How much effort do you need to find a potential client, get this client interested in your institution, convince him/her to choose your financial institution, and, finally, to create the necessary conditions for a long-term relationship with this client?!!!
It is generally accepted that acquiring new customers takes a lot of time and effort. Also, many would agree that acquiring new customers is much more expensive than retaining existing ones.
When a business is new to a market, focusing on acquiring new customers would be a natural choice. But as the business grows and gains a foothold in the market, it becomes increasingly difficult to acquire new customers, while retaining existing customers becomes less resource intensive by comparison. The focus shifts to retention.
No matter how many new clients an institution acquires each month, if it is unable to retain at least a part of these, then it will be difficult to build up a sustainable business.
Although the practice of retaining customers is often taken for granted, financial institutions may face challenges in effectively implementing a customer retention strategy.
Financial institutions seek answers to such questions as how to create loyalty among existing clients, what factors should be considered, what steps will help to gain sizeable results.
In this publication, we will look at the measures you can use to retain customers and the preparation steps you need to take. Both customer acquisition and customer retention strategies ask for investment of time, energy, and resources, so you should consider all options and choose the most appropriate one for the current situation at your organization.
Where to start?
Understanding your own client base and identifying priority client groups serve as basis for your customer retention activities.
As a rule, potential profitability of a specific customer group in the long-term perspective serves as benchmark. Calculating potential customer profitability is important for identifying those groups of customers which could have the greatest economic impact on your institution if they would leave. Identified groups can be further split into subgroups or even down to the level of individual clients based on selected parameters.
It is essential to make activities aimed at customer retention an ongoing practice. One-off measures usually do not help to keep your customers in the long run. You need a strategy and a systematic approach. While strategy development is undoubtedly important, systematic implementation of measures is equally important.
In some cases, short-term adjustments of your selected retention measures may be required within your adopted strategy, but overall, it is important to focus on long-term goals, adhering to your strategic vision and principles, even if you temporarily adapt some measures. The consistency and predictability of your financial institution are very important to your customers, as most of them seek stability in cooperation with financial institutions.
Continuous efforts to build up a reliable image of your institution in the eyes of customers, the consistency of products/services offered, a focus on high service standards, and other measures implemented in a consistent and on-going manner are prerequisites of successful customer retention.
Now, let us move on to concrete measures that you can implement.
- Understanding how to get started
Once you have identified priority customer groups, you should assess the current situation. First, you should analyze what share of customers you lose, respectively, retain by calculating the customer retention rate (CRR - Customer Retention Rate).
First, you need to determine the period for which you want to get this indicator. This indicator is usually calculated per quarter or per year. It can be calculated for the entire financial institution, by line of business, by product, department, or individual employee.
The next step is to collect data:
- the number of clients at the beginning of the period
- the number of clients at the end of the period
- the number of new clients acquired over the period
These are input data used for the client retention rate formula:
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CRR = (Number of clients at end of period – Number of new clients acquired over the period) / Number of clients at beginning of period |
Ideally, the CRR should be as high as possible. However, you should note that it is virtually impossible to achieve a retention rate of 100%. There are some reasons for losing customers that are beyond the control of a financial institution.
- Analyzing why customers end cooperation with your financial institution (this measure is known as customer churn analysis)
Understanding the reasons why customers leave (or stop using your services) is key to solving existing problems and creating conditions for successful customer retention.[1] Usually, short surveys are useful to find out the reasons why customers leave (customer churn).
Develop a short questionnaire on reasons for leaving and send it to those customers who stopped using a product/s of your financial institution. Instead of a long 10-minute survey, make your survey form short and easy to fill out. The main point of your interest is why your customers are leaving.
Such a survey is a quick way to find out the main reasons why customers stop cooperating with your organization. It is also helpful in calculating losses due to each of the reasons.
For a qualitative analysis, it is recommended that you collect as many responses as possible from customers using your core products, grouped by similar characteristics: for example, entrepreneurs, salaried employees, housewives, students, or other categories. It is also advisable to break down customers by major product groups, as the reasons for closing a deposit or a credit card may be different.
Understanding the reasons why customers leave will give you a list of the main indicators that influence a client's decision to leave or not.
These may include quality of services, location of branches, convenience of the online platform, price, lack of a specific function, unsatisfactory speed of customer service, hidden fees, and so on.
It is also important to consider factors which may seem irrelevant for your institution. We often tend to make assumptions, but we may be wrong about what customers really think about our products. Therefore, you should not make assumptions about customer opinions, but rather use detailed lists of reasons to obtain reliable results (including a field where clients can add reasons you may not have anticipated).
In addition, it can be helpful to conduct a survey among existing customers, focusing on the reasons why they chose your institution. This will help you to understand the factors your customers highly appreciate about your organization.
- An alternative approach to identifying reasons for losing clients
Churn analysis can also be carried out on the database level. The prerequisites for this analysis are having a sufficiently detailed client database and meaningful indicators. This analysis will not give you information about customer opinions, but it can reveal a predisposition to leave for different client categories.
Determine the factors that may affect churn, test your assumptions on an initial customer sample. After initial testing of your hypothesis, choose the final criteria that are most likely to influence churn.
As an example, the following customer variables can be used:
- activity
- number of services used
- income level
- age
- number of months of cooperation with the FI
- etc.
Once the model has been defined, it becomes clear which of the criteria is mainly associated with losing customers. The most important criteria typically associated with high probabilities for customer churn are (the below are examples of indicators and parameters only):
- Number of products: Which customer group is associated with the highest churn rate – customers using 1 to 2 products or customers using 3 to 4 products?
- Age: Which age group is more prone to churn?
- Customer activity: The most proven trend is that inactive customers are more likely to leave the institution.
- Customer income level: For example, customers with a higher income level are more likely to close credit products.
- Number of months of cooperation: To your surprise, you might notice that some clients leave after only a few months with the institution. This indicates an urgent need to analyze the reasons for customer dissatisfaction.
The best solution would be to carry out both types of analysis simultaneously. This will help you draw conclusions that can help you improve potential customer acquisition, as well as give you an understanding of what negatively affects retention and which aspects you should immediately start working on to improve the situation.
Improvement measures
Based on customer feedback and results of your analysis, as a next step, it is recommended to plan the most important changes to how customer support services are organized, remedy shortcomings in the perceived convenience of branches, enhance accessibility and smooth functioning of the online platform, review and rework product characteristics, advertising, etc. or other aspects of the operations of your financial institution.
Depending on the results of your analysis, this can lead to strategic changes and/or to determining the most appropriate measures for the specific situation of your financial institution. When planning your growth and customer retention strategy, consider the identified top reasons why customers are leaving and focus on those that are causing the greatest loss of revenue.
Also, after each implemented improvement, inform clients about these changes. This process should be continuous. It is advisable to plan the analysis of causes and the development of improvement measures for each subsequent period, including the assignment of responsible officers, and the clear definition of expected results and reporting deadlines.
Ideally, all these steps are part of the long-term development strategy of a financial institution. They should be regularly discussed during planning for the next period at strategic meetings and discussions.
What specific measures can or should be implemented? Specific measures depend on the reasons identified, the available budget, the mission, the development plans of the financial institution and other factors. The following are examples of key measures that often help to improve customer retention in the financial sector.
Customer retention methods
High quality customer service is top priority at all stages
Poor service quality is one of the most common reasons why customers change financial institutions, especially if there are players with high service standards in the market.
In this regard, it is important not only to make efforts to continuously improve offered products, their features and price, but also to plan real, systematic actions to continuously monitor and improve quality of service.
To ensure a high level of service, ensuring service quality should become a key priority at all stages of the provision of services and products.
An effective process begins with the selection of client-oriented personnel, with regular training in sales and customer service.
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Service quality: required base |
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Choosing the right people is key to improving the quality of service because, regardless of the training they receive, not everyone has the necessary personal qualities to develop client-orientation and willingness to serve customers in the best possible way.
Serving people is not an easy task. It involves constant communication and demands a special service-oriented mentality from an employee, i.e. having an innate interest in helping/supporting clients in finding best solutions which meet their needs. This mentality should be part of an employee's psychological profile. Otherwise, it is difficult to expect major improvement in service quality from an employee.
The topic of selecting candidates suitable for a respective position is quite extensive, you can read more about this in the publication "Staff recruitment: important preparatory stages" on the RSBP platform.
It is also important to implement an effective approach to careful analysis and resolution of customer complaints, continually improving this practice and applying disciplinary action if necessary. It is important to pay attention not only to front-office employees who directly work with clients, but also to the work of back-office employees regarding timely resolution of respective customer requests.
It is good practice to be attentive to customers, to clarify their situation, and come up with a suitable solution.
In summary, effective client orientation is the ability to identify customer needs and, ideally, meet them beyond the customer’s expectations.
The following are aspects relevant for implementation of a client-oriented approach:
- recruitment and training of suitable people for a respective position, i.e. client-oriented people
- having a clear understanding of who your clients are, segments, typical client profiles in each segment
- knowledge of main client needs for each segment, regular monitoring for any changes
- finding solutions that best suit the situation of a concrete client group or client, refining offers for specific groups
In addition to smooth processes and coordinated work of departments, the list of measures to improve customer experience could include:
- expanding self-service areas, maximizing the range of available services
- ensuring access to these areas 24/7
- at the initial stage, it is advisable to hire a customer assistant who will introduce customers to the new functions
Regular initiation of communication
Regular contacts with your clients have an overall positive effect on their loyalty and retention.
It is critically important to ensure a smooth start of cooperation, agree on communication channels, prepare training materials explaining how to use your products and platforms, applications, and provide answers quickly to all questions. Do your best to make clients feel their importance to your organization and that you value their well-being and time before and after conclusion of a contract.
The following measures can be implemented to ensure regular communication with clients:
Invite your clients to sign up to your institution’s blogs in social networks. Accordingly, it is important to ensure regular publication of your company’s news to keep your clients informed about the latest developments, improvements, innovations.
Invite clients to take part in surveys on how to improve the work of your institution.
When was the last time you asked your existing clients about what can be improved regarding the products and services of your institution?
You should not wait until clients leave before you find out why your institution does not meet their demands.
The easiest way is to send a short questionnaire to your clients. It is especially valuable to introduce a systematic practice of conducting surveys of current clients, to assign a person responsible for collecting, processing responses and, most importantly, for proposing improvement measures based on the analysis of results.
Regularly send newsletters and additional information to customers, either by email or through their preferred messenger. In today's world, it is desirable to keep such materials concise, visually attractive, and easily readable from mobile devices.
Making direct and easy-to-use communication channels available to clients is the fundamental basis for successful regular communication.
Provide for quick response to issues
Clients seek to receive feedback and prompt professional responses to any issues they may have.
It is advisable to carry out inspections to make sure that:
- there is a functioning feedback system in place at your institution that clients can easily use
- customers understand the difference between existing communication channels
- customers can quickly get feedback through different channels
- all channels work promptly
- customers have easy access to information about all existing communication channels
- and, most importantly, that answers are meaningful, that is, understandable and useful to clients
Priority should be given to respond quickly to any customer requests, such as:
- requests for additional information
- requests for support on technical issues
- questions
- requests for help
- complaints
We want to draw special attention to complaints/claims. A filed complaint in itself does not yet mean that a customer is going to leave your financial institution. The factor that may prompt the customer to take this decision is how your organization responds to the complaint.
The biggest mistake is to ignore a complaint or take a late decision. Searching for who is at fault or making excuses are not likely to satisfy the client either.
Below is a proposed complaint management algorithm:
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Proposed complaint management algorithm |
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(1) Let the client see that you accept and understand the complaint; inform the client about the deadline for your answer. |
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(2) Respond as promptly as possible:
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(3) Establish customer feedback channels: assess the client’s satisfaction level after corrective measures have been taken. |
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(4) It is important to record all complaints by creating a catalog of reasons. This database is an extremely important tool for analyzing the root causes of customer dissatisfaction and identifying measures for improvement. |
Some additional important aspects:
- If a problem occurred due to internal reasons, admit the mistake and apologize - customers appreciate this
- Behave professionally even if the client is very emotional about the cause of his/her complaint
Loyalty programs
Customer retention is often associated with loyalty programs which, however, are only part of an effective customer retention framework.
Loyalty programs can be divided into programs involving direct financial incentives for clients:
- reduction of fees, preferential terms and conditions, a month/year of free service
- branded gifts: pens, mugs, T-shirts, calendars, flash drives, notebooks
- special conditions, special products, bonus systems, etc.
and programs involving other incentives:
- assigning an individual client manager; access to the bank’s leadership; the status of a VIP-client
- free training for customers: e-mailing articles and links, coaching, training, consultations
- creating additional opportunities: a more flexible payment schedule, help in preparing documents, etc.
Such programs can undoubtedly attract customer attention. However, on their own, they usually do not significantly affect client loyalty and customer retention, not unless existing issues as described above are resolved.
What can individual employees do to retain customers?
Above we described “macro” level aspects, i.e. measures that financial institutions usually define on the institutional level. However, there are a lot of measures and steps that can be applied on the “micro” level by each individual employee in their day-to-day work.
It is you, as customer relationship manager or customer support back-office manager, who forms the image of your financial institution in the eyes of its customers.
So, what exactly can you do?
Start with a smile, a polite, professional attitude towards each client. When communicating with each client, show your interest, be an active listener, try to quickly resolve the client's request or offer a realistic time frame during which this request can be resolved.
Remember that to win a client, a certain effort is required. You don't need to wait for a dissatisfied customer or a formal complaint to start serving your customers better.
At every financial institution, you can probably find aspects that could be improved, but you should not wait for improvements to happen to then, based on this, provide better service. You should take the initiative and take daily steps to improve customer relations. This is within your power.
Shift the focus from “I cannot do anything until leadership changes the program/product/price, etc.” to “What can I myself do in this situation?”
As we have already discussed, regular communication with clients can help increase their loyalty. So, what can you do in this respect?
- For example, if your financial institution has not yet introduced a practice of regular mailing to current customers, you can create monthly customer birthday lists and mail personalized greetings to important customers.
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Employee service quality |
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- If your institution does not yet have a CRM or another institutional system for tracking and managing customer relationships, you can create your own system (e.g., an Excel spreadsheet) to track essential information and timelines, or other useful information.
- If you are traveling to a specific city or district, it would be great to combine this with visiting important customers located nearby. Remind them about yourself and your institution, find out how the client is doing and ask if he/she has any urgent needs that your institution can help to resolve, or inform them about new services that may be of interest to them.
When you work with people, unexpected situations are not rare. When serving your current clients, try to meet the request of the concrete client in front of you, on the other end of the line or chat.
- If, for example, your client has a currency transfer problem, you can pass the request to the department responsible for currency transactions and explain the issue instead of making client to repeat it. Subsequently check if his issue has been resolved. If the issue was not resolved, deal with it internally /clearly explain what is missing to solve it.
Clients highly appreciate when they feel that they will be provided with an adequate solution for their situation and that the financial institution is not just interested in its own sales but really also cares about the prosperity and development of clients.
- For example, a client wants to get a credit card. However, after you have studied the client’s needs and current situation, you understand that s/he will not be able to repay the credit card debt within the grace period and will have to pay high interest. Well … you could ignore this fact and meet the client's request. But, if you want to enhance the client's confidence in you and your financial institution, the best choice would be to explain the case to the client and offer a more suitable product with lower interest. This behavior will demonstrate that your institution is not interested in just making a quick profit but cares about the client’s well-being. Such an attitude and approach usually help financial institutions to establish long-term relationships with clients.
Of course, there are more ways to increase customer loyalty. However, by implementing at least the above measures, you can already increase the level of customer confidence and loyalty. This topic should always be on the agenda. It is important to think about building long-term relationships with clients, since having a contract with a client today by no means guarantees its renewal tomorrow.
If compared to the acquisition of new clients, your attention and prompt response to the needs of your current customers does not require much investment of time and effort, but it can help increase customer satisfaction and loyalty. Through effective work with your existing clients, you will also free up resources which you can use on more effective acquisition of new customers.
As a result of successful retention efforts, satisfied customers are more likely to expand the range of your products they use. In addition, loyal customers tend to recommend the services of their financial institution to their acquaintances, which increases the number of potential new customers that can be acquired at comparatively low cost to your organization. Finally, the churn rate of current customers will decrease, and the customer base will be more stable and predictable, which allows for more effective planning.
[1] It is also possible to analyze why certain customer groups no longer use certain services.
The EBRD Business Guide is an online platform for SMEs which employees of financial institutions will find useful when working with SME. The site provides information and resources on how SMEs have resolved challenges, legal information and tools. The resource offers a range of modules and templates on finance, strategy and planning, HR as well as checklists on digitalization, work safety and other.
The platform is accessible at the following address: https://businessguide.ebrd.com/
All material is available in English and, among others, selected material is available in Russian.
Kyrgyzstan Tajikistan Uzbekistan
This is a recording of an online webinar on Islamic finance organised by the RSBP for Central Asia for financial institutions in Kazakhstan.
The key subjects discussed at this webinar were the following:
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Islamic Finance and Islamic Products (Day 1)
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The Management of Islamic Financial Institutions (Day 2)
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Day #1: Islamic Finance and Islamic Products
Day #2: The Management of Islamic Financial Institutions
The analysis of qualitative indicators in lending to micro, small and medium-sized enterprises is of great importance. It is an essential part of the analysis and as important as collection and analysis of financial results. Moreover, a comprehensive and meaningful analysis of financial indicators is only possible if the current situation of a business and its qualitative characteristics are fully understood.
There have been quite a number of cases where businesses with - in principle - good financial performance did not meet their credit obligations due to irrational decisions taken by owners, disagreements among owners or other internal problems. By analysing only numbers without understanding their origin, their exact meaning, without understanding the business model, its main development milestones, the competence of management, relations between owners, their strategies and business development plans, it is extremely difficult to get a full picture of the potential borrower’s credit capacity and possible risks ...
In view of often extremely limited reliable and confirmed financial information, a qualitative analysis of data is of particular importance for the analysis of micro, small and medium-sized enterprises (MSMEs).
In this article, we discuss the main qualitative factors to be considered when taking lending decisions on MSME clients, we provide examples of risks relating to qualitative criteria, and give recommendations for conducting qualitative analyses.
The main areas of qualitative analysis[1]
The process of qualitative analysis includes a detailed analysis of owners and the management team, the business environment, and internal organization.
The primary goal of the analysis is to understand the client's business, identify potential risks and assess their impact on the client's ability to repay the requested loan amount. However, you should take a broader approach to the analysis of each client and consider the potential for long-term mutually beneficial and profitable co-operation: business development support with the help of existing products, cross-selling of other products and the perspective for successfully catering to most, if not all, financial needs of the client, rather than focusing on a single transaction.
For such an analysis, you typically use information from the loan application, from the documents submitted by the client, information obtained during client meetings and interviews with owners and other individuals involved in the business, information obtained from observations made during client visits and from other available sources, including the Internet.
We take a complex approach to data collection and assessment. The information collected from the different sources can be grouped into blocks. Among other options, collected data can be grouped as follows:
- business background, owners and management, quality of management;
- business organization; risks arising from the business model; business environment and competitors and related potential risks;
- feasibility analysis of the client's loan request, the client's plans and the business development strategy;
- assessment of the likelihood of the business belonging to a group of related entities and the group’s impact on the borrower's business (and vice versa).
In the following, we go through key aspects of analysing each of the above areas, including examples for potential risks.
Business background, owners and management quality
To understand the current business situation and potential threats to successful development, it is useful and recommended to analyse the history of business development: who exactly founded the business and who is managing it? You should clarify the development strategy chosen by owners, the client's plans and the qualification/competence of business managers. It is also necessary to determine the real owner, as in some cases nominal owners may apply for a loan.
Generally, the following aspects should be analysed:
- how the business was founded; start-up capital and its sources;
- business development milestones; the current ownership structure, the level of competence of the management;
- the strategy of owners, development plans, analysis of the business environment;
- ownership with a view of identifying actual owners;
- key persons in the business and their competence in the respective area.
It is important to consider any changes in ownership or main activities over time, especially over the last year, and the main reasons for these changes. In addition, we recommend to check if there are plans for strategic changes (in the composition of owners/key persons, in business activities or geographical coverage, etc.), and to understand the reasons for planning these changes.
Meeting key decision-makers can give you valuable information, since the level of their expertise and competence can significantly affect the development of the business and, accordingly, the ability to repay the requested loan on time.
It is important to consider the sources of start-up capital as well as whether there is access to additional funding for business development if needed – to be provided either by owners or through alternative sources. For legal entities, it is worth paying attention to paid-up authorized capital rather than only the authorized capital indicated in founding documents as this may not yet have been fully paid in.
It is important to pay attention to the owners’ experience, character, the purpose of creating the business, the main business development plans, both short-term and long-term.
Most of the information for analyzing these factors can be retrieved during interviews with the management team and business owners. In the process of the analysis, we recommend to compare verbal information with statutory documents presented by the client and historical results as documented in the financial statements for previous periods.
For reference, the table below outlines possible risks in this area.
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Examples of risks associated with business owners and governance |
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Internal risks associated with business management and ownership structure are quite common, so it is important to pay due attention to the analysis of the factors described above. Their critical assessment helps you to identify weaknesses in the management system and thus identify potential risks for your financial institution. You should bear in mind that one client may be exposed to several of the above risks.
Business organization: risks associated with the business model
In addition, we recommend to analyse the organizational details of the operations of a potential client, the client’s relations with major customers and suppliers, the level of staff qualification and other aspects of the business model. The main factors to be considered at this stage are:
- Dependence on certain suppliers (supplier concentration), main terms of cooperation;
- Dependence on certain customers (customer concentration) and who is responsible for client acquisition;
- How well-established sales channels are;
- Staff turnover, labour shortages;
- Risk of business interruptions; risk that business operations may be temporarily suspended or stopped completely
- Internal control over the business.
Risks arising from the respective business model are inherent business risks, regardless of business size and experience. Therefore, when analysing a loan application, we recommend to try to fully understand how the client's business is organized. Understanding the business model is the basis for identifying and assessing potentially existing risks.
The table below presents a short list of potential risks associated with the business model:
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Examples of risks associated with the business model |
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For customers operating in sectors such as manufacturing and transportation, the following risk factors may be of particular relevance: improper equipment maintenance leading to breakdowns; dependence on narrowly specialized staff; licensing problems; fixed asset registration to third parties; high workplace injury risks, fire hazardous production process.
It is necessary to carefully analyse business organization, the owners’ awareness of potential risks and the measures they can realistically take to reduce them.
Feasibility analysis of the client's loan request, the client's business development plans and strategy
One of the most important parts of any qualitative business analysis for the purposes of loan decision-making is the analysis of the feasibility of the client's loan request (loan application). First, it is necessary to have a clear understanding of the purpose of the loan requested: will it be used for the needs of an existing business, to expand an existing business, to develop a new business line, to penetrate a new market or start a completely new business.
However, for a feasibility analysis of the requested loan, it is not enough just to note down the client's request and clarify what exactly the funds will be invested in. It is important to understand what goal the client is pursuing with the requested funding, what (s)he plans to achieve, why (s)he decided to apply for a loan, how exactly the loan will affect business performance. It is also necessary to carefully analyse the grounds for these expectations of the client, assess their feasibility and the time frame for project completion/full implementation of the project.
An interview with the owner and/or management of the business is the main source of information for this analysis, supported by documentation confirming that the request is financially sound (issued bills, business plans, assessment of investments in construction and renovation, Internet research to verify data provided by the client, etc.).
Depending on the loan purpose, you need to pay attention to various factors.
Request for a working capital loan
In general, working capital loans tend to be less risky than investment loans for the purchase of property, production plants, and equipment. Nevertheless, the loan officer/client relationship manager must carefully assess the main reasons for requesting additional working capital financing.
Once the loan officer/client relationship manager has identified what exactly the client is requesting, (s)he must take a closer look at what really prompted the application. If the purpose of requesting a working capital loan is to increase production or replenish inventory to meet increased demand, then the request seems reasonable. However, it is necessary to cross-check the client's calculations and the availability of sufficient resources, premises and potential demand, to make sure that increasing production volumes is feasible and necessary. If the loan officer/client relationship manager finds that the client does not yet have the necessary additional resources, (s)he must check if the client has a clear plan for acquiring the necessary resources (hire and train additional employees, find extra premises, conduct an additional advertising campaign) and a realistic time frame for implementing these plans.
If the client is requesting financing for the purchase of additional inventory that is noticeably different from normal inventory levels, you should pay particular attention to the reasons for the request and make sure there are no potential problems behind this. It is important to check the client's capacity to achieve the planned increase in sales, the client’s warehousing capacity to store larger volumes of inventory, the feasibility of forecasts, to verify what measures were already implemented with what result and whether the client's expectations are/can be met.
Fixed asset financing
Fixed asset financing can be requested by an existing business to replace existing assets or for business expansion: introduction of a new product/service or opening new business locations / entering new markets, opening a new business line or starting a completely new business. It is important to understand the reasons for investing and carefully analyse the loan purpose, since the cost of such investments is usually high and payback periods are long. Investments in fixed assets can affect a client's existing business in different ways, and impact can quantitative and qualitative.
Quantitative effects usually involve an increase in production, sales, net profit, equity, reduced operating costs (maintenance, labour, rental costs) or increased operating costs - if additional staff is needed.
Qualitative effects usually involve an improved competitive position in the market, an increased share in an existing market, improved product quality or reduced environmental pollution.
In any case, it is important to double-check the client's expectations, question the forecasts and check them against own market research and main trends in the sector.
Employees of the financial institution must evaluate the entire business plan of the client, and not just the part that will be financed by the requested loan. Among other things, it is important to determine the investment and repayment deadlines and sources. The investment plan of a business must be assessed in a comprehensive manner, and it must be demonstrable that there are sufficient resources (including time, labour, expertise) for its implementation, that expected results are reasonable, not inflated, and that the business will actually benefit from financing.
Having analysed a given business plan you will not only understand the loan purpose, but also all impact (direct and indirect) on the client's business in the short- and long-term. In conjunction with this you should also analyse the owners' business development plans and compare whether the current request for financing is logical in the context of the chosen development strategy.
Development plans and strategy
In general, it is extremely important to analyze the plans of a client in MSME finance. It is not uncommon for the MSME sector that a profitable business may deteriorate due to irrational decisions made by owner(s) or overly ambitious development plans.
You should assess the attitude of the business owners to business development: do they plan to develop the business only at the expense of their own funds, or are they applying for more and more loans every year? Are profits reinvested in the business, withdrawn completely or invested in other areas? Do owners prefer stability or focus on aggressive growth and market capture?
For financial institutions, the risk level largely depends on the business owner’s style of decision-making about changes in the business: how carefully does the owner approach these decisions? Does the owner conduct adequate preliminary analysis? Does (s)he prepare for remedial measures in response to possible negative scenarios in advance or are his/her decisions spontaneous?
It is also advisable to check the targeted and actual use as well as conditions of earlier loans. The fulfilment/non-fulfilment of the terms and conditions for earlier loans is an additional sign of the potential borrower’s organized nature, diligence, and good faith. In addition, the client’s past behaviour can help assess his/her qualities as a leader, a successful entrepreneur, a quality manager who really can competently create and implement plans, including resolving obstacles that may arise during plan implementation.
Assessing the likelihood of a business belonging to a group of related entities and the group’s impact on the borrower's business
As a separate aspect of the analysis, it is worth mentioning the analysis of the likelihood of the borrower’s relation/connection to a group of related entities and the group’s impact on the borrower’s business results (and occasionally vice versa). If a business owner has a parallel business (or businesses), the sources of potential risks increase and the overall risk profile may change, since there may be counter-flows of goods and money between connected entities (both regular, easily traceable, and irregular, unsystematic).
The financial situation of connected entities can be stable, or it can deteriorate and require significant investments, so that owners may withdraw funds from one business to stabilize another business, thus weakening the financial position of the first business. In addition, any related business may be exposed to the different risks described in this article, which may negatively affect the performance of the entire group.
Regardless of a thorough analysis of the borrower as a stand-alone business, financial institutions will often not have all information needed to fully assess risks without an analysis of the group of connected entities. In practice, various tools are used when financing such clients, taking into account the possibility of additional sources of potential risks. The main tools involve mitigation of potential risks by requesting additional or harder collateral, using a higher collateral coverage ratio and/or consolidation of the group's financial results to assess existing risks.
Consolidation of the results of a group of connected entities for a more informed decision (when appropriate for a given segment) means analysing the financial results of all related businesses. Thus, you can assess the entire range of risks, as well as identify all potential needs for additional resources. [2]
For segments or cases where fully-fledged data consolidation of connected entities is not economically justified (the work and trouble involved is too high if compared to loan amount, possible profit etc.), it is advisable at least to analyse the existing connections in the group to a level that makes it possible to understand the main interrelations, measure and foresee/eliminate the main risks associated with the group. For such situations, the requirements for loan security are usually higher (including the possibility of additional disbursement preconditions and provision of additional guarantees) than in the case of a fully transparent group of entities.
How can we determine if a potential borrower belongs to a group of connected entities? You should pay attention to indirect evidence. The table below outlines basic examples.
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Examples of evidence/red flags signaling the possibility of connected entities |
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In Central Asia, groups of connected entities and operating businesses in parallel in the SME segment are quite common. Identifying related individuals is critical to assessing the risks associated with the group and making an informed decision. Therefore, such information should be double-checked with due care.
The list of qualitative analysis factors can be continued, including the cross-checking of information provided, of the declared scope of activities etc. In this publication, we cover the most significant factors, and their detailed analysis will allow us to come to a comprehensive understanding of the client's creditworthiness and the factors that can have an impact on it.
It is important to remember that the presence of any of the listed potential risks does not mean that you need to stop working on an application in hand and refuse the client. Identifying a particular risk means that when making a loan decision, you should consider the potential impact of this risk on the client's solvency and business, including overall future of the business. Additionally it means, that it should be evaluated the optimal financing format given the identified risks and the possible ways to mitigate these risks, including taking additional loan security. In some cases, risks may be such that – even if additional loan security would be available – it is advisable to refrain from lending.
Considering the business, its potential and existing risks you can arrive at a sound lending decision. To build a long-term relationship, we also recommend to discuss the situation with the client, highlight the identified problematic aspects and, if the client asks for it, provide him/her with suggestions on possible solutions.
What is important to consider when conducting a qualitative analysis?
Further recommendations for conducting a quality analysis
The main objectives of a quality analysis:
- cross-check the provided financial results based on an understanding of the client's business organization and its main business processes;
- assess financial sustainability and factors that can affect the performance of the potential borrower’s business, including the ability to adapt to a changing environment, plan business updates in accordance with sector trends;
- analyse the situation in the sector, key economic indicators and trends;
- assess how critical the identified qualitative risks are and how they can affect the repayment of the requested loan;
- analyse the arguments for accepting these risks and formulating additional conditions for mitigating them;
- formulate your conclusions for decision-makers.
We recommend to include space in the analytical forms for the description of main findings regarding identified qualitative risks, foreseeing a different area for each of the qualitative analysis aspects.
For successful implementation of the analysis of qualitative factors in the process of decision making, it is important to pay close attention to the risks identified and to the findings/conclusions drawn as a result of such an analysis.
We recommend to make the qualitative analysis part of the methodology, to structure the approach, and determine the method of documenting the findings of the analysis. Qualitative factors serve as basis for understanding quantitative indicators as well as basis for their correct interpretation and cross-checking, and are critical for sound risk assessment and decision making. The inclusion of qualitative factors in the analysis, along with quantitative indicators, will allow your financial institution to conduct a comprehensive analysis of borrowers and make informed and sound lending decisions.
[1] This topic requires special attention, and a separate online course has been devoted to it on this online platform – “OL2001 Online Course: Data consolidation and relationship between financial statements in SME finance”.
[2] In view of the negative consequences of Covid-19 for economies, additional factors should be considered in analyses, such as, for example, decision-making flexibility and speed with which steps aimed at business optimization can be implemented. These are described in detail in the publication “ANALYZING BUSINESSES IN TIMES OF CRISIS”.