partnerships, including• The popularity of the system—as of 2011, Smart mobile operators, banks and payment service Money had eight million subscribers—has caught the providers. attention of the financial industry throughout the 3. A pay-per-transaction fee structure increases Philippines. The Rural Bankers’ Association of the affordability and offers economics suited to a lower- Philippines, which has almost 700 member banks and income population. 2,100 branches nationwide, has agreed to provide access to the Smart Money platform. 4. Security, an intuitive user interface, and a large network of cash management and usage channels are critical• Since 2006, Smart Money and other mobile payment to generate adoption among the low-income market platforms have helped accredited rural banks in the segment. Philippines process more than 2.5 million mobile phone transactions, valued at more than PHP13 billion (US$308 million). The Philippines’ rural banking References initiative has disbursed a total of PHP39 billion (US$923 ABS-CBN News. 2008. “Smart, Rural Banks Team up for Mobile million) in microloans covering roughly 950,000 clients. Banking Project.” ABS-CBN News.com. November 29, 2008. CGAP (Consultative Group to Assist the Poor). 2010. Notes on• In 2009, monthly turnover of Smart Money amounted Regulation of Branchless Banking in the Philippines. Washington for PHP8 billion (US$174 million). DC: CGAP. MasterCard Worldwide, 2009. “MasterCard Launches MasterCard Mobile Payments Gateway to Spark Mobile Commerce Globally.”Potential Implementation Challenges Press Release. November 16, 2009.• By its nature, a system that makes it too easy to Philippine Airlines. Smart Money MasterCard. http://www. transfer money has the potential for abuse. That makes philippineairlines.com/faq/smart_money_mastercard/faq_smart_ it essential to implement anti-laundering controls and money_mastercard.jsp. other security procedures, some of which may involve Philippine Star. 2012. “Smart Money Ties up with Bayad Center.” The a government authority. Smart Money has Philippine Star. January 17, 2012. implemented personal identification registration and SMART. Smart Money. http://www1.smart.com.ph/money. allows mobile phone credit reloads of no more than Torres, T.P. 2012. “Rural Bankers Disburse P39 B in Microloans.” The PHP50,000 (about US$1,200) and daily withdrawals of Philippine Star. December 24, 2012. PHP20,000 (US$480).• National habits and customs may make some countries a better bet than others for a mobile payment platform. Filipinos are already accustomed to the practice of mobile phone “reloading,” as 98 percent of the mobile phone subscriptions in the country are prepaid. To many Filipinos, reloading money onto their mobile payment platform may well seem like an extension of something they already do.• There are many barriers to adoption for first-time users. They will need to be educated about the benefits of the system and to receive instruction on how to use it if rollouts are to succeed. Redefining the Emerging Market Opportunity | 89
    • CASE STUDY 8Instant Disbursement of Vehicle-Based FinancingAdoption of on-site assessment capabilities can allow providers to deliver instant loandisbursement.Srisawad Ngern Tid Lor (Money on Wheels), ThailandMarket Opportunity KRUNGSRI, a major private bank in Thailand, afterIn emerging markets, people on the lower end of the operating as part of AIG between 2007 and 2009.income spectrum often have an irregular income streamand rely on financing to cover emergency expenses, Srisawad’s main business is providing “Fast and Easy”make major purchases, or start new businesses. But cash through asset-secured lending to borrowers fromsuch financing may not be available if regulators— the low-income population. It has special expertise inresponsible for safeguarding the health of the banking appraising vehicles as collateral. Although motorcyclessector—limit banks’ exposure to high-risk consumer were introduced first, the company now also acceptslending. For example, the Bank of Thailand prevents any cars, mini-trucks, and tractors as collateral.organization from giving unsecured loans to borrowerswith a monthly salary of less than THB15,000 (US$480). Business Model OverviewOne problem is that low-income people often cannot offer For motorcycle-based financing, Srisawad’s average loantraditional forms of collateral. They usually do not own is around THB10,000 (US$320), though the companytheir homes, and thus cannot back loans with real estate. offers loans of as little as THB5,000 (US$160). TheFor financial institutions, the challenge is working with the company bundles insurance into most products to protectkinds of collateral that low-income populations actually itself against the risk of default while also allowing thehave. Thailand has 16 million motorcycle owners, most of borrower to retain possession and use of the vehicle thatwhom are in the lower-income segment. Providing lending has been put up as collateral.with motorcycles as the collateral is thus a significant Srisawad’s proposition is appealing to low-incomeopportunity. borrowers for a few reasons, including the simplicity of the application process. Borrowers need to provide onlyStakeholder Overview personal identification, proof of residence, and licenseSrisawad Ngern Tid Lor (Money on Wheels), established in registration—and they do not need to make a personal1980, is the biggest motorcycle-based financing company guarantee. In addition, loans are disbursed quickly, withinin Thailand, with current loans outstanding of THB3 billion 30 minutes for motorcycle loans and one day for cars,(US$96 million). In 1991, Srisawad changed its name to compared to a period of at least three days in the case ofSrisawad International and expanded its business to 130 other low-income loan providers. In addition, Srisawad’sbranches throughout Thailand. Srisawad is now owned by interactions with borrowers, and its disbursements of loans, happen primarily at townhouses in densely Redefining the Emerging Market Opportunity | 91
    • Case Study 8: Instant Disbursement of Vehicle-Based FinancingSrisawad: Comparison of motorcycle-based financing in Srisawad with other financiers Srisawad Other financiers • Application form is simple and does not include • Application form is more complex, often including Loan application guarantor requirements. guarantor requirements and cumbersome documentation. • Assessment is instant with in-branch vehicle • Documents are sent to credit scoring center for Loan assessment valuator and credit assessor. assessment. • Higher safety margin with insurance bundled. • Lower safety margin with no insurance bundled. • Disbursement occurs instantly through either cash • Disbursement occurs after credit scoring center Loan disbursement or a bank account. forwards its decision to disbursement center. • Vehicle remains with customers to use. • Vehicle often retained as collateral. Time to disbursement 30 minutes 3 days or longerpopulated areas, where its customers are likely to feel • Srisawad has experienced significant scale-up, with acomfortable, rather than in the more formal office settings 100 percent increase in loans outstanding in 2010 towhere personal loans are usually made. Prospective THB3.2 billion (US$106 million).borrowers come in with their vehicles, get the cash theyneed, and leave with the same vehicles, able to carry on • Non-performing loans dropped by 30 percent in 2010,with their daily activities. with only 2 percent of loans written off as unrecoverable.In order to make its business a success, Srisawademploys automobile valuators in every branch, to makequick credit decisions and disbursements. These Potential Implementation Challengesspecialists get in-house training. Among Srisawad’s other • A model such as Srisawad’s relies on a physicaloperating tactics are the use of townhouses as branches network to serve customers, and the ramp-up must be(which also controls costs); the use of a larger collateral- done in stages. This is a disadvantage vis-a-visto-loan margin than would be necessary with a full bank commercial banks that may have large branches—andassessment; marketing that is specifically tailored to a therefore a substantial presence—in plannedlow-income customer base; and an automated calling expansion areas.system that notifies borrowers that they are late on • To drive growth and efficiency, there is a need topayments—and that has significantly reduced the default expand into a wider range of collaterals. Srisawadrate. originally focused on motorcycle-based loans. To build scale and increase the size of its loan portfolio, theImpact company developed specialization and valuation• Srisawad has 80,000 customers and 183 branches as capability in related collateral areas, specifically, other of mid-2011. kinds of vehicles.• Srisawad’s revenue increased to THB798 million • When offering loans to a low-income population, a (US$26.4 million) in 2010 from THB209 million (US$6.9 financial institution must first have a strong risk- million) in 2007. During the same period, its operating management process in place. This means establishing profit improved to THB57 million (US$1.9 million) from a an appropriate safety margin and a systematic loan- loss of THB164 million (US$5.4 million). recovery process, and may involve the use of a bundled insurance fee to protect the lender from default.92 | Redefining the Emerging Market Opportunity
    • Case Study 8: Instant Disbursement of Vehicle-Based FinancingKEY LESSONS LEARNED1. Specialization in collateral types—especially if it is done at the branch level—allows institutions to shorten the time for disbursement on asset-based loans.2. Institutions can manage the risk associated with movable asset-based lending by applying suitable loan-to-value safety margins, instituting late payment reminders, and insuring themselves against the possibility of customer default.ReferencesCFG Services Co., Ltd. 2011. “’Srisawad Ngern Tid Lor’ (Money on Wheels) Grew Its Loan Volume in 2010 by 100% Under its ‘Fast and Easy’ Strategy.” Press Release. March 21, 2011.Srisawad Ngern Tid Lor. 2010. “Beyond Target.” Press Release. May 3, 2010.Ukritnukun, P. 2011. Interview by author with Piyasak Ukritnukun, Chief Marketing Officer, Srisawad Ngern Tid Lor. August, 2011. Redefining the Emerging Market Opportunity | 93
    • CASE STUDY 9Adopting a Franchise Model to Expand Low-IncomeFinancial ServicesFranchise partnerships can expand branch networks quickly and inexpensively toprovide financial services to low-income communities.WAFACASH, MOROCCOMarket Opportunity Over time, Wafacash has become a full-service providerPhysical branches continue to be an important of money transfers, including international remittances,distribution channel for financial services. In Morocco, through agreements with other institutions such asbranches have traditionally been concentrated in urban MoneyGram and RIA, and national remittances with Cashareas. However, Morocco’s low-income population tends Express, its self-developed service and brand. Moreto be dispersed in suburban and rural regions. As a result, recently, it has formed an alliance with BICS to create aaround 60 percent of Morocco’s population lacks access remittance corridor between Belgium and Morocco.to financial services. In the last few years, Wafacash has used these outlets toExpanding traditional branch networks requires expand customer offerings beyond remittances to othersubstantial investment, and creating branches to serve financial services, as the market for its traditional clientelelow-income communities alone can be prohibitively costly. served through normal branches has become saturated.Further, a traditional banking branch, with a sophisticatedlook, large staff, and full range of services, is oftenintimidating to Morocco’s low-income population. A Business Model Overviewfranchise model, in which financial institutions employ the Wafacash’s distribution strategy is to use small, friendly,existing assets and capital of partners, can help quickly low-touch branches to provide nationwide money transferexpand a bank’s physical network with a look and feel services. It currently has 650 branches throughoutmore suited to the low-income population. Morocco, mostly located in poor neighborhoods. Wafacash outlets are small and efficient, resulting in low operating costs. They offer friendly service and flexibleStakeholder Overview operating hours to accommodate the characteristics ofAttijariwafa is Morocco’s largest bank. In 1995, its low- and irregular-income customers.subsidiary, Wafacash, became the first entity in Moroccoto receive a Western Union license for remittance Around 65 percent of Wafacash outlets today arebusiness. established through franchise arrangements. Franchise outlets are mostly located and operated by existing smallWafacash needed to scale up quickly to demonstrate its retail establishments in neighborhoods convenient forability to gain market share. To do this with limited low-income residents. The Wafacash franchise modelexpense, it adopted a franchise model. includes the following key elements: Redefining the Emerging Market Opportunity | 95
    • Case Study 9: Adopting a Franchise Model to Expand Low-Income Financial ServicesWafacash branch network structure Wafacash central operations • Determines outlet locations • Manages and supervises all outlets • Ensures service consistency and compliance • Provides products and back-office processing 25 franchise small-business partners • Each manages at least 5 branches • Directly manage outlets to ensure strong sales, service, and compliance Wafacash’s self-owned branches Franchise branches (one-third of branch network) (two-thirds of branch network) • Manage front-line business, including sales and • Manage front-line business, including sales and service service • Report money flow that occurs during the day for • Report money flow that occurs during the day for compliance purposes compliance purposes• Wafacash has about 25 franchise partners. The That led Wafacash to begin using the franchises to deliver smallest partner has five outlets. Limiting the number the full range of products once available only at wholly- of partners ensures central operations are not over- owned branches. Currently, the main products and burdened with related management activities. services offered to Wafacash customers include: Wafacash ensures that franchisees are big enough to have proper management and procedures. • Money transfers, which provide the majority of Wafacash’s revenues. Wafacash offers domestic and• Franchises are tightly controlled by Wafacash to ensure international money transfer services. Remittance that services are properly delivered and that operations services are also helped in part by Wafacash’s large meet monetary and regulatory requirements. Activities international footprint, as well as Morocco’s status as such as mystery shopping and training programs are the ninth-largest recipient of remittances, at US$6 conducted regularly. billion annually.• Wafacash uses an analytics tool to determine high- • Floussy, launched in 2008, is a pre-paid card that potential locations for new outlets, based on market- allows the non-banked population to benefit from a potential assessments. These results are shared with better, more secure means of payment. partners and Wafacash ensures strong coordination to avoid competition between partners. • Hissab Bikhir, a product launched by Attijariwafa bank in 2009 and offered through Wafacash, aims to provide• Wafacash pays partners based on volume of simple banking services to the low-income population. completed transactions. Compensation is settled daily The core product is a non-interest-bearing bank to meet Wafacash’s compliance requirements for account without checkbook, which also entitles the recording cash flow. client to basic electronic banking and cash services. Conditions for opening a Hissab Bikhir account complyMarketing studies revealed that low-income customers with the banking regulation and are similar toare more comfortable in Wafacash’s small shop outlets. conventional banks, but the distribution channel is96 | Redefining the Emerging Market Opportunity
    • Case Study 9: Adopting a Franchise Model to Expand Low-Income Financial Services cheaper to operate and more convenient to target 3. To appeal to the low-income population, institutions clients. Clients of Hissab Bikhir may also qualify for a need to ensure that their outlets are located close to range of financing products. poor neighborhoods, offer flexible operating hours, and have a friendly culture.• Carte Bikhir, introduced in 2010, is a bank card that can be used for purchases and cash withdrawals at any ATM. References African Business. 2011. “Calm Before the Storm.” African Business 379: 38-39.Impact Attijariwafa Bank. 2010. Annual Report 2010. Casablanca: Attijariwafa• Wafacash’s branch network has grown quickly at over Bank. 20 percent annually since 2006. Initially, the franchise Douiri, I. 2011. Phone interview by author with Ismail Douiri, Director network comprised over 80 percent of Wafacash’s General, Attijariwafa Bank, August 2011. total outlets; it currently comprises about 65 percent. Kabbaj, M. 2012. Phone interview by author with Maria Kabbaj, Strategy and Development, Attijariwafa Bank, January 2012.• Wafacash’s customers have exceeded 2 million. La Nouvelle Tribune. “Western Union fête ses agents dont Wafacash.” Transactions in 2010 were 31 percent higher than in La Nouvelle Tribune. June 2011. the previous year, reaching 8 million, while volume Maghreb Confidential. 2010. “Giving Western Union a Run for its flows increased 29 percent over that same period to Money.” Maghreb Confidential. July 2010. reach MAD22.7 billion (US$2.7 billion). Telecompaper. 2011. “BICS Starts Mobile Money Transfers to Morocco.” Telecompaper. September 2011.• Wafacash’s gross operating income reached MAD74 million (US$8.7 million) by 2010, an increase of 15.2 percent from the previous year, despite a downward trend in fees collected by the Western Union money transfer business. Wafacash’s net banking income is MAD163 million (US$19.1 million)Potential Implementation Challenges• Ensuring compliance and service quality in all outlets can be a challenge initially. Robust monitoring and training functions, as well as regular coordination with partners, are critical to success.• At the outset, the franchise model is more easily suited to providing purely transactional services. Supporting a full suite of banking products requires extended training and more detailed product knowledge by franchise partners, as well as sophisticated sales efforts to which they are often unaccustomed. However, with proper training, franchises offer an inexpensive platform for delivering full services with minimal investment.• One shortcoming of the franchise model is that outlets are profitable only in sufficiently populated areas. To serve rural areas, Wafacash is experimenting with mobile agencies using vans and trucks.KEY LESSONS LEARNED1. A franchise model can help financial institutions to ramp up their physical networks quickly and with limited expenditure.2. Simple operations and products allow for fast initial roll-out and enhance branch standardization. Once established, franchise networks can deploy a wider range of financial offerings. Redefining the Emerging Market Opportunity | 97
    • CASE STUDY 10Using Equity to Finance SMEs in Credit-ConstrainedMarketsEquity funding of SMEs is catching on in emerging markets as investors find ways toprovide management and technical assistance to companies challenges and to get goodearly stage financial returns.Aureos Capital, Africa and Business Partners International, KenyaMarket Opportunity management successfully bought out the fund, andCredit access is a considerable problem for African it is now entirely staff-owned. Aureos has more thanSMEs. The World Bank estimates that only 25 percent of US$1 billion in assets under management.small African enterprises receive loans and more than 41percent are credit constrained. Wariness on the part of Business Partners International (BPI) is a fund-lenders is a result of a sharp rise in defaults and a high management company that supports SME growth bypercentage of non-performing loans in the wake of the providing financing, expert sectoral knowledge, andglobal recession of 2008-2009. Since then, collateral value-added services to SMEs in sub-Saharan Africa. Itrequirements for traditional financing have risen, often to was established in 2004 as a subsidiary of Businessunattainable levels over the loan’s value. Partners Limited to apply an investment model developed in South Africa to other African countries. BPI nowIn such an environment, alternative schemes such as operates subsidiaries in Madagascar, Kenya, Rwanda,equity financing can be extremely valuable to SMEs. and Mozambique. The BPI Kenya Fund—on which thisSuch financing is currently available as institutional case study focuses—grew out of funds provided to BPI byinvestors look to get a toehold in high-growth emerging the International Finance Corporation’s SME Solutionseconomies. In equity financing, investors can take stakes Center, which included a US$2.5 million technicalin SME ownership or charge fees based on revenue- assistance fund. BPI Kenya now has a bigger set ofsharing schemes. investors, including the European Investment Bank, Commonwealth Development Corporation, TransCentury, and the East African Development Bank.Stakeholder OverviewAureos Capital is a private equity firm that makes equityand quasi-equity investments in SMEs in Africa and other Business Model Overviewdeveloping regions. (Quasi-equity investments are debt Aureos makes large investments, putting betweeninstruments that are counted toward equity for US$500,000 and US$10 million into most of its deals. BPIshareholder-reporting purposes.) Aureos was originally a Kenya’s investments average US$200,000 and rarelyjoint venture of Norfund, a private equity firm owned by exceed US$500,000. Aureos typically requires that firmsthe Norwegian Ministry of Foreign Affairs, and have an operating history of five to seven years, while BPICommonwealth Development, a similar organization requires only three to five years.owned by the British government. In 2008, Aureos’s Redefining the Emerging Market Opportunity | 99
    • Case Study 10: Using Equity to Finance SMEs in Credit-Constrained MarketsSME equity financing in emerging markets vs. traditional private equity model Traditional private equity Aureos Capital/BPI Kenya Central or local office Central or local office Screening and assessment Minority Stake + Technical assistance (~30-40%) or training, and Investment revenue-based funding at zero options Leveraged Majority Acquisition for fee interest rate2 buy-out stake restructuring On-the-ground representatives1 Enterprise Enterprise Enterprise Client identification SME3 • Focus on more mature enterprises • Technical assistance provided, but client usually still has autonomy over daily operations • Many investment options • Similar investment structures: • Lower autonomy for enterprises receiving funding, either minority stake or fee as percent of revenue as investor often places a management representative • Focus on ground-level search and identification1  Direct, on-the-ground checks to identify potential targets2  Require technical assistance to ensure efficient use of capital3  Similar investment structure for all SMEs100 | Redefining the Emerging Market Opportunity
    • Case Study 10: Using Equity to Finance SMEs in Credit-Constrained MarketsBeyond that, there are broad similarities in the Aureos infrastructure while diversifying their portfolios acrossand BPI operating models. Both require that target geographies and industries.companies be profitable and well positioned in themarket. Both generally take large minority stakes ranging • SMEs in emerging markets often struggle tofrom 30 to 40 percent, with the option to acquire control absorb large capital injections properly due to a lackat a later date, or else adopt a revenue-sharing of management experience. This increases themechanism in which fees represent a percent of sales. importance of providing high-quality technicalBoth avoid leveraged buy-outs, takeovers, and assistance.restructurings. Aureos seeks to avoid excessive • SMEs might have limited exposure to equity financingconcentration of risk by diversifying geographically. Only and—despite their own inexperience—may not always45 percent of Aureos’s capital is invested in Africa; the listen to investors’ recommendations. Funds mustrest is in Asia, Latin America, and the Middle East. BPI actively educate their portfolio companies on theKenya is less diversified, though its holding companies nature of private equity and link their continued fundingoperate in many parts of sub-Saharan Africa. to the companies’ use of technical assistance.Aureos and BPI Kenya both provide support, guidance, • Emerging-market fundraising can be a difficult andand advice on working with the government, and have protracted process because of the risks andnetworks of regionally based experts to which their challenges of finding knowledgeable investors. Fundsportfolio companies can turn. The technical assistance may need to invest in their own infrastructures beforefund at BPI ensures that recipients of the funds get some actually raising money.training in business management and industry know-howto ensure they can efficiently absorb injected capital tobenefit their businesses. The money allocated to technical KEY LESSONS LEARNEDassistance is quite sizeable. For example, BPI Kenya relies 1. An equity financing scheme allows large pools of fundson a US$2.5 million technical assistance fund, which the to be channeled into the SME sector, bypassingInternational Finance Corporation (IFC) and the World obstacles present in the bank loan system.Bank have designated as a mandatory condition forSME investment. 2. Investors can get healthy returns by investing in emerging-market SMEs, though they should take care to put risk-management mechanisms into place, suchImpact as diversifying their investment portfolio and setting• Aureos has completed 250 transactions and has had a robust investment selection guidelines. strong performance: 3. Investors can greatly improve governance and ——Its first-generation portfolio has realized gains of management through proactive technical support and US$141 million and 30 percent internal rate of return assistance. These improvements tend to be reflected (IRR). in investment returns. ——Its second-generation portfolio has realized US$4 million in gains from 3 percent of invested capital. References The rest will remain invested for several more years. Aureos Capital. Website. http://www.aureos.com. ——Seventy-four percent of Aureos’s returns come from — 2011. “Building Mid-Market Businesses.” Presentation at Nigeria’s —. National Pension Commission (PenCom) Private Equity Round earnings growth, 12 percent from yield, and 14 Table. Lagos, September 2011. percent from selling at higher multiples. — 2007. Case Study: Aureos Southern Africa Fund. Sandton, South —. Africa: Aureos Capital.• BPI Kenya has disbursed US$7.3 million in investments to 62 projects, with an IRR in the mid-teens, according Business Partners Limited. About Business Partners International. http:// www.businesspartners.co.za/page/bp-international. to the IFC. It has created approximately 1,000 new jobs in Kenya. Forty SMEs have received advisory IFC (International Finance Corporation). 2010a. Scaling-Up SME Access to Financial Services in the Developing World. Washington DC: assistance amounting to US$500,000. IFC.• The success of Aureos and BPI Kenya has attracted — 2010b. SME Solutions Center—Kenya: Developing Alternative —. Financing Solutions for Small and Medium Enterprises. more equity funds to the region. Eight new SME Washington DC: IFC. funds now focus on Africa, with a total of US$400 Sharma, K. 2008. Speech at Aureos Investors Day. London, November million to invest. 3, 2008. Text available at http://www.thecommonwealth.org/spee ch/181889/34293/35178/184760/aureos.htm.Potential Implementation Challenges• Because of their small scale, SMEs have proportionally higher overhead costs and higher failure rates than bigger businesses. Equity funds should centralize their Redefining the Emerging Market Opportunity | 101
    • CASE STUDY 11Federalizing Product Development to Tailor LoanProducts to SMEsDecentralizing product development—while keeping other operations centralized—is oneway to serve the diverse SME market.Bank of ChinaMarket Opportunity and to lower its exposure to the concentrated risks ofGetting financing from banks was, for a long time, a large companies.source of pain for SMEs in China. As of 2005, about 80percent of SMEs in the Eastern provinces had trouble A key BOC initiative was the Credit Factory program,raising money, resulting in several production stoppages. which was set up to provide a variety of tailored offeringsA survey conducted in 2006 found that little had changed; to meet the specific needs of different SMEs. The Creditif anything, some SMEs said the financing environment Factory program started as a joint research andhad deteriorated. development effort with Temasek Holdings of Singapore Ltd., a BOC strategic investor.Since then, China’s central government has takenproactive measures. In 2007, it launched a set ofguidelines and policies to support the development of Business Model OverviewSMEs. The goal was to encourage financial institutions to The BOC Credit Factory program was piloted in Shanghaifocus on this critical segment of the economy. and Quanzhou and was expanded to 27 first-tier branches in 2010. The first-tier branches were responsibleFollowing the government’s move, large banks in China for developing products that would work in their regionsstarted to take a new approach toward SMEs. Many and for pushing them out to their sub-branches. Nineteenbanks tried to address their inflexible repayment terms branches had internal SME business departments andand collateral requirements, and started looking at SMEs the other eight established independent SME businessas individual businesses requiring more flexible terms and centers.products. Credit Factory has resulted in more than 200 credit products and services, each tailored to meet a specificStakeholder Overview SME demand, with terms and conditions to suit theBank of China (BOC) was established in 1912. In 1994, it characteristics of SME by region, industry stage ofbecame a commercial bank, providing a full range of growth, and business conditions. One example isfinancial services, with a primary focus on corporate financing for Zhejiang’s approved film and televisionbanking, personal banking, and financial markets. In 2007, cultural SME, using intellectual property as collateral.after the government brought new attention to the needs Loan products tailored to support the development ofof SMEs, BOC moved to build up this part of its business local apple processing and sales enterprises in Shandong offer another example. Redefining the Emerging Market Opportunity | 103
    • Case Study 11: Federalizing Product Development to Tailor Loan Products to SMEsExample of segment-specific products in Bank of China’s credit factory program Heilongjiang Grain Credit Henan Dairy Credit Shandong Apple Credit Over RMB200 million disbursed to support Loans disbursed to households raising Support development of 31 local apple local grain production and processing dairy cows, bridging supply from farmer processing and sales enterprises, covering enterprises in bulk operating mode. and demand from enterprises. over 400 upstream and downstream SMEs. Jiangsu Construction Credit Suzhou branch introduced loan to support rural construction in local areas. Zhejiang Movie & TV Drama Credit RMB39 million loaned to film and television SME using intellectual property as collateral. Sichuan Market Booth Credit Guizhou (Zhongguancun) Technology Credit Guangdong Investment Banking Credit Bank of China signed contract with community Loan for SME in the Zhongguancun National IPO support for SMEs with Bank of China market to lend credits to merchant using leasing Innovation Demonstration Zone using intellectual International as promoter and underwriter. rights to booth as collateral. property as collateral.Source: http://www.boc.cn/en/.The following elements helped Credit Factory to succeed: • Simplified, factory-like operating model with automated credit approval mechanism to reduce the approval• Decentralized consumer-insight and product-tailoring period to five days from 20 days. functions to address the needs of specific SME segments and to leverage local market knowledge to • Dedicated and automated, industry-linked SME risk collate non-financial information. management system from customer acquisitions to the loan recovery stage. The system includes clearly• Scalable operating model with centralized loan defined questions to assess non-financial information, operations in six areas: customer assessment, a multi-dimensional early warning mechanism, and marketing, loan approval, post-loan management, an checks against artificial manipulation. It also monitors accountability mechanism, and enterprise credit developments in different SME industries. management.104 | Redefining the Emerging Market Opportunity
    • Case Study 11: Federalizing Product Development to Tailor Loan Products to SMEsImpact• The program disbursed CNY140 billion (US$22.2 billion) of loans from its inception through May 2011, reaching more than 22,000 SMEs.• The Credit Factory program contributed to the growth of BOC’s SME loan segment, with total SME loans outstanding reaching CNY1,052 billion (US$166.8 billion) in 2010 (36 percent compound annual growth rate from 2008).• Improved risk management performance, with the non-performing loan ratio declining to less than 0.1 percent in May 2011 from 2.7 percent in 2010.Potential Implementation Challenges• Decentralizing the consumer-insight and product- tailoring functions means regional staff must have specific skill-sets to understand the nature of customers’ businesses, their individual needs, and the potential risks they pose.• An effective, standardized risk-management tool to cover multiple industries, geographies, and business conditions is possible only with the right data. This requires a comprehensive supporting research and information infrastructure. The model is likely to need refinement as the program expands.KEY LESSONS LEARNED1. Decentralization of product development can succeed in delivering tailored products that better meet the needs of various SMEs based on geography, industry, and business conditions.2. The stringent credit process used for large corporations is inappropriate with SMEs, which require a fast turnaround. Banks need to improve turnaround speed by adopting a factory-like model for loan processes.3. There is still a place for centralized operations in a decentralized model, particularly in areas related to loan assessment, operations and risk management.ReferencesBank of China. Website. http://www.boc.cn/en/.— 2011. 2011 Annual Report. Beijing: Bank of China Ltd. —.— 2010. 2010 CSR Report of Bank of China. Beijing: Bank of China —. Ltd.CCTV. 2010. “Zhejiang Province: Banks Offer ‘Credit Factory’ for Smaller Companies.” CCTV.com. March 29, 2010.China Daily. 2009. “Changing Concepts and Innovating Models: BOC Actively Explores New Methods of SME Financial Services.” China Daily. March 12, 2009. Redefining the Emerging Market Opportunity | 105
    • CASE STUDY 12Adapting POS Networks to Deliver SME LoansFinancial institutions can adapt retail electronic-payment networks, includingpoint-of-sale and ATM channels, to approve and deliver SME loans.GARANTI BANK, TURKEYMarket Opportunity As part of its outreach, the bank convenes severalWhile small enterprises play a lead role in Turkey’s meetings yearly, inviting small-business owners,economic development, their own growth is hobbled by industrialists, and commercial experts to discusslimited access to financing. Companies employing 250 or solutions to regional SME issues. Since 2002, the Bankfewer workers accounted for 77 percent of Turkish has met 22,000 SME representatives at 69 gatherings inemployment and 56 percent of exports in 2010. At the 51 provinces.same time, they were the slowest-growing group in theeconomy, lagging their counterparts in Eastern Europeand Central Asia. Business Model Overview Garanti has served SMEs with a customer-centeredThe main obstacle to SME growth is lack of working approach that is notable for two innovations:capital. Seventeen percent of small business loanapplications are rejected, compared with 12 percent for • A high-speed loan approval process that allows SMElarger companies. Loan collateral required of SMEs, on clients to apply for and receive loans directly throughaverage, exceeds 90 percent. Their need for easier and their machines in the bank’s nationwide POS network;faster credit is an opportunity for banks with innovative andproducts and more efficient delivery models. • A program of flexible, industry-specific loan packages tailored to the needs of 17 small-business sectors.Stakeholder Overview Garanti’s loans-via-POS program addresses theGaranti is the second-largest private bank in Turkey. It has occasional need by SMEs for urgent financing. Sincetotal consolidated assets of US$90 billion and a network speed of delivery is important, the loan applicationof 856 branches covering 96 percent of the country. process involves a single step: clients simply enter aGaranti began focusing on small enterprises in 1997 and proposed loan amount and repayment term directly ontohas become known as the bank of SMEs. It has created a their POS terminal. Loan amounts range from TRY2,000wide range of small-business products and Turkey’s to TRY9,000 and repayment terms from three to 12largest point-of-sale (POS) electronic transaction network, months.with 190,000 POS machines. Redefining the Emerging Market Opportunity | 107
    • Case Study 12: Adapting POS Networks to Deliver SME LoansDeveloping effective SME solutions by identifying local/sectoral needs POS owner keys in loan amount Historical transactional data from POS needed into menu installed in POS machine is used as inputs in Garanti’s machine. credit scoring model. POS at retail vendor Garanti Loan is approved within five minutes via SMS, and money is transferred into the vendor’s bank account, accessible through POS machine, ATM, and phone banking. • Loan size TRY2,000-9,000 (US$1,200-5,200). • Loan term 3-12 months. • No documentation, guarantor, or collateral required.While accelerating loans to small businesses, POS Other SME banking products and services—includingsystems and other electronic channels also reduce banks’ checking accounts, insurance, credit cards, cashcosts of risk assessment and loan delivery by leveraging management, and pension plans—are bundled with theborrowers’ transactional information captured through the loan packages, enhancing efficiency and boosting thechannel. Automatic scoring models, based on POS data, bank’s profitability.ensure effective risk assessment and credit approval atlow operational cost. To receive a Garanti loan, applicants Garanti’s sector-based loan packages include:must be Garanti customers and POS users for at least a • Manufacturing: machinery and equipment loans withyear and record a minimum turnover of TRY10,000 in the six-month grace periods to begin production; rawprevious year. Credit amounts are approved based on material loans with adapted collection schedules;historical transactional data of each POS owner. POS total business premise loans extending to 96 months; ISOturnover volume and frequency are used as proxies for and CE certificate-acquisition loans.business health. No additional documentation, collateral,or guarantors are required. • Tourism: flexible repayment loans, adapted to strong and weak cash-flow periods; extended-term premiseAutomatic notification of the result of the loan application renewal and technology development loans.is delivered within five minutes via SMS, providing aneffective communication channel without diverting SME • Pharmacy: 60-month loans to purchase inventory usedowners’ time from their businesses. as collateral.Garanti launched the sector-specific loan packages in2007 to help SMEs finance investments and working Impactcapital. It has since expanded the loans to 17 categories • Garanti’s POS-based approval process and itsin sectors as diverse as agriculture, manufacturing, sector-specific loan packages have each contributedtourism, retail pharmacy, furniture, food wholesaling, and to the overall success of the bank’s SME business:logistics. Loan terms include repayment schedules andcollateral obligations customized by the industry’s ——In 2010, the banking volume contributed by SMEbusiness cycle and growth stage. The loans have reduced banking was up 38 percent as compared withdefault rates by easing repayment constraints. 2009, and reached TRY20 billion (US$12.9 billion).108 | Redefining the Emerging Market Opportunity
    • Case Study 12: Adapting POS Networks to Deliver SME Loans ——In the same year, Garanti increased the number of its SME banking customers to 1,271,000, with 157,000 new loans extended to SMEs, comprising a total worth of TRY6.7 billion (US$4.3 billion). ——The NPL ratio stood at 3.3 percent as of December 2010, significantly below the overall sector’s ratio of 7.5 percent.Potential Implementation Challenges• To operate effective POS-based loan approval and delivery systems, financial institutions must develop credit-scoring models based on merchant transaction information and current account data.• Approving, delivering, and servicing loans electronically requires a large, established POS network and is therefore appropriate for banks with a substantial retail payments business.• Customizing loan products or services by sector requires an in-depth understanding of the risks associated with the multiple businesses. This prerequisite, in turn, relies on an established infrastructure capable of supporting clear credit- approval procedures, structuring loan terms, and handling collateral across multiple industries.KEY LESSONS LEARNED1. Financial providers can adapt electronic payment channels to deliver SME loans faster, more conveniently, and at lower cost.2. Creating tailored loan products and terms to meet the needs of specific business sectors improves the product proposition and makes it easier for business owners to fulfill their financial obligations.3. Direct input from customers and industry experts is mainstreamed into the product development process to rapidly roll-out innovative financial solutions for SMEs.ReferencesGaranti Bank. 2011. 2011 Annual Report. Istanbul: Garanti Bank.Lord, N. 2011. “IFR: Sekerbank Readies Turkey’s First Covered Bond.” Reuters. April 1, 2011.Oz, S. and M. Yildrin. 2011. Phone interview with Selin Oz, SME Banking Small Enterprise Marketing Manager, and Muge Yildirin, SME Banking Central Market Supervisor, Garanti Bank, October 2011.Şeker, M. and P.G. Correa. 2010. “Obstacles to Growth for Small and Medium Enterprises in Turkey.” Policy Research Working Paper 5323. Washington DC: The World Bank.Veziroglu, L. 2011. Phone interview by author with Levent Veziroglu, Executive Vice President, Dogus Holding. July 2011. Redefining the Emerging Market Opportunity | 109
    • CASE STUDY 13Using a Pawnshop-Bank Partnership to ImprovePropositions for Customers and ProvidersPartnerships between banks and informal providers such as pawnshops can produceloans faster and on better terms—creating advantages for all parties.Huaxia Pawnshop, Bank of Communications, ICBC and Hua Xia Bank, ChinaMarket Opportunity In 2009, Huaxia Pawnshop entered into a joint project,Chinese banks are having a harder time lending to SMEs called the Bank-Pawn-Expressway program, with theprofitably, particularly in the wake of the central bank’s Bank of Communications, the Industrial and Commercialmove in 2011 to curb inflation by raising the reserve Bank of China (ICBC), and Hua Xia Bank. The purposerequirement ratio six times. was to offer a funding solution to SMEs.The growth of the pawn brokering market in China hasprovided SMEs with an alternative source of funding. Business Model OverviewPawnshops have the advantage of being able to disburse The partnership between Huaxia Pawnshop and theloans within days, rather than the weeks required by banks creates a beneficial synergy. SMEs gain quicktraditional banks, which often require detailed access to short-term loans from pawnshops, which theydocumentation. On the other hand, pawnshops’ interest repay at a lower cost of capital using long-term loansrates are often six to seven times higher than those from the banks. The pawnshops guarantee these bankcharged by banks. For instance, the interest rates loans. Additionally, there are no covenants on the use ofcharged for loans backed by real estate or moveable funds.assets can reach 38 percent and 56 percent per year,respectively, according to the Beijing Pawn Trade The structure of the partnership leverages pawnshops’Association. By contrast, Chinese banks can offer loans capacity to store, maintain, and perform quick andto SMEs at 6-8 percent per year. accurate due diligence on different kinds of collateral, as well as their ability to interact with borrowers directly. These features simplify the banks’ credit assessmentStakeholder Overview process and reduce the cost of acquiring and servingEstablished in 1993, Huaxia Pawnshop is Beijing’s first SME customers. In return, Huaxia Pawnshop receivespawnshop and the country’s leading chain, with 11 bank financing for its business expansion. In 2009, thebranches. The chain accepts many forms of collateral, Bank of Communications granted the Bank-Pawn-including land, buildings, cars, jewelry, luxury products, Expressway program a credit line of CNY300 millionstocks, bonds, and art. These are valued by experts in (US$47.9 million), with an option to double the amount tothe appropriate fields. CNY600 million. Redefining the Emerging Market Opportunity | 111
    • Case Study 13: Using a Pawnshop-Bank Partnership“Bank-Pawn-Expressway” Program through HuaXia Pawnshop and Bank of Communications Partnership Medium-term loan at lower interest rate Short-term loan Pay short-term loan before bank approval on behalf of SMEs • Collateral assessment • Collateral assessment • Application fees information • Monthly interest or • Principal can be guarantee fee guaranteed by credit guarantee programs SME Pawnbroker Bank Huaxia Pawnshop Huaxia Bank, ICBC, Bank of Communications Repay pawn broker Monthly interest nd principal payment aThe success of the partnership can be attributed to the other countries. Chinese pawnshops also operatefollowing factors: efficiently and professionally—another fact that has gotten the Bank-Pawn-Expressway off to a good start.• Close regulation of the pawn brokering industry. The Chinese government has taken steps to ensure the stability of the pawn brokering industry, which has Impact been expanding. In 2005, the Ministry of Commerce • In 2008, Huaxia Pawnshop’s operating income and the Ministry of Public Security were given reached CNY120 million (US$19 million). regulatory responsibility and released a modified set of guidelines for the pawn industry. • Bao Rui Tong Pawn Shop replicated Huaxia’s Bank- Pawn-Expressway business model by partnering with• Special capability for performing due diligence. China Agriculture Bank, Shenzhen Development Bank, Turnaround times are substantially shorter because of and Bank of Beijing. Bank-Pawn-Expressway’s expertise in valuing different forms of collateral. Customers usually receive loans ——In 2010, Bao Rui Tong Pawn Shop generated a within two days. For autos and real estate, the revenue of CNY143 million (US$21.6 million) and an pawnshop guarantees cash within one week. operating profit of CNY14.6 million (US$2.2 million).• Clear division of roles. The pawnshop handles initial ——Bao Rui Tong’s outstanding loans grew from around loans for the short term; banks provide medium- to CNY3 billion (US$440 million) in 2009 to CNY5 billion longer-term loans. (US$786 million) in 2011.• Attractive premises of Chinese pawnshops and their reputation for efficient operations. Chinese pawnshops Potential Implementation Challenges generally have modern décors and well-trained • People coming into pawnshops have a lot of different professional staffs, which give them a reputation and forms of collateral—from real estate to jewelry to service quality that pawnshops do not enjoy in many stocks. Thus, the pawnshops must have professionals with the ability to appraise widely different assets.112 | Redefining the Emerging Market Opportunity
    • Case Study 13: Using a Pawnshop-Bank Partnership• Pawnshops have a negative reputation in many countries in terms of their prestige and reliability. As such, it is necessary to select professional pawnshops, and the government must regulate and restructure the sector.• The large, efficient pawnshops that exist in China might not exist in some emerging markets. The limited presence and lack of operating efficiency of pawnbrokers in many countries could be a disincentive for banks to pursue these partnerships elsewhere.• Consumers sometimes default on loans, and the incidence of this rises during difficult economic times. A risk-management strategy that works within the partnership model must be created.KEY LESSONS LEARNED1. Partnership with and professionalization of suitable pawnshops allow banks to provide better financing solutions to SMEs by combining simpler and more flexible terms for short-term loans with options for cheaper longer-term financing.2. Banks benefit from the partnerships by getting access to, and information about, new customers, with lower acquisition costs, lower physical network requirements, and lower risk.3. Partnerships of this sort can work efficiently in markets that have large and efficient informal providers, such as large pawnshops, and frameworks for both legal and regulatory support.ReferencesBi, X. 2009. “Bank-Pawnshop Project Targets Small Firms.” China Daily. October 19, 2009.China Daily. 2011. “SMEs Turn to Pawnshops for Loans.” China Daily. February 16, 2011.Huaxia Pawnshop. Website. http://www.huaxiapawn.com.Yidi, Z., D. Zhang, and I. Shen. 2012. “Pawn Shops Lead China Small- Business Loans as Bank Credit Wanes.” Bloomberg. February 5, 2012. Redefining the Emerging Market Opportunity | 113
    • CASE STUDY 14Using an Electronic Platform to Provide Supply-ChainFinancing for SMEsDeveloping an integrated online solution for SMEs operating within the supply chain oflarge corporations allows banks to target the SME segment more cost-effectively and atlower risk while growing their transaction business.Kasikorn Bank, ThailandMarket Opportunity K-Bank started the K-Supply Chain initiative in 2007. ItA major barrier to SMEs obtaining bank loans is the includes an online platform to facilitate working capitalinformal nature of their businesses. When financial and loans to SMEs that operate in the supply chains of largemanagement records are unavailable, banks cannot corporations (the Sponsors). By taking advantage ofassess how likely an SME is to meet its financial larger corporations’ credit-worthiness and historicalobligations. This is a big problem in Thailand, which transaction data, K-Bank can offer collateral-free loans todepends on its almost three million SMEs for most of the the corporations’ SME business partners, while loweringnation’s jobs. Roughly seven in 10 Thais works for an its own risks and operational costs.SME. Yet, as of 2010, only a third of Thailand’s SMEs hadaccess to bank loans. Business Model OverviewFactoring, which is a widely used practice in supply In the K-Supply Chain, financial products and services arechains, presents an alternative to bank loans by integrated into a single supply chain, instead of beingtransferring credit risk to credible buyers. In Thailand, offered as standalone solutions. This increaseshowever, factoring has not been available to SMEs. Many transactional efficiency and provides cost savings to allThai SMEs still have to contend with a complex participants, including the bank.application process and a high cost of capital for loans,which constrain their ability to grow. K-Supplier Financing benefits upstream business partners—SMEs supplying raw materials to the Sponsors— by extending immediate loans to them before credit is due.Stakeholder Overview The speed of loan approval—within three working days—isKasikorn Bank (K-Bank) is Thailand’s fourth-largest bank a major advantage over traditional factoring. Conversely,by assets and has a reputation for innovating in the SME K-Buyer Financing benefits downstream businessspace. The bank has developed products and services to partners—SMEs buying materials from Sponsors—bymeet the needs of SMEs in different industries and at giving them an immediate line of credit to take advantage ofdifferent stages of development. As of 2010, K-Bank had discounts for early payment or extended payment beyonda total SME loan balance of THB928 billion (US$30.1 credit limits. K-Bank can initially provide lower-risk financing,billion), representing 29 percent of all SME bank loans in such as factoring, to new SME customers. Subsequently,Thailand—the most of any bank in the country. when sufficient track records and information are collected, Redefining the Emerging Market Opportunity | 115
    • Case Study 14: Using an Electronic Platform to Provide Supply-Chain Financing for SMEsK-Supply Chain financing program SUPPLIER FINANCING BUYER FINANCING 1. Sponsor uploads invoices to 1. Sponsor uploads invoices to K-Supply Chain online platform. K-Supply Chain online platform. 2. SME Supplier chooses invoice or 2. SME Buyer chooses invoice or purchase order to be financed purchase order to be financed through online platform. and pays non-financed invoices through online platform. 3. K-Bank disburses financing to 3. K-Bank pays Sponsor on SME SME Supplier. Buyer’s behalf. 4. Upon payment due date, Sponsor 4. Upon payment due date, SME makes payment through K-Bank. Buyer makes payment through K-Bank in the amount of principal plus interest. 5. K-Bank deducts the principal amount plus interest and credit remaining amount from SME Supplier’s account.Note: SME suppliers or buyers must qualify for the program based on pre-specified requirements set by K-Bank.116 | Redefining the Emerging Market Opportunity
    • Case Study 14: Using an Electronic Platform to Provide Supply-Chain Financing for SMEsthey can offer other solutions, such as purchase-order or • The success of K-Supply Chain has contributed to theworking-capital financing. growth of K-Bank’s SME loans, which now account for almost 40 percent of its loan portfolio.Within the electronic supply-chain financing platform(e-SCF), K-Bank maintains a large database oftransactions between the Sponsors and their SME Potential Implementation Challengesbusiness partners. After confirming the loan applications • Integrating an electronic loan and invoicing platform intoof SME buyers and suppliers based on information from an industry’s supply chain can work only if the necessarythe Sponsors, K-Bank disburses collateral-free loans to legal framework is in place. Regulators must providethe SMEs’ accounts within three working days. The loans robust laws covering electronic signatures and security.are at lower interest rates than the SMEs would get if theyapplied for loans independently. The e-SCF also offers a • Banks with smaller transaction businesses may initiallysimpler payment procedure and lower transaction costs be reluctant to commit capital expenditure funds tofor both the Sponsors and their SME business partners. developing an electronic platform because of the time and scale needed to get a return. They can overcomeSuppliers or buyers must meet a number of criteria to be this reluctance if they consider not just the financingeligible for the K-Supply Chain program. They must: income, but also the increased transaction fees and deposit business from new SME customers.• Own a business that is registered, and operates in, Thailand. • Corporate customers are needed to amass scale in a financial supply-chain system. Hence, financial• Have been a business partner to the Sponsors for institutions that do not already have a strong corporate more than one year, or engaged in the same business banking business may be cut off from this opportunity. for more than two years. • Business-model and stage-of-development differences• Show increased revenue and profit over the course of within the upstream and downstream SME customer the past year. bases impose a burden on financial institutions, as they must fine-tune their credit-assessment models. The• Not have been involved in financial litigation and not challenge is greater for supply-chain financing solutions have filed for bankruptcy. beyond factoring, such as purchase-order financing and• Have no non-performing loans on record and never distributor financing. have refinanced existing loans with any financial institutions. KEY LESSONS LEARNEDK-Supply Chain has succeeded for two main reasons. 1. Existing relationships with large corporations can helpOne is the bank’s careful selection of growth-oriented providers lower their cost of SME acquisition and riskSponsors. In a sense, these Sponsors have already done assessment, grow deposit and transaction businesses,some of the due diligence work that K-Bank would and increase customer retention.otherwise do, since the Sponsors’ own success depends 2. Corporate SME and transaction businesses canon their having good SME partners with healthy financials reinforce one another. Financial institutions can benefitand sustainable business models. The other ingredient of from growing these businesses in parallel.K-Supply Chain’s success is its electronic operationplatform. The platform allows companies to upload 3. Financial institutions can initially provide lower-riskinvoices and flexibly select those they would like to financing solutions, such as factoring, in order tofinance. K-Bank’s e-SCF can handle up to 1,000 gather customer information before expanding intoaccounts per business network. The scale of the platform other supply-chain financing programs.makes it relatively efficient to operate, and itssophistication allows it to handle transaction data from 4. Electronic transaction platforms benefit both the financialremote locations and to minimize fraudulent events. The providers that operate them and their supply-chainuse of the electronic platform also improves customer customers by improving efficiency and lowering costs ofretention, as it would be more costly and cumbersome for receivables and payables management.them to switch to other financial providers. ReferencesImpact Kasikorn Bank. K-Supply Chain Solutions. https://ksupplychain.• K-Bank is the top market player in supply-chain kasikornbank.com/html/index.html. financing, with THB40 billion (US$1.3 billion) of loans — 2012. KasikornBankGroup: Investor Presentation as of 4Q11. —. granted to more than 62 supply chain businesses in Available at http://www.kasikornbank.com/EN/Investors/ PresentationJournal/Pages/PresentationWebCast.aspx. areas as diverse as hypermarkets, sugar production, auto-parts manufacturing, and airlines. — 2010. Annual Report 2010. Bangkok: KasikornBank PCL. —. Tivarati.com. 2011. “KBank introduces K-Value Chain Solutions, the First of Its Kind in Thailand, to Reduce Operating Costs for Business by up to 30 percent.” Tivarati.com. April 1, 2011. Redefining the Emerging Market Opportunity | 117
    • CASE STUDY 15Finance SME Suppliers through National ReverseFactoring InfrastructureA national reverse factoring network can provide SME suppliers with short-term workingcapital by transferring their credit risk to higher quality partners in the supply chain.Nacional Financiera (Nafin), MexicoMarket Opportunity Stakeholder OverviewSMEs are an important contributor to Mexico’s economic Nacional Financiera (Nafin) is a development bank createdgrowth, accounting for more than 60 percent of by the Mexican government to provide commercialemployment and more than 40 percent of GDP. However, financing. In 2000, Nafin was directed to use newMexican SMEs traditionally have not been able to count technology to make micro SME loans. Nafin did this byon banks for financing. The typical Mexican SME receives developing the Productive Chains Program (Cadenas65 percent of its working capital from family savings and Productivas) in 2001.personal funds, and only a very small portion comes frombanks. The chain between large buyers and small suppliers allows high-risk SMEs to use their receivables to obtainTraditional factoring, though convenient, has generally not cheaper working-capital financing by effectivelybeen a viable option for Mexican SMEs that need transferring their credit risk to their high-qualityshort-term money quickly. The problem has been customers.factoring’s time-intensive requirements for creditassessments and invoice processing. Business Model OverviewReverse factoring—in which the buyer, instead of the Nafin’s online platform captures buyer transactionseller, finances the receivables—has emerged as a useful information within the network, allowing lenders to reducealternative. All three parties benefit. The lender, working credit risk and assessment costs. The platform alsowith just a few credit-worthy buyers, lowers its information eliminates the need to move documents physically, a bigcosts and credit exposure. High-risk sellers gain access expense in off-line factoring.to short-term working-capital financing at a lower ratethan they could get otherwise. Buyers have the chance to Nafin offers four key services within the Productive Chainoutsource their receivables management and negotiate Program. First is the reverse factoring itself, which isbetter terms with their suppliers. offered without a service fee, without any collateral requirement, and at interest rates well below the ones SMEs could get from commercial banks. Second, there is purchase-order financing, again at advantageous interest rates and without fees or collateral. Third are training programs, which teach credit application and other basic Redefining the Emerging Market Opportunity | 119
    • Case Study 15: Finance SME Suppliers through National Reverse Factoring InfrastructureTraditional factoring vs. reverse factoring models Traditional Factoring Supplier Buyer 1 Buyer 2 Buyer 3 Credit assessments and financing conducted for all buyers of a supplier Reverse Factoring Supplier 1 Supplier 2 Buyer 1 Buyer 2 Buyer 1 Buyer 3 Buyer 4 Credit assessments and financing conducted only for supply chain of selected high-quality buyers. Productive Chains Program Model Purchase order financing Receivables factoring Day 1 Day 10 Day 50 Day 80 Supplier S and Big Buyer S delivers the order and B S receives a purchase order B repays funds to L directly B sign contract with Nafin posts information about the from B due in 40 days. through the Nafin system. to establish a line of credit specific receivable on its facility against a future Nafin website, payable to S purchase order or receivable. S receives a line of credit in 30 days. from Nafin equal to 50% of the purchase order (with Nafin factors the receivable interest). with Lender L that offers the best interest rate. S receives amount = receivable value – (used portion of credit line plus interest) – receivable factoring interest.120 | Redefining the Emerging Market Opportunity
    • Case Study 15: Finance SME Suppliers through National Reverse Factoring Infrastructurebusiness skills. Fourth is technical assistance—basically a KEY LESSONS LEARNEDhelp desk for participating SME suppliers. 1. A national reverse factoring program can help SMEsThe success of Nafin’s program derives from a transfer credit risk to their high quality customers—combination of factors: increasing appetite from financing providers and speeding up the process of financing their short-term• The electronic platform helps with turnaround times working capital needs. and cost controls. 2. An electronic platform is essential to facilitate fast and• Nafin does not charge an overhead fee for the platform efficient transactions, enhance risk management, and itself, instead getting a payment with each finance reduce operating costs. transaction. 3. The tax, legal and regulatory frameworks must all• The lack of collateral for factoring allows SMEs to support development of electronic factoring increase their cash holdings and improve their balance operations. It is particularly important to recognize sheets. factoring as a formal financial service and ensure the legal status of electronic receivables transactions.• The presence of 20 domestic lenders in the network promotes competition and lowers interest rates for participating SMEs. References Klapper, L. 2006. The Role of “Reverse Factoring” in Supplier Financing• Risk management is solid. SMEs must meet basic of Small and Medium Sized Enterprises. Washington DC: The eligibility requirements, such as compliance and World Bank. frequency of purchase orders. Nacional Financiera. Website. www.nafin.com. — 2010. Annual Report 2010. Mexico City: Nacional Financiera. —.Impact Singh, P. 2011. Phone interview by author of Priyamvada Singh, East Asia Regional Head, International Finance Corporation, June 2011.• By 2004—three years after launch—the Productive Chain Program was serving 451 large corporations and agencies (big buyers) and more than 70,000 SME suppliers.• Nafin’s factoring market share surged to 60 percent in 2004 from 2 percent in 2001.• The Productive Chain Program is now the largest source of SME financing in Mexico. In 2009, the loan balance from the program was MXN205 billion (US$15.5 billion), equivalent to 74 percent of loan balance to private sector financing. It grew at an average of 26 percent per annum from 2006 to 2009.• During the financial crisis of 2008, Nafin’s reverse- factoring program was the primary source of working capital for SMEs. As such, it prevented a bad situation from getting worse.Potential Implementation Challenges• Reverse factoring will not work without a tax, legal, and regulatory environment that protects creditor interests. Factoring transactions must be treated favorably from a tax perspective and, for legal purposes, recognized as a purchase and sale as well as a financial service.• A supportive regulatory environment for electronic security is essential, so that factors and borrowers are assured that their transactions will be recognized, confidential, and secure.• The infrastructure must be robust. Improvements to back-office systems are often needed to bring SMEs up to the required standards of an electronic program. Redefining the Emerging Market Opportunity | 121
    • CASE STUDY 16Developing the Venture Capital Industry throughCo-Investment with Foreign InvestorsGovernment co-investment programs can enhance the success of SMEs by leveragingprofessional venture capitalists’ know-how, management experience, and fundingcapability.Yozma Fund, IsraelMarket Opportunity officers. Yozma’s implementation was also based onIn the late 1980s, the Israeli government set out to US-proven VC characteristics, which were then adapteddevelop its high-technology industry. It stumbled as the for the Israeli environment.start-ups it financed failed to commercialize their ideas.Between 1989 and 1992, only 10 percent of Israel’shigh-tech start-ups succeeded in raising venture capital Business Model Overview(VC); the remainder were self-financed. In the world of Yozma started with the government investing US$100start-up high technology, this was a dismal performance, million in two fund types, both focused on high-tech SMEand not even a government guarantee to limit the start-ups in Israel. US$20 million was channeled into adownside of VC funds traded on the Tel Aviv Stock government-owned fund and invested directly in high-Exchange improved it. tech SMEs. The other US$80 million became seed capital for a series of private funds which Israeli VCs ran withIn analyzing what had gone wrong, Israel realized that more experienced VCs from other parts of the world.successful VC financing requires more than money flow. Through Yozma, the government invested 40 percent ofIn its next bid to create a VC industry, Israel switched its the money raised for these funds. There were 10 of thesefocus to technology-industry management abilities and private Yozma funds altogether, and their job was to raisebusiness know-how—qualities it had to go abroad to find. a total of US$120 million from foreign VC partners. They ended up raising US$263 million, and jointly invested the money it in 164 start-up companies.Stakeholder OverviewIn 1993, Israel’s Ministry of Finance created the Yozma The developers of Yozma had clear priorities. They knewprogram to restart Israel’s VC industry. (In Hebrew, Yozma that Israel’s VCs needed exposure to world-class VCmeans initiative.) The funds were created to focus on high- practices, and so they insisted that all foreign partners betechnology start-ups, and to tap into foreign capital and leading international VC firms. To lure such partners, theforeign VC expertise. Israeli government gave them an option to buy its stake in the funds at cost plus a five-to-seven-percent annualThe design of Yozma involved a long and intensive interest rate, within the first five years of the partnership.preparation phase, including visits by the Office of Chief That was a huge incentive to the foreign VCs, and IsraelScientists to Silicon Valley and interviews with US believed it would motivate its international partners toentrepreneurs, venture capitalists, investment banks, manage the VC investments successfully. In addition,financial institutions, and Small Business Administration Redefining the Emerging Market Opportunity | 123
    • Case Study 16: Developing the Venture Capital Industry through Co-Investment with Foreign InvestorsFund structure of Yozma venture capital partnership with investors International exposure to technical knowledge, management experience and global network Exit via IPO or M&A Private and 40% equity fund by international VC VCs Private VC sells stake 60% equity fund by and can exercise government government options High-tech SME 5-year option to buy Government funds government equity used for future at cost plus interest investments Government upon successful exit SME high-tech equity fundIsrael was more interested in the transfer of knowledge Impactand skills from foreign VCs to local managers than it was • Between 1993 and 2000, Yozma’s first round of fundsin making money on any individual company or fund. had an exit rate of 56 percent via IPOs or mergers andAmong the international VCs who became partners were acquisitions, far above the average 27 percent exit rateAdvent, MVP, CMS, and Walden from the United States; of VCs and the 14 percent exit rate of the entireDaimler-Benz, DEG, Van Leer Group, and TVM from population of Israeli start-ups.Europe; and Oxton, AVX, Kyocera, and Vertex from Asia. • Follow-up Yozma funds raised US$3.2 billion in 2000Israel also wanted the foreign VCs because it believed and US$5.9 billion in 2008, accounting for 48 percentthey would be able to help successful Israeli companies of total capital raised in Israeli industry.go public on NASDAQ and other international exchanges,rather than being limited to the Israeli Stock Exchange. An • From 1993 to 2008, more than 2,200 Israeli start-upsinitial public offering on NASDAQ, they reasoned, would were backed by VCs, and 48 of them went public onmean more efficient price discovery and, possibly, a NASDAQ. In fact, Israel has more companies tradingbetter means of raising fresh funds in the future, if on NASDAQ than any other country besides the Unitedneeded. States.Some external developments contributed to the success • The size of VC funds in Israel went from US$20 millionof Yozma and the other Israeli funds that followed it. One in 1990 to US$250 million in 1995 and nearly US$2.1was the rise in stock prices on NASDAQ throughout the billion in 2008.1990s—a development that spurred technology investing • As of 2008, Israel’s VC industry was second only toall over the world. Another was the development, in the that of the United States, with 80 active funds andmid-1990s, of state-of-the-art practices and protocols at more than US$10 billion under management. Four orthe Tel Aviv Stock Exchange to meet the standards of five former Yozma funds were among the top 10 VCinternational modern exchanges. A final development was companies in Israel during the years 1996-2008.the reduction of corporate taxes in Israel to 27 percent in2008 from 36 percent in 2003.124 | Redefining the Emerging Market Opportunity
    • Case Study 16: Developing the Venture Capital Industry through Co-Investment with Foreign InvestorsPotential Implementation Challenges• There is intense competition among nations to attract foreign direct investment—with political stability and some amount of infrastructure development being non-negotiable prerequisites. Countries also need to ensure that their macroeconomic policies (e.g, corporate income-tax rates) are attractants rather than repellants.• Countries looking to build up their SME base via venture capital need to be realistic about their native capabilities. Israel’s focus on its high-tech industry made sense because of its abundant human capital in the area of scientists, engineers, and physicists, many of whom were emigrants from Russia and new arrivals in Israel in the early 1990s.KEY LESSONS LEARNED1. Government co-investment support can significantly aid development of new financing schemes for SMEs, such as VC financing.2. Successful program design requires attractive upside potential for investors and a clear exit plan for government to ensure continuity of the program and promote independence by the private sector.3. Leveraging professional investors’ know-how and networks can tremendously accelerate growth and improve the likelihood of success for local SMEs.4. Alignment in sector focus (e.g., high-tech industries) with other government policies goes a long way toward ensuring success of investment funds.ReferencesAvnimelech, G. 2009. VC Policy: Yozma Program 15-Years Perspective. Presented at DRUID Summer Conference. Copenhagen, June 17-19, 2009.Avnimelech, G. and M. Teubal. 2003. Government Promotion of Learning and Innovation in SMEs of Industrializing Economies: Subsidies, Venture Capital, and Private Equity. Presentation. Available at http://redesist.ie.ufrj.br/globelics/pdfs/ GLOBELICS_0060_AvnimelechTeubal.pdf.Buchwald, D. 2008. “Israel’s High-Tech Boom.” inFocus Quarterly Journal 2 (2).Yozma Group. Website. http://www.yozma.com. Redefining the Emerging Market Opportunity | 125
    • CASE STUDY 17Forging Central Bank Partnerships to Build the Marketfor a Region’s BondsRegional cooperation between regulators, along with ongoing interactions between thepublic and private sectors, can help establish needed infrastructure and attract investors.Asian Bond Fund (ABF)Market Opportunity Business Model OverviewFollowing the Asian financial crisis of the late 1990s, manyAsian governments set out to strengthen regional ties. Regional Bond FundsAmong other steps, they sought to develop the region’s The first Asian Bond Fund (ABF1), launched in 2003, holdsbond markets. This proved to be no easy task. Asian approximately US$1 billion and invests in a basket of USbond markets in the early 2000s were underdeveloped, a dollar-denominated bonds issued by sovereign andconsequence of inadequate market infrastructure and of quasi-sovereign Asian issues in EMEAP economiesAsian countries’ preference for investing money outside (excluding Japan, Australia, and New Zealand). The Bankthe region. To overcome these obstacles and capitalize for International Settlements, which manages ABF1,on this opportunity, policymakers at several Asian central pursues a passive investment strategy by focusing on abanks came together and established a regional bond specific benchmark. ABF1 performance is monitored byfund. In doing so, Asian countries found a way to an EMEAP Oversight Committee.accelerate the development of domestic corporate bond Asian Bond Fund 2 (ABF2), a collaborative effort of themarkets that will facilitate economic growth and stability in public and private sectors, was launched in 2004. Itthe region. invests in China, Hong Kong, Indonesia, Korea, Malaysia, the Philippines, Singapore, and Thailand, with the goal ofStakeholder Overview improving the size and liquidity of those countries’The Executives’ Meeting of East Asia Pacific Central local-currency government- and corporate-bond markets.Banks (EMEAP) is a forum of central banks and monetary ABF2 has two components. The first is a Pan-Asia Bondauthorities in the East Asia and Pacific region. Its Index Fund (PAIF) quoted in US dollars. This fund hadmembers are the central banks of Australia, China, Hong cumulative returns of 40 percent between its inceptionKong, Indonesia, Japan, South Korea, Malaysia, New and April 2010, helped by a particularly strongZealand, the Philippines, Singapore, and Thailand. In the performance in the Indonesian and Philippine parts of theearly 2000s, EMEAP oversaw the launch of two Asian fund. The second component of ABF2 is a Fund of Bondsbond funds, with the goal of raising awareness of, and Fund (FoBF) that invests in eight single-market funds.interest in, Asian bonds. Redefining the Emerging Market Opportunity | 127
    • Case Study 17: Forging Central Bank Partnerships to Build the Market for a Region’s BondsABF 2 structure Fund of Bond Funds Pan-Asian Bond EMEAP Group’s Investment in ABF 2 (FoBF) Parent Fund ~US$1 billion ~US$1 billion Index Fund (PAIF) Eight single market funds China Hong Kong Indonesia Korea Malaysia Philippines Singapore Thailand Sub-fund Sub-fund Sub-fund Sub-fund Sub-fund Sub-fund Sub-fund Sub-fund Underlying bondsAs a benchmark index, ABF2 provides asset managers roles in many of the world’s biggest fixed-income markets,with a frame of reference in portfolio construction, and have greatly increased the liquidity of certain ABF2 bondalso gives investors the ability to compare the markets, including Indonesia and Malaysia.performance of passively managed portfolios with activelymanaged portfolios. The index’s credibility derives partlyfrom the fact that it was created through a public-private Impactpartnership with large broker-dealers such as HSBC, • These regional initiatives have provided the bondJPMorgan Chase, and Citigroup. The involvement of markets of the eight ABF2 economies with a significantthese entities has brought considerable attention and boost. Collectively, these bond markets grew to US$12market recognition to the regional Asian funds. trillion in 2007 from US$4.5 trillion in 1997. In addition, Australia, China, Japan, and Korea all have corporate bond markets exceeding US$100 billion—the thresholdAdding Scale and Depth to Local Bond Markets for a deep and liquid bond market.By accurately reflecting the pricing of corporate bonds,benchmark yields increase the depth and liquidity of a • Asian corporations were able to access local corporatecountry’s bond market. ABF2 governments—the bond markets for their funding needs during the crisisPhilippines is a good example—have pursued this of 2008-2009, when many global corporate bondobjective by consolidating government securities with a markets were effectively shut down.wide range of existing maturities into just a fewbenchmark securities. Potential Implementation ChallengesLiquidity also depends on having the right infrastructure— • Interest in the FoBF parent fund on the part of non-including a critical mass of market makers. The number of EMEAP central banks has leveled off after an initialdesignated market makers in ABF2 varies, with China period of growth. As of July 2010, total non-EMEAPhaving the most. Having foreign market makers is investment in FoBF was US$129 million, comparedparticularly important, as these provide access to with US$716 million in the PAIF fund. PAIF has thenon-resident investors—a form of diversity that promotes advantage of residing in Singapore, which has a moreliquidity. Most of the market makers in Singapore, and developed capital market structure, and of trading onabout half in Malaysia and Thailand, are foreign. the Hong Kong and Tokyo Stock Exchanges.Interdealer voice brokers are also an important part of themarket’s infrastructure. These brokers, who play critical128 | Redefining the Emerging Market Opportunity
    • Case Study 17: Forging Central Bank Partnerships to Build the Market for a Region’s Bonds• Governments that participate in these regional bond fund initiatives have to weigh the desirability of attracting foreign capital against the risk of overheating their economies. Policies relating to tax withholding and credit access for non-residents are important factors in the level of outside investment that a country can get.• In many of these countries, there is not yet a well- designed system for settling debt trades, which means an absence of efficient clearing and settlement. This has kept transaction costs high.• Since the 2008 crisis, a disproportionate share of the corporate bonds issued through the ABF2 has been attributed to the China Development Bank and the Export-Import Bank of China. Both are quasi- governmental entities that do not effectively contribute to corporate bond market development.• The secondary market for corporate bonds in most ABF2 countries still lacks depth and liquidity. This could be addressed by adding transparency and openness with respect to price, quantity, and party information.KEY LESSONS LEARNED1. Central Banks act as investors by directly contributing to the regional bond fund. As such, they are better able to identify and overcome market obstacles and actively contribute to the development of practical solutions.2. Multi-country funds can help attract international investments and promote standardization across the different markets in the region.3. Involving the private sector can be a more effective means to overcome market frictions, as demonstrated by investor preference to use indices created by the large broker-dealers.ReferencesABF (Asian Bond Fund). Pan Asia Bond Index Fund. http://www.abf-paif. com.Chan, E., M. Chui, F. Packer, and E. Remolona. 2011. Local Currency Bond Markets and the Asian Bond Fund 2 Initiative. Basel, Switzerland and Hong Kong: Bank for International Settlements.EMEAP (Executives’ Meeting of East Asia Pacific Central Banks), Working Group on Financial Markets. 2006. Review of the Asian Bond Fund 2 Initiative. EMEAP.— Website. http://www.emeap.org. —.Ma, G. 2005. “Opening Markets through a Bond Fund: The Asian Bond Fund II.” APEC (Asia-Pacific Finance and Development Center) Developing Asian Bond Markets Seminar: From Investors’ Perspective. Shanghai, November 4-6.Suk, H. and J.Hong Bum. 2008. Bond Market Development in Asia. Bangkok: ESCAP (United Nations Economic and Social Commission for Asia and the Pacific).Yam, J. 2005. “The Asian Bond Fund Initiative.” Keynote remarks by Joseph Yam, Chief Executive of the Hong Kong Monetary Authority, at the Global Bond Summit. Hong Kong, November 14-16. Redefining the Emerging Market Opportunity | 129
    • CASE STUDY 18Building a Bond Investor Base through Pension Fundand Insurance ReformRegulatory reform to develop pension and insurance systems and increased flexibility ofinvestment from these institutions are important pre-requisites to build a strongcorporate bond market.CHILEMarket Opportunity Business Model OverviewWell-developed local bond markets create many benefitsfor countries, starting with the long-term financing they Pension System Overhauloffer to indigenous companies. A local bond market also Chile laid the groundwork for a stronger local-currencymitigates risks and reduces volatility by limiting the effects bond market in 1980, when it replaced its state-operated,of currency, interest rate, and funding mismatches. pay-as-you-go pension system with a fully-funded capitalization system based on individual accounts thatIn Chile in the 1980s, a local currency bond market barely are operated by the private sector and regulated by theexisted; corporate bonds amounted to only 1.4 percent of Superintendency of Pensions. Chile’s pension funds areGDP, and the market lacked liquidity and depth. To be managed by the Administradoras de Fondos desure, Chile had a built-in disadvantage—its small base of Pensiones (AFPs), companies that charge fees andinstitutional investors. But the country had made matters commissions for managing individual capital accounts.worse by imposing tight restrictions on pension funds’and insurance companies’ ability to invest in corporate Privatization was a response to the financial pressures thebonds. As part of a broader set of reforms aimed at pension system was experiencing, with obligations itmodernizing the non-banking financial services sector, could no longer meet. As part of the change, the uniformthe country introduced a number of measures that sought retirement age was increased to 65 from 60 for men andto build and strengthen the investor base for the country’s to 60 from 55 for women. Workers are free to choose theprimary bond market. AFP they want to manage their money. All workers, except the self-employed, must contribute to the retirement system, and a more recent change will extendStakeholder Overview the law to self-employed workers in 2015. To encouragePensions, mutual funds, and insurance companies have participation, a tax benefit was provided in 2002 forbeen key targets of Chile’s efforts to reform its financial people willing to increase their pension contributionsystem and develop a market for long-term lending. beyond the legal minimum.Through these non-banking financial institutions, theChilean government has increased its investor base, A more recent reform in 2008 overhauled the individualsubstantially strengthening the local-currency bond accounts system and expanded coverage to a largermarket. portion of the population. To expand individual account Redefining the Emerging Market Opportunity | 131
    • Case Study 18: Building a Bond Investor BaseKey initiatives for developing a primary investor base 1976 1990 2001 A stock register is created and The market becomes progressively The Capital Market I (MKI) reform public disclosure of information more open to foreign investment as focuses on taxation, institutional reforms, becomes mandatory. international capital controls setting and pension funds. minimum performance requirements for direct investments are relaxed. 1981 2002 The Securities Market Law Chile provides a tax benefit for opens the brokerage of people willing to increase their securities to competition, pension contributions beyond the allows for securities dealers legal minimum. (Agencias de Valores), and modernizes the regulations governing mutual funds. 1980 1987 1997 Chile replaces the The Insurance Law Banks are allowed to participate existing state- and Securities Market in non-traditional banking in operated, pay-as- Law are amended so order to grow the insurance you-go pension that all instruments industry that generates demand system with a fully eligible for investment for longer-term products. funded system with by the private pension private provision. funds must be rated by a private risk-rating agency. 2008 Law 20.255 expands pension 1985 coverage to a larger segment of Restrictions on pension the population. Measures funds’ ability to acquire are taken to increase company shares are participation among women and partially removed. young, low-income workers.contributions to women, the government enacted a requirements that had made foreign investors wary ofnumber of steps, including providing each woman aged investing in Chilean securities. And, starting in 1997, the65 or older with a bond equal to 18 monthly contributions government allowed banks to enter some areas that hadbased on the minimum wage for each child she had. previously been off-limits—a change that increased the demand for longer-term securities, including corporate bonds.Non-Banking Financial Institution ReformsNew regulations in 1987 required all instruments eligible Corporate bonds got another boost in 2001 withfor investment by private pension funds to be rated by a Chile’s Capital Market I (MKI) reform, which includedprivate risk-rating agency, as well as by the official Risk changes in taxation, institutional investments, andRating Commission. This change set the stage for pension funds. First, MKI eliminated a 15 percentcorporate bonds to receive greater exposure and become capital gains tax on the sale of high-volume stocksviable investments for pension funds. Additionally, since and securities, making assets such as corporate1990, the government has relaxed some of the bonds more attractive.132 | Redefining the Emerging Market Opportunity
    • Case Study 18: Building a Bond Investor BaseSecond, MKI relaxed the limits that insurers faced on their match the maturity structure of their assets andinvestment portfolios. The reform allowed insurers to liabilities. They may have an incentive to favor short-invest up to 25 percent of their portfolios in corporate term investments—which could be a disincentive forbonds rated above BBB and up to 5 percent in riskier them to invest in corporate bonds.bonds. This was particularly important for thedevelopment of a base of corporate-bond investors • Chile’s pension funds tend to exhibit a herd mentality inbecause, as a group, insurance companies are the their investment behavior. Such investing behavior issecond-largest institutional investor in Chile. problematic because it creates price asymmetries, reduces efficiency, and increases market risk,The third set of reforms was directly related to pension especially in corporate bonds, as they are traded lessfunds and the desire of institutional investors to invest in frequently than government bonds and equity.products with higher yields. MKI implemented a multi-fund scheme so that pension contributors could makeflexible investment decisions based on their specific risk KEY LESSONS LEARNEDprofile. The reform allowed Chile’s pension fund 1. Building an institutional investor base through pensionadministrators to offer contributors five different funds funds, insurance and mutual fund reform is a critical(Fund A to E) that vary according to risk-return pillar in driving demand for a domestic bond market,combinations. Fund A is the riskiest of the five funds and including corporate bonds.permits holding the highest proportion of domestic 2. In order to draw initial participation to quickly buildfixed-income instruments. scale of non-bank financial institutions, governments must reform key policies to encourage savings throughImpact these institutions, such as introducing tax incentives.• As Chile’s institutional investor base has increased, so 3. Pension fund development can initially target the has the demand for corporate bonds. formal labor sector, before targeting larger population ——Between 1989 and 2010, corporate bonds groups (women, youth, and the self-employed sectors). outstanding (including financial institutions) 4. Regulations of non-bank financial institutions need to increased from 8 percent of GDP to 18 percent of be flexible with respect to corporate bond and GDP. investment allocations generally. This creates an ——Between 2000 and 2010, the amount of corporate environment where bonds have a chance of attracting bonds outstanding increased from US$75.2 billion to more capital. US$203.2 billion.• Insurance companies have become the largest holders References of corporate bonds. As of 2004, insurance companies’ BIS (Bank for International Settlements). 2011. “Statistical Annex.” BIS Quarterly Review, June 2011. share of corporate bonds was 49 percent, compared with 30 percent in the 1990s. Cifuentes, R., J. Desormeaux, and C. González. 2002. “Capital Markets in Chile: From Financial Repression to Financial Deepening.” BIS Papers No. 11: The Development of Bond Markets in Emerging• Pension funds have grown substantially since the old Economies. Basel, Switzerland: BIS. pay-as-you-go system was replaced with a fully funded IMF (International Monetary Fund). 2011. World Economic Outlook capitalization system based on individual accounts Database, September 2011. Washington DC: IMF. system. Private pension funds are now the largest Kopf, C. 2006. Sailing in Calmer Waters: The Prospects for Domestic institutional investors in Chile. In 2004, their assets Bond Markets in Latin America. Frankfurt: Deutsche Bank represented more than 50 percent of GDP and were Research. twice as large as the combined assets of insurance Kritzer, B.E. 2008. “Chile’s Next Generation Pension Reform.” Social companies and mutual funds. Security Bulletin 68(2): 69-84. OECD (Organisation for Economic Co-operation and Development). 1998. “The Chilean Pension System.” Ageing Working Paper 5.6.Potential Implementation Challenges Paris: OECD.• The delivery costs of a pension and insurance system Raddatz, C., and S.L. Schmukler. 2011. “Deconstructing Herding: are closely correlated with scale. Successful Evidence from Pension Fund Investor Behavior.” Policy Research development of the pension fund and insurance Working Paper 5700. Washington DC: World Bank Group. industries requires initiatives to expedite participation in Rodríguez, I. 2011. “Domestic Debt Market Development: The Role these programs. of Pension Funds in Chile.” Presentation at DMF Stakeholders´ Forum. Berne, Switzerland, June 8-9.• Unlike insurance firms, mutual and pension funds in emerging markets do not have significant long-term liabilities and therefore have, at best, a limited need to Redefining the Emerging Market Opportunity | 133
    • CASE STUDY 19Building Liquidity in Government Bonds to Pave theWay for Corporate IssuancesIn strengthening their government bond markets and making them more liquid, countriescan create a strong foundation for corporate issuers.MoroccoMarket Opportunity Business Model OverviewIn the wake of an economic crisis in the early 1980s, Morocco’s reforms had three components. The firstMorocco resolved to become less reliant on international involved replacing obligatory purchases of treasury issuesfunding. The country saw this as a way to increase its with a competitive auction. Under the new process, theeconomic stability. With the help of the International central bank became the intermediary for investors, usingMonetary Fund, Morocco set out to build a high- a network of four preferred dealers, called IVTs, that metfunctioning domestic government bond market, partly as with the government monthly to discuss market frictionsa prelude to developing a market for corporate bonds. and keep the reforms on track. These dealers were given preferential access to government bond issues. InGovernment bonds spur the development of a corporate return—to ensure liquidity—they had to trade a specifiedbond market, not least by providing a benchmark for volume of securities to participate in the government’svarious maturities. However, in a relatively small economy auctions. Within a few years, to help diversify the investorsuch as Morocco’s, it helps to get a regulator involved. base, the bid process was opened up to non-IVT issuers, although IVTs remain trusted and important advisors to the central bank.Stakeholder OverviewSince the early 1990s, the Moroccan government has The second part of the reform involved modernizingbeen working to build up its government bond market. To Morocco’s regulatory agencies. A critical step toward thisthis end, it has expanded the responsibilities of its central was the creation, in 1994, of the Deontologic Council forbank and its securities commission. An important aspect Securities, a watchdog organization. More recently, inof these changes was the selection of a privileged 2006, the central bank, Bank Al-Maghrib, was granted fullnetwork of primary dealers to act as market makers. The autonomy.dealers’ job was to ensure liquidity at the early stages ofmarket development. Third, Morocco has liberalized its financial markets. It has, among other steps, legalized mutual funds and theMorocco also took steps to develop a domestic corporate repurchase agreement (repo) market, and allowed banksbond market, focusing on both supply and demand to begin proprietary trading activities. These two changeselements. It diversified the investor base for all bonds and added liquidity, even on a limited debt base. In addition,simplified issuance requirements for corporate bonds. since the financial crisis of 2008, the government has allowed futures trading on treasury bonds. Redefining the Emerging Market Opportunity | 135
    • Case Study 19: Building Liquidity in Government Bonds to Pave the Way for Corporate IssuancesKey steps in developing the local currency bond market in Morocco 1993 Early 2000s 2006 • Appointed the central • Formally legalized the • Granted full bank as designated repo market. autonomy to intermediary between • Allowed banks to central bank, treasury and investors. begin proprietary Bank Al-Maghrib. • Assigned IVTs to take part trading activities to in regular government boost secondary- bond auctions. market liquidity. Creation of competitive Modernization of Financial market bidding and IVTs regulatory agencies liberalization 1994 Post-2008 • Established Deontologic Council for • Allowed creation of futures Securities as market watchdog to market based on treasury strengthen the financial markets. bonds. • Legally recognized mutual funds to • Simplified corporate bond replace the cessation of retail-oriented disclosure requirements bond issuances. by exempting smaller • Opened up bidding process to non- issuances from CDVM. IVT issuers to help diversify investor base, and maintained IVT role as trusted advisors to central bank.136 | Redefining the Emerging Market Opportunity
    • Case Study 19: Building Liquidity in Government Bonds to Pave the Way for Corporate IssuancesAs the government bond market became more liquid, KEY LESSONS LEARNEDMorocco started looking to develop its corporate bond 1. The use of primary dealers—or, as Morocco callsmarket. Typically, barriers for potential issuers include them, IVTs—can improve government bond marketsknowing the right price at which to sell debt, as well as and increase market liquidity. After an initial period,administrative costs and barriers. To help with this latter however, it generally makes sense to open treasuryproblem, Morocco has reduced the requirements for debt bidding to non-IVT participants in order to expand thesales targeting fewer than 10 investors and involving less investor base.than US$60 million in principal. Bonds at that level cannow get to the market in two or three months, as 2. Simplifying the requirements for corporate bondcompared with the year they might have taken in the past. issuances can help drive corporate bond market development at an early stage.Impact 3. Creation of a repo market is required to further drive• Government bonds outstanding in Morocco grew to bond-market liquidity. 277 billion Moroccan dirhams (US$32.8 billion) in 2010, almost 40 percent of GDP. This is up from MAD214.8 billion in 2004 and MAD72.3 billion in 1998. References African Development Bank. 2008. Mapping of Current Ongoing• Liquidity in the secondary bond market more than Initiatives Related to Bond Market Development in Africa. Tunis, doubled, to 65 percent of the outstanding market Tunisia: African Development Bank. (MAD180 million) in 2010 from 32 percent (MAD63 AMCML (Al Masah Capital Management Limited). 2010. MENA Bond million) in 2003. Market: Untapped Potential and Its Impact on Your Portfolio. Dubai, UAE: AMCML.• The repo market grew to MAD4.3 billion in 2006 from Bank Al-Maghrib. Website. http://www.bkam.ma. 2.8 billion in 2003. — 2010. Annual Report 2010. Rabat, Morocco: Bank Al-Maghrib. —.• The investor base for the bond market has diversified Bourse de Casablanca. Website. http://www.casablanca-bourse.com. away from banks. As of 2010, banks held only 15 IMF (International Monetary Fund). 2008. Morocco: Financial System percent of issued bonds, compared with 27 percent in Stability Assessment. Washington DC: IMF. 2004. Mutual funds held 41 percent of bond issuance McCauley, R. and E. Remolona. 2000. “Size and Liquidity of in 2010, up from 35 percent in 2004. Government Bond Markets.” BIS Quarterly Review, November 2000.• Corporate bond issuance has more than quadrupled in Ministry of Economy and Finance. 2010. Monetary and Bond Market recent years, to 8 percent of GDP in 2010 from 2 Trends in 2009. Rabat, Morocco: Ministry of Economy and Finance. percent of GDP in 2003.Potential Implementation Challenges• In emerging countries, and where government borrowing is declining, it can be a challenge to maintain a full yield curve and achieve liquidity. This has been an issue in Morocco. The treasury has responded by becoming more strategic in its debt sales, targeting fewer maturities and key benchmark points in the yield curve.• Although the current over-the-counter trading is relatively efficient, Morocco may decide to move bond trading to the Casablanca Stock Exchange. If it does, investors may get some false reads, at least on maturities with lower balances, as small volumes can move prices very quickly. Redefining the Emerging Market Opportunity | 137
    • CASE STUDY 20Overcoming Institutional Voids to Issue CorporateDebtIn politically unstable regions, private placement is a good mechanism for corporatebond issuance, especially for issuers with economic and political clout and a willingnessto work with outside experts.PADICO, PalestineMarket Opportunity offering are to be used for debt repayment andThe Palestinian territories have had uneven economic infrastructure development projects in the West Bank andgrowth over the past two decades—a consequence of Gaza Strip, including a US$300 million power stationtheir small size and tumultuous politics. There is little planned for the northern West Bank and a tourism andlending except through banks and, until recently, there real-estate project in Jericho.was no such thing as bonds, at either the government orthe corporate level. The lack of liquidity has impeded Padico’s size—as of 2010, the company had paid-in-growth and produced volatility in the bank-led financing capital of US$250 million and revenues of US$103market. Despite the political instability, corporate bond million—and its high profile were critical in earning theissuance is a hugely underserved market in this region. support of the Palestinian government and in speeding up the bond issuance process. Because no government bond market exists in the Palestinian territories, PadicoStakeholder Overview had to look to other markets to price its bonds. WorkingPalestine Development and Investment Limited (Padico) is with the help of the International Finance Corporation, aan economic development firm that has survived mostly part of the World Bank, PADICO identified some similaron the basis of investments it has made outside the debt instruments in Jordan to benchmark its own bonds.Palestinian territories, in the Gulf. The 19-year-old firm also It also worked with two financial firms in Jordan to selectinvests in local projects. Padico has traditionally relied on the coupon rates and collateral that would appeal toshort-term bank loans to finance its investments and to potential investors, and to understand the financialcover the interest and principal payments it makes to its disclosure information that investors needed. These twobank lenders every year. By issuing a corporate bond, the financial firms were not only advisors to Padico but alsocompany sought to restructure its debt and create a more purchasers of its bond, and, in retrospect, it seems clearfavorable liability structure. that Padico’s willingness to work with investors from the beginning was instrumental in the success of its private placement. To make sure it was in compliance withBusiness Model Overview regulations in Liberia, where it is registered, PadicoIn 2011, Padico carried out the first-ever Palestinian bond retained law firms in the United States and Unitedissuance, a US$70 million private placement bought by 14 Kingdom.Palestinian and Jordanian banks. The proceeds of the Redefining the Emerging Market Opportunity | 139
    • Case Study 20: Overcoming Institutional Voids to Issue Corporate DebtStructure of PADICO’s corporate bond private placement $85 MILLION ISSUANCE Issuer Months 1–30 Months 31–60 Investor Variable interest rate of 14 Palestinian Fixed interest 6-month LIBOR + 2.5% PADICO and rate of 5% (floor of 5% Jordanian banks and ceiling of 6.5%) Secured by 31 ow % n ed PALTEL stockThe bonds carry an interest rate of 5 percent for the first • Padico’s success has already encouraged another30 months. For the remainder of the term, they pay a Palestinian company to do a private placement. Thatvariable rate of six-month LIBOR plus 2.5 percent with a second bond sale—of about US$20 million infloor of 5 percent and ceiling of 6.5 percent. They are principal—is a further sign that a government bondsecured by stock in Palestine Telecommunication Group market is not strictly necessary for a market for(PALTEL), a telecommunications company that is 31 corporate bonds to be viable.percent owned by Padico.Padico did not need to go through any credit-rating Potential Implementation Challengesprocess since the bonds were not intended to be listed or • In less-developed markets, the opportunity to selltraded. However, the lack of a credit rating prompted bonds—absent the existence of a market for sovereignPadico and its advisors to do the private placement debt and without the need for credit ratings—is likely tolargely with local banks, which were best able to assess be limited. Many governments will have to bethe credit risks associated with the company. As Padico convinced that they should allow it. Companies thatdevelops a track record for its bonds, the company are not big and that do not have connections withshould be able to sell its debt more widely, including to government decision makers may not be able toinstitutions and foreign investors. overcome this hurdle. • Small investor bases represent a big obstacle inImpact emerging markets, forcing those who want to sell• The success of the offering was clear in the demand corporate bonds to compete for capital, including for Padico’s bond issue, which enabled Padico to against government bonds issuances. In many cases, expand the offering from US$70 million to US$85 institutions face a statutory requirement to buy million. government bonds. In Palestine, in particular, banks are allowed to invest only 10 percent of their capital in• The funds provided by the private placement allowed bond instruments. Without expanding the investor Padico to pay consistent cash dividends and to reduce base, the potential market for corporate bonds is the need for continual recycling of short-term bank greatly limited. loans.140 | Redefining the Emerging Market Opportunity
    • Case Study 20: Overcoming Institutional Voids to Issue Corporate DebtKEY LESSONS LEARNED1. Large, well-established firms can overcome the odds and succeed in issuing corporate bonds in politically complex regions where there is not yet a government bond market.2. Advice from parties in other countries can be pivotal in developing the regulatory and infrastructural know- how needed for bond issuances.3. Private placements are often a good option in immature financial markets, partly because the dynamic of such deals allows for direct negotiations between issuers and potential investors. Also, private placements do not require a credit-rating process—a step that can be costly and cumbersome in an immature market, if it is available at all.4. Regulatory changes—especially ones that relax the requirement to invest in government debt—can allow more market-driven investment practices to take hold. The resulting efficiencies may lead to growth in both sovereign and corporate debt markets.ReferencesBuck, T. 2011. “Palestinian Bond Issue Raises $70M.” Financial Times. May 11, 2011.Dougherty, P. 1995. “Padico Points the Way for Private Sector.” Middle East Economic Digest. March 13, 1995.Friedson, F. and D. Rosenberg. 2011. “Padico Issues First-Ever Palestinian Corporate Bond.” The Jerusalem Post. November 5, 2001.News Bites. 2011. “Palestine Development & Investment [Al-Quds] Unchanged on Average Volume.” News Bites. December 15, 2011.Padico Holding. Website. http://www.padico.com.Palestine Development and Investment Limited (Padico). 2010. Consolidated Financial Statements, December 31, 2010.Perry, T. 2011. “PADICO Eyes Growth in More Transparent Middle East.” Reuters. October 24, 2011.Sahem Trading and Investments Co. 2010. Palestine Development & Investment (PADICO Holding). Ramallah, Gaza: Sahem Trading and Investments Co.Tomlinson, H. 2008. “Padico to Be Split in Two After Replacing Chief Executive.” Middle East Economic Digest. April 18, 2008. Redefining the Emerging Market Opportunity | 141
    • AcknowledgmentsThis Report would not have been possible without theinvaluable contributions and feedback of the members ofthe Expert Committee. On behalf of the World EconomicForum, we would like to express our gratitude to them.We are thankful to the numerous individuals at TheBoston Consulting Group who provided information andsupport. Particular thanks go to Sasirat Kittichungchit andPanyisa Samatadol who provided considerable help withthe case study research.Thank you to Jonathan Gage, Gilly Nadel, RobertHertzberg, Neil Weinberg, and the Publications Team atthe World Economic Forum and The Boston ConsultingGroup for their assistance in the production of this Report.Last, but not least, thanks to Amy Cassidy and theFinancial Services team at the World Economic Forum. Redefining the Emerging Market Opportunity | 143
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