Consumer Banking BNK603 book HANDOUTS in pdf

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LESSON 01
CONSUMER BANKING
Objectives of Course
􀂙 To help Students gain some fundamental knowledge/information about this important
component of Banking Business. As educated citizen of the country they are expected to develop a
balanced perspective & establish the relevant context towards the contribution this banking
practice could make in the growth/development of Economic and Social Sectors of our country
􀂙 To provide Students with an opportunity to undertake some additional/complimentary learning
which could help them succeed in their work/professional lives, i.e. choosing any
occupation/carrier in general or Banking/Finance in particular
􀂙 To assist Students in making better decisions in their capacity as Consumers themselves. With
their educational background they represent a Key Societal Stakeholders Category and as such
constitute a significant Prospective Customers Segment for the banks
Five Forces of Competitive Position
Let us take Porters Five Forces model as an example:
􀂙 Information can provide us with the details of buyers, suppliers, substitutes, competition, etc.
􀂙 Knowledge can show us how to build Porter's 5 forces mode with this information
􀂙 Understanding can explain to us why we utilized the model (objective is to determine industry
attractiveness and/or use as a threat matrix)
􀂙 Wisdom enables us to discern the objective's value or relevance to us and our desired outcome
􀂙 Wisdom is about effectiveness while the rest are about efficiency
Systems Framework
Consumer Banking is a separate course but we are not going to learn about it “in Isolation”.
Our endeavors will be to understand it by applying the process of learning cycle described earlier and take a “Systemic View” of the nature & characteristics of this subject, i.e. in the wider & a macro context.
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What are Systems?
􀂾 System is a group of interacting, interrelated, and interdependent components that form a complex
and unified whole
􀂾 Systems are everywhere—for example, the R&D department in your organization, the circulatory
system in your body, the predator/prey relationships in nature, the ignition system in your car, and
so on
􀂾 A system has a purpose
􀂾 The parts combine in a particular way for the system to carry out its purpose
􀂾 Systems serve specific purposes within larger systems
􀂾 Systems seek stability
􀂾 Systems have feedback
The methods of systems thinking provide us with tools for better understanding difficult management
problems. The methods have been used for around fifty years (Forrester 1961) and are now well
established. However, these approaches require a shift in the way we think about the performance of an
organization. In particular, they require that we move away from looking at isolated events and their causes
(usually assumed to be some other events), and start to look at the organization as a system made up of
interacting parts. We use the term system to mean an interdependent group of items forming a unified
pattern. Since our interest here is in business processes, we will focus on systems of people and technology
intended to design, market, produce, and distribute products or services. Almost everything that goes on in
business is part of one or more systems. As noted above, when we face a management problem we tend to
assume that some external event caused it. With a systems approach, we take an alternative viewpoint --
namely that the internal structure of the system is often more important than external events in generating
the problem.
Systems Thinking is a process of discovery and diagnosis an inquiry into the governing process underlying
the problems we face. It helps in building more choices not answers, into our thinking process. It creates a
framework for productive dialogue.
Business Model
• Can you think beyond new Products and new Services to entirely new business concepts --- ones
that meet deep customer needs in unconventional ways?
• Can you think of unconventional ways of recharging an existing business concept? Can you go
non-linear? To be an industry revolutionary, you must develop an instinctive capacity to think
about Business Models in their entirety
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In order to better understand systemic behavior & dynamics (Linkages, Interdependencies,
Interconnectedness of System’s components) of Consumer Banking Segment within a Commercial
Banking set up, let’s develop a base in order to activate the learning process. One such base could be the
concept of “Business Model”.
Customer Interface
Customer Interface has four elements:
1. Fulfillment and Support
2. Information and Insight
3. Relationship Dynamics
4. Pricing Structure
1. Fulfillment and Support
This refers to the way the firm “goes to the market”, how it actually reaches customers ---which channels it
uses, what kind of customer support it offers, and what level of service it provides.
2. Information and Insight
This refers to all the knowledge that is collected from and utilized on behalf of the customers. The
information contents of the customer interface. It also refers to the ability of a company to extract insights
from the information. Insights that can help it do cool new things for customers. It also covers the
information that is made available to customers’ pre-and post-purchase.
3. Relationship Dynamics
This element refers to the nature of the interaction between the producer and the customer. It looks at if
the interaction is face to face or indirect, is it continuous or sporadic, how easy is it for the customer to
interact with the producer, what feelings do these interactions invoke on the part of the customer, is there
any sense of “loyalty” created by the pattern of the interactions? The notion of relationship dynamics
acknowledges the fact that there are emotional, as well as transactional, elements in the interactions of the
producers and consumers, and that these can be the basis for a highly differentiated business concept.
Value
Network
Strategic
Resources
Core
Strategy
Customer
Interface
Company
Configuration Boundaries
Customer
Benefits
Business Model
• Fulfillment &
Support
• Information
& Insight
• Relationship
Dynamics
• Pricing
Structure
• Business
Mission
• Product &
Market Scope
• Basis of
Differentiation
• Core
Competencies
• Strategic
Assets
• Core
Processes
• Suppliers
• Partners
• Coalitions
Efficient/Unique/Fit/Profit Boosters
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4. Pricing Structure
You have several choices in what you charge. You can charge customers for a product or for service. You
can charge customers directly or indirectly through a third party. You can bundle components or price them
separately. You can charge a flat rate or charge for time or distance. You can have set prices or marketbased
prices. Each of these choices offers the chance for business concept innovation, depending on the
traditions of your industry.
Customer Benefits
Intermediating between the Core Strategy and Customer Interface is another bridge component ---the
particular bundle of Benefits that is actually being offered to the customer. Benefits refer to a customerderived
definition of the basic needs and wants that are satisfied. Benefits are what link the Core Strategy to
the needs of the customer. An important component of any business concept is the decision as to which
benefits are or are not going to be included.
Core Strategy
Core strategy is the essence of ‘how’ the firm chooses to compete. The key elements of Core Strategy
include:
1. Business Mission
2. Product/Market Scope
3. Basis of Differentiation
Whatever your strategy, whether it is low prices or innovative products, it will work if it is sharply defined,
clearly communicated, and well understood by employees, customers, partners, and investors. The key
components:
􀂙 Build a strategy around a clear value proposition for the customer
􀂙 Develop strategy from the outside in, based on what your customers, partners, and investors have
to say—and how they behave—not on gut feel or instinct
􀂙 Continually fine-tune your strategy based on changes in the marketplace—for example, a new
technology, a social trend, a government regulation, or a competitor’s breakaway product
􀂙 Clearly communicate your strategy within the organization and to customers and other external
stakeholders
􀂙 Keep focused. Grow your core business, and beware the unfamiliar
1. The Business Mission:
This captures the overall objective of the strategy ---what the business model is designed to accomplish or
deliver. The business mission encompasses things such as the “Value Proposition”, “Strategic Intent”,
or “Purpose” and overall performance objectives. It implies a sense of direction and a set of criteria against
which to measure progress.
2. Product/Market Scope
This captures the essence of where the firm competes ---which customers, which geographies, and what
product segments ---and where, by implication, it does not compete. A company’s definition of
Product/Market Scope can be a source of business concept innovation when it is quite different from that
of traditional competitors.
3. Basis for Differentiation
This captures the essence of how the firm competes and, in particular, how it competes differently than its
competitors. A famous PC Company has redefined what a computer should look like. For years, the PC was
the ugliest thing in your home or office. It looked like a disemboweled robot with cords & cables spilling
everywhere. And it came in only one color, deadly boring beige. Why? Because most of the companies
making PCs had an industrial products heritage they were filled with engineers not artists. This new design
sold 400,000 units in the first month after its launch, and introduced an entirely new dimension of
Differentiation i.e. Aesthetics into the computer industry.
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Strategic Resources
Every competitive advantage worthy of the name rests on unique firm-specific resources. Dramatically
changing the resource base for competition can be source of business concept innovation. The key
components include:
1. Core Competencies
2. Strategic Assets
3. Core Processes
1. Core Competencies
This is what the firm knows. It encompasses skills & unique capabilities that enable a company to provide a
particular benefit to customers. Some examples are:
􀂙 At a Japanese electronic company that benefit is “pocket ability” and the core competence is
“miniaturization”
􀂙 At a global courier company the benefit is “on-time delivery”, and the core competence, at a very
high level, is “logistic management”
􀂙 Logistics are also central to an American retail stores giant to provide customers with the benefits
of choice, availability, and value
􀂙 At one major IT company the customer benefit is seamless information flows, and one of the
contributing core competencies is “systems integration”
2. Strategic Assets
These are what the firm owns. They are things, rather than know-how. They include:
􀂙 Brands
􀂙 Patents
􀂙 Infrastructure
􀂙 Proprietary Standards
􀂙 Customer Data
􀂙 And anything else that is both rare and valuable
3. Core Processes
This is what people in the firm actually do. Core Processes are methodologies and routines used in
transforming inputs into outputs. Core Processes are activities, rather than “assets” or “skills”. They are
used in translating competencies, assets, and other inputs into value for customers. A fundamental
reinvention of a Core Process can be the basis of business concept innovation.
Configuration
Intermediating between a company’s Core Strategy and its Strategic Resources is a bridge component which
could be called Configuration. It refers to the unique way in which Competencies, Assets, and Processes are
combined & interrelated in support of a particular strategy. It refers to the linkages between
Competencies, Assets, and Processes and how those linkages are managed. The notion of Configuration
recognizes that great strategies (and great business models) rest on a unique blending of Competencies,
Assets, and Processes.
Value Network
Value Network is the component that surrounds the firm, and which complements and amplifies the firm’s
own resources. Today many of the resources that are critical to a firm’s success lie outside its direct control.
The key components include:
46. Suppliers
47. Partners
48. Coalitions
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1. Suppliers
Suppliers typically reside “up the value chain” from the producers. Privileged access to or a deep
relationship with Suppliers can be a central element of a novel business model. Part of what has made a
major internet plumbing company the most nimble competitor in the communication business has been its
use of outside Suppliers. More than 50 per cent of its product does not touch its factory or employees. It
just gets magically assembled and shipped, and the customer doesn’t even know the company never
touched it. Increasingly, such companies are using their Supplier network to dramatically reduce Working
Capital and increase Flexibility.
2. Partners
Partners typically supply critical ―compliments to a final product or “solution”. Their relationship with
producers is more horizontal and less vertical than that of suppliers. An imaginative use of Partners can be
the key to industry revolution. The success of Windows platform is in large part due to the support the
producer has lavished on its software development partners. Making it easy for Independent Software
Vendors (ISVs) to write for Windows increases the numbers of applications running on Windows and
further strengthens its market position. As early as 1999, the Developer Network included over 10,000
ISVs.
3. Coalitions
Business concept innovation requires a company to join together with other, like-minded competitors in a
Coalition. This is particularly likely to be the case where investment or technology hurdles are high or where
there is a high risk of ending up on the losing side of a winner-take-all standard battle. Coalition members
are more than Partners, they share directly in the risk and rewards of industry revolution. A consortium of
France, Germany, British, and Spain aerospace companies, is one of the world’s most successful Coalitions.
Company Boundaries
Intermediating between a company’s Strategic Resources and its Value Network are the firm’s Boundaries.
This bridge component refers to the decisions that have been made about what the firm does and what it
contracts out to the Value Network. Again, an important aspect of any business model is the choice of what
the firm will do for itself and what it will outsource to Suppliers, Partners, or Coalition Members. Changing
these Boundaries is often an important contributor to business concept innovation.
Expanding the Innovation Horizon:
A Global CEO Study
Leaders frequently define their businesses in terms of the products and services they take to market and
naturally focus their innovative energy there. But with technological advances and globalization presenting
so many new opportunities – and threats – CEOs are now giving business model innovation as prominent a
place on their agendas as products/services/markets innovation and operational innovation. As one CEO
suggested, “the three areas are essential, equally important and inseparable from each other.” Some CEOs
who have not focused on business model innovation in the past now believe it is time. In one CEO’s
words, “We are at the critical point where we should transform our business model itself.” While the fact
that CEOs are now focusing almost 30 percent of their innovation efforts on their business models is
surprising, our financial analysis uncovered an even more interesting point. Companies that have grown
their operating margins faster than their competitors were putting twice as much emphasis on business
model innovation as underperformers. Although business model innovation is clearly important to CEOs, it
is part of a combination – which makes it critical to understand more about how CEOs have been
managing each type of innovation.
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So, what actions are CEOs taking to adapt their business models?
Major strategic partnerships and organization structure changes topped the list of most significant business
model innovations (see Figure 4).
One CEO explained that the success of strategic partnerships depends heavily on a company specializing
and then working toward mutually beneficial value creation. “We need to develop a business model based
on strategic partnerships that creates value not just for our company, but also for the industry as a whole.
We cannot do everything in this era of specialization.”
Cost reduction and strategic flexibility were considered top benefits from business model innovation –
reported by over half of all business model innovators (see Figure5).
Business model innovation allows companies to specialize and move more quickly to seize emerging growth
opportunities. Overall, CEOs’ rankings suggest that business model innovation is helping their
organizations become more nimble and responsive, while at the same time lowering costs. One CEO
explained: “Innovating with respect to business models and operations will not only create opportunities for
cost savings, but will also lead to additional revenue generation opportunities.”
When we looked at financial performance over a five-year period, we found striking differences across the
three types of innovation. Business model innovation had a much stronger correlation with operating
margin growth than the other two types of innovation (see Figure 6).
Looking across the top actions business model innovators were taking, we found that companies innovating
through strategic partnerships enjoyed the highest operating margin growth.
As one CEO remarked, “reducing the cost base through cooperative models is important for any growth
strategy.”
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Special Note: New Ways of Thinking about Learning;
An extract from the book, “Presence, Human Purpose & the Field of the Future” co-authored by Peter Senge, Otto
Scharmer, Joseph Jaworski, & Betty Flowers.
QUOTE:
When any of us acts in a state of fear or anxiety, our actions are likely to revert to what is most habitual; our
most instinctual behaviors dominate, ultimately reducing us to the “fight-or- flight” programming of the
reptilian brain stem. Collective actions are no different. Even as conditions in the world change
dramatically, most businesses, governments, schools, and other large organizations continue to take the
same kinds of institutional actions that they always have.
This does not means that no learning occurs. But it is a limited type of learning; learning how best to react
to circumstances we see ourselves as having had no hand in creating. Reactive learning is governed by
“downloading” habitual ways of thinking, of continuing to see the world within the familiar categories we
are comfortable with. We discount interpretations and options for actions that are different from those we
know and trust. We act to defend our interests. In reactive learning, our actions are actually reenacted
habits, and we invariably end up reinforcing pre-established Mental Models. Regardless of the outcome, we
end up being “right”. At best, we get better at what we have always done. We remain secure in the cocoon
of our own worldview, isolated from the larger world.
But different types of learning are possible. More than five years ago, we (the authors) began interviewing
leading scientists and business and social entrepreneurs.
Those interviews --- which now total more than 150 --- created the impetus for this book. We often simply
began by asking each person,
“What question lies at the heart of your work?”
In our conversations with scientists, we explored emerging ideas that have the potential to shift longestablished
views of the separation of humanity and nature. In our interviews with entrepreneurs, we
explored how new ideas and intuitive knowing are brought into reality. Together, the two groups
illuminated a type of learning that could lead to the creation of a world not governed primarily by habit.
All learning integrates thinking and doing. All learning is about how we interact in the world and the types
of capacities that develop from interactions. What differ are the depth of awareness and the consequent
source of action. If awareness never reaches beyond superficial events and current circumstances, actions
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will be reactions. If, on the other hand, we penetrate more deeply to see the larger whole that generate
“what is” and our connection to this wholeness, the source and effectiveness of our actions can change
dramatically.
In talking with pioneering scientists, we found extraordinary insights into this capacity for deeper seeing and
the effects such awareness can have on our understanding, our sense of self, and our sense of belonging in
the world. In talking with entrepreneurs, we found extraordinary clarity regarding what it means to act in the
service of what is emerging. But we also found that for the most part, neither of these groups talks with the
other. We came to realize that both groups are really talking about the same process --- the process whereby
we learn to “presence” an emerging whole, to become what George Bernard Shaw called “a force of
nature.”
The Field of the Future
The key to the deeper levels of learning is that the larger living wholes of which we are an active part are not
inherently static. Like all living systems, they both conserve features essential to their existence and seek to
evolve. When we become more aware of the dynamic whole, we also become more aware of what is
emerging.
Jonas Salk, the inventor of polio vaccine, spoke of tapping into the continually unfolding “dynamism” of
the universe, and experiencing its evolution as “an active process that . . . I can guide by the choices I
make”. He felt that this ability had enabled him to reject common wisdom and develop a vaccine that
eventually saved millions of lives. Many of the entrepreneurs we interviewed had successfully created
multiple businesses and organizations. Consistently, each felt that the entrepreneurial ability was an
expression of the capacity to sense an emerging reality and to act in harmony with it. As W. Brian Arthur,
noted economist, put it, “Every profound innovation is based on an inward- bound journey, on going to a
deeper place where knowing comes to the surface”.
This inward-bound journey lies at the heart of all creativity, whether in the arts, in business, or in science.
Many scientists and inventors, like artists and entrepreneurs, live in a paradoxical state of great confidence --
- knowing that their choices and actions really matter --- and profound humility --- feeling guided by forces
beyond their making. Their work is to “release the hand from the marble that holds it prisoner,” as
Michelangelo put it. They know that their actions are vital to this accomplishment, but they also know that
the hand “wants to be released.”
Can living institutions learn to tap into a larger field to guide them toward what is healthy for the whole?
What understanding and capacities will this require of people individually and collectively?
Presence
We have come to believe that the core capacity needed for accessing the field of the future is Presence. We
first thought of presence as being fully conscious and aware in the present moment. Then we began to
appreciate presence as deep listening, of being open beyond one’s preconceptions and historical ways of
making sense. We came to see the importance of letting go of old identities and the need to control and, as
Salk said, making choices to serve the evolution of life. Ultimately, we came to see all these aspects of
presence as leading to a state of “letting come,” of consciously participating in a larger field of change.
When this happens, the field shifts, and the forces shaping a situation can shift from re-creating the past to
manifesting or realizing an emerging future.
Through our interviews, we have discovered similarities to shifts in awareness that have recognized in
spiritual traditions around the world for thousands of years. This process involves an essential quieting of
the mind, where the normal flow of thoughts ceases and the normal boundaries between self and world
dissolve. In the mystic traditions of Islam, such as Sufism, this shift is known simply as “opening the heart”.
Each religion describes this shift a little differently, but all recognize it as being central to personal
cultivation or maturation.
In the end, we concluded that understanding presence and the possibilities of larger fields for change can
come only from many perspectives --- from the emerging science of living systems, from the creative arts,
from profound organizational change experiences --- and from directly understanding the generative
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capacities of Nature. Virtually all indigenous or native cultures have regarded Nature or Universe or
Mother Earth as the ultimate teacher. At few times in history has there been a greater need to
rediscover this teacher.
Contemporary theories of change seemed, paradoxically, neither narrow enough nor broad enough. The
changes in which we will be called upon to participate in the future will be both deeply personal and
inherently systemic. The deeper dimensions of transformational change represent a largely unexplored
territory both in current management research and in our understanding of Leadership in general. As Otto
puts it, “This blind spot concerns not the what and how --- not what leaders do and how they do it --- but
the who, who we are and the inner place or source from which we operate, both individually and
collectively.”
Source/Reference:
1) Leading the Revolution, by Gary Hamel
2) IBM Global CEO Survey 2006
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LESSON 02
PROFIT BOOSTERS
The key components of profit boosters are:
􀂙 Increasing Returns
􀂙 Competitor Lock-out
􀂙 Strategic Economies
􀂙 Strategic Flexibility
Increasing Returns
This term simply refers to a competitive situation where rich tend to get richer, and the poor, poorer. It
denotes a flywheel effect that tends to perpetuate early success. Those who are ahead will get further ahead,
and those who are behind will fall further behind. In industries with Increasing Returns, if you win early,
you’re likely to get big. Economies of Scale are largely static and increasing returns are dynamics.
1. Network Effects
Some Business Models benefit from a strange kind of value multiplier known as “Network Effect”.
In some cases, the value of a network increases as the square of the growth of “nodes”, or members in the
network.
2. Positive Feedback Effects
It refers specifically to the way one uses market feedback to turn an initial lead into an unbridgeable chasm
for competitors. A firm with a large users' base, and a way of rapidly extracting feedback from those users,
may be able to improve its products & services faster than its competitors. As a result, its offerings become
better yet, and it captures even more customers. Another virtuous circle ensues.
Increasing
Returns
Competitor
Lock-Out
Strategic
Economies
Strategic
Flexibility
• Network
Effects
• Positive
Feedback
Effects
• Learning
Effects
• Preemptio
n
• Choke
Points
• Customer
Lock-In
• Scale
• Focus
• Scope
• Portfolio
Breadth
• Operating
Agility
• Lower
Breakeven
Profit Boosters
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3. Learning Effects
More & more industries are becoming knowledge-intensive. A company that gets an early start in
accumulating knowledge, and then continues to learn faster than its rivals, can build an almost
insurmountable lead. Knowledge accumulation is often highly correlated with experience. The notion is
simple; the application of knowledge begets new knowledge. This is particularly true in cases where the
critical knowledge is both complex & tacit.
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Competitors Lock-Out
When you find a window of opportunity, the goal is to crawl through it and lock it behind you. You want all
the windfall and you don’t want to have to fight for it. That’s why really slick Business Model locks
competitors out through:
1. Preemption
2. Choke Points
3. Customer Lock-In
1. Preemption
Where there is a great potential for increasing, merely being first may be enough to put competitors out of
contention. In industries that are R&D-intensive or that have high fixed costs, there is often no second
place ---you are either first or you’re nowhere. First-mover advantages are never absolute, but they are often
pivotal in industries with a rapid pace of technological development and relatively short product lifecycle.
2. Choke Points
Its Choke Point when in the new millennium you are trying to gain control of the cable TV Infrastructure
that will allow broadband webcasting. Whoever owns the Choke Point collects the toll. If you are unwilling
to pay up, you are locked-out. Window may be history’s most effective Choke Point. (How & Why? Hint:
IP & HTML are in public domain.) Choke Points come in many shapes & sizes; A Technical Standard,
Control of some costly infrastructure, Preferential access to a government buyer, A Patent, or a Prime
Location.
3. Customer Lock-In
Competitor lock-out often means Customer Lock-In. But even when you can’t Lock-out all your
competitors, you can Lock-In some of your customers ---through long-term supply contracts, proprietary
product designs that keep them for upgrades and add-ons, or control over a local monopoly. There are
many ways you can tie up your customers, but you have to be careful. A customer that feels locked in is a
particularly angry beast. You got to use velvet ropes.
Strategic Economies
Unlike operational efficiencies, Strategic Economies don’t drive from Operational Excellence, but from the
business concept itself. Strategic Economies come in three varieties:
1. Scale
2. Focus
3. Scope
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1. Scale
Scale can derive efficiencies in many ways through:
􀂙 Better Plant Utilization
􀂙 Greater Purchasing Power
􀂙 The Muscle to enforce industry wide price discipline Industries revolutionaries often consolidate
fragmented industries. Any that gets caught behind the consolidation curve and misses the chance
to build Scale Advantage will be left with a notable disadvantage
2. Focus
A company with a high degree of Focus & Specialization may reap economies compared with competitors
with a more diffused Business Mission and a less coherent mix of products & services.
Focus is not about efficiency in a cost sense; it’s about in a don’t-get-distracted, get-all-the-wood-behindone-
arrow sense.
3. Scope
The idea here is almost opposite of focus. A company that can leverage resources and management talents
across a broad array of opportunities may have an efficiency advantage over firms that cannot. Scope
Economies come from sharing things across business units & countries; Brands, Facilities, Best Practices,
Scare Talent, IT Infrastructure, and so on. Scope Economies come in a variety of flavors; Channel Power &
access to distribution channels, Economies in buying ad space & running high-tech distribution centers.
Strategic Flexibility
In a fast changing world, with unpredictable demand cycles, Strategic Flexibility can generate/sustain higher
profits by helping a company stay perfectly tuned to the market and avoid getting trapped in dead-end
Business Models. Strategic Flexibility comes from:
1. Portfolio Breadth
2. Operating Agility
3. Low Break-Even Point
1. Portfolio Breadth:
Focus is great, but if the world moves against you, you may lack other options. Linking the fortunes of your
company to the fortunes of a single market can be a high-risk gamble. A company with a broad offering
may prove more resilient in the face of rapidly shifting customer priorities than a more narrowly focused
competitor. A portfolio can consist of Countries, Products, Businesses, Competencies, or Customer Types.
The essential point is that it helps to hedge a company’s exposure to the vagaries of one particular market
niche.
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2. Operating Agility
A company that is able to quickly refocus its efforts is better placed to respond to changes in demand and
can thereby even out profit swings.
Given the fact that a very successful American Computer Company owns few fixed assets, it is able to
quickly reconfigure its selling approach & product line to suit changing market conditions.
The emerging world of on demand:
• As the financial services industry heads toward an on demand operating environment, monolithic,
vertically integrated institutions face stark new challenges
• In today’s hyper-responsive marketplace, survival favors the agile; speed can be a critical
differentiator; and the organizational status quo is often a liability
• An on demand business is an enterprise whose business processes –integrated end-to-end across
the company and with key partners, suppliers and customers –can respond with flexibility and
speed to virtually any customer demand, market opportunity or external threat.
3. Lower Break Even
A business concept that carries a high breakeven point is inherently less flexible than one with a lower
breakeven point. Capital intensity, a big debt load, high fixed cost ---such factors tend to reduce the
financial flexibility of a Business Model. In doing so, they also reduce Strategic Flexibility, in that they make
it more difficult to pay off one thing so that you can go on and do another thing.
Bank Business and Operating Model Dynamics
The business model represents the value proposition to the customer; it is made up of the products and
services for which the customer will pay and success will be defined by the degree to which customer needs
are met. While the business model can be configured in a number of different ways, customer segment,
product and geography are typical for many banks.
The operating model is made up of the functions required to support, control and manage the delivery of
the products and services that make up the customer value proposition. Typically, these functions are not
directly paid for by the customer, but might be integral to the product or services offered – business
support functions. Alternatively, they are functions that are required to support, control and manage value
creation for the bank itself – corporate functions. While they can be grouped in a number of ways, we
consider five core operating model functions: governance, risk and control; financial management; delivery
(channel, operations and technology), legal and physical structure; and people and reward. (See diagram
below).
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Bank Model
Bank Business Model
It represents the Value Proposition to the customer; it is made up of the Products & Services for which
the customer will pay and success will be defined by the degree to which customer needs are met.
While the Business Model can be configured in a number of different ways, the typical are:
􀂙 Customer Segment
􀂙 Product Category
􀂙 Geographical Differentiation
Value Proposition
A business or marketing statement that summarizes why a consumer should buy a product or use a service.
This statement should convince a potential consumer that one particular product or service will add more
value or better solve a problem than other similar offerings. The ideal value proposition is concise and
appeals to the customer's strongest decision-making drivers. Companies pay a high price when customers
lose sight of the company's value proposition.
Survivability - degree to which the Business & Operating Model align
to customer needs, competitive threats & regulatory intent
Customer Value Proposition Governance, Risk, &Control
Financial & Performance
Management
Legal & Physical Structure
People & Reward
Bank Business Model Bank Operating Model
Delivery Channel, Operations, & Technology
The way Bank creates value
for its Customers ---
Generates Revenue
The way Bank creates value
for itself --- Generates
Margin
Efficiency -
degree to which
the Business &
Operating
Model align
strategy &
policy
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In the context of these seven dimensions let’s take the example of a Bank:
Financial
This dimension concerns Returns/Profit paid on deposits or other investments products, Mark-Up charged
on Loans and other credit facilities, Fees/Commission recovered for various Non-Financial Services
provided to the customer. Here the concept is not only that Rates/Fees/Commission are competitive and
favorable to the customer but they should have been advised/communicated to the customer in a timely,
unambiguous, and transparent manner with no fine print or hidden elements. It is an observed
phenomenon that a number of customers don’t mind paying premium price for some products/services if
they perceive having received higher value due to the overall value package.
Procedural
This refers to the various processes/steps involved while entering into/maintaining a relationship with the
bank. How simple and convenient it is for a customer to deal with the bank while undertaking any
transaction. To what extent bank systems are customer friendly and the bank is not a “prisoner” of its own
systems.
Deliverable
Although banking is a service business with no tangible products but certain items still needs actual delivery
while maintaining quality standards. Examples are Cash/Currency Notes, Check Book, Credit/ATM Card,
Statements of Account, Promotional Items, and Gift Packs on various occasions.
Informational
This dimension deals with the Reliability, Timeliness, Accuracy, Authenticity, Currency, and Relevancy of
various information provided to the customer. These attributes will establish the level of confidence and
trust which the customer should have with its banker and will be key in the decision making process of the
customer in purchasing the products/services offered by the bank. Above all, there should be the highest
level of transparency in every aspect of customer information and communication processes.
Environmental
This concern with the Physical Setting, Aesthetics, Cleanliness, Hygienic Conditions of the Branch, ATM
Booth, Kiosks, or any other place where customer physically experiences an interaction with his/her
banker. A place with proper lighting arrangement, Air-Conditioning/Heating System, Signage, Comfortable
Environmental Sensory Interpersonal
Financial
Procedural Deliverable Informational
Seven Dimensions of the Customer Value Package
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Waiting Area, Queuing arrangement, Public Address/Sound System are some examples of what makes a
positive impression on a customer.
Sensory
This dimension deals with the human sensory attributes of Touch, Sight, Sound, and Smell. Any “Touch
Point” where a customer has a pleasant sensory experience in the above mentioned attributes will add to the
good image of the bank and could contribute towards its value building efforts.
Interpersonal
Attitude & Behavior of the staff members especially towards the customers is crucial in providing a higher
Value Proposition. A cooperative, friendly, energetic, responsive, and empathetic staff will be a key
differentiator between a bank and its competitors. Nowadays it is common for all organizations especially
those having extensive customer interface to pursue the policy of “Hire for Attitude, Train for Skills.”
Bank Operating Model
It is made of the Functions required to Support, Control, and Manage the Delivery of the Products &
Services that make up the Customer Value Proposition.
Typically, these functions are not directly paid for by the customer, but might be integral to the Products or
Services offered --- Business Support Functions. Alternatively, they are functions that are required to
Support, Control, and Manage value creation for the Bank itself --- Corporate Functions.
Business Support Functions or Corporate Functions in the Operating Model usually consist of the
following Core Functions:
􀂙 Governance, Risk, and Control
􀂙 Financial & Performance Management
􀂙 Delivery (Channel, Operations, and Technology)
􀂙 Legal & Physical Structure
􀂙 People & Reward
Governance, Risk and Control
Addressing the overall levers of Control and Management, governance, risk, and control are central to the
decision-making required to derive Value Creation. The key components include how the Board and Non-
Executive Directors (NEDs) are measured, are the Executives robustly supported and challenged, controls
& policies embedded within the business, are these controls & policies adhered to when they clash with the
Business Model.
Financial and Performance Management
This Function has line of sight on the overall profitability of the Bank and it needs to align costs
appropriately to the Business Model. As a consequence of recent global financial crisis, expected lower
returns & higher capital ratios will result in financial management having greater involvement in product
design and franchise targeting. The key issues include:
􀂙 Simplification of Capital & Funding Structure
􀂙 Responding to new patterns of Supervision
􀂙 Aligning internal performance reporting and emerging external techniques for analyzing & valuing
Bank performance
Delivery (Channel, Operations, Technology)
This function typically spans both Business & Operating Model in that it also encompasses the core
business support functions. The key issues include:
􀂙 Platform resilience & redundancy
􀂙 Strategic Sourcing
􀂙 Managing supply chain security & scale through shared services
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Legal and Physical Structure
The Structure of the Bank is under increasing review. Recent bank failures have highlighted the complex
legal entities that have developed at a number of institutions, often without any alignment to Business and
Operating Model efficiency. As Banks consider the best ways to ensure funding, regulatory alignment & tax
efficiency, the legal and physical structure of the Bank requires realignment & simplification.
People and Reward
Reward across the Business Model needs to be reconsidered; both to ensure it is genuinely aligned to longterm
sustainable value and allows the functions that determine the sustainable profit of the business to
stand on equal footing to those that generate its immediate revenue. The key issues include:
􀂙 Incorporating Risk into performance measures
􀂙 Design of deferred compensation
􀂙 Remuneration governance
As banks look to the future, transitional change will probably be insufficient – structural and
transformational change must be considered. Regardless of changes to the business strategy, the way that
strategy is delivered will certainly change.
Transformational changes to the business and operating model are rarely undertaken, but the current
environment provides a ‘perfect storm’ of the driving forces behind such wholesale reconstruction:
dramatic adverse changes in financial performance, significant regulatory intervention and substantial
changes to leadership teams.
Short-term survival is clearly critical, but, as balance sheet stability is restored, banks need to consider
appropriate business and operating models that will ensure their long-term survival. The urgent need to
address short-term financial considerations can lead to longer-term mistakes when assessing which assets
are core and which are non-core.
Instead, these longer-term decisions on which assets are vital to the new strategy need to be derived from
basic thinking around the customer value proposition and the ongoing ability of the bank to derive value
from that model having regard for the appropriate levels of risk versus reward.
Banks will need to consider the appropriate mix of products and services they can deliver and manage,
where they sit on the mono-line – universal bank continuum, the balance between distribution and
manufacture, the ability to scale and the effectiveness of embedded control.
The future will probably bring changes to whichever part of the value chain banks choose to operate in,
particularly for the universal banking model, where most will recognize they lack the scale and reach to
serve fully their franchise with owned product and infrastructure.
The nimble, who have a fully developed, needs-based customer value proposition will understand that
packaging an appropriate set of products and services together, some of which might be white labeled from
others, adds more value than providing a limited range of fully owned products and services.
Banks need to understand clearly all the different aspects of their business and operating model because
they are intertwined – decisions to change one part of the model will have significant consequences for the
other aspects. This interconnectivity makes structural change highly complex and the process of change can,
in itself, be a cause of operating model failure. With this in mind, banks must be wary of poorly thought
through or knee-jerk reactions.
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LESSON 03
BANK BUSINESS & OPERATING MODEL (BOM): AN EXTENDED CONTEXT
Where Are We Now…
The financial services sector has been blessed by a benign business and regulatory environment over the last
decade, which masked a number of unsustainable business models within the industry. But a more
awkward truth for many is that the financial crisis and wider global recession have challenged the
core operating models responsible for delivering the business strategy.
As banks look to the future, transitional change is probably insufficient – structural and
transformational change must be considered. This is not simply a case of conducting a review of the
business model and reassessing the value proposition of the bank, but understanding how the future
business model will be delivered. Regardless of changes to the business strategy, the way the strategy is
delivered will certainly change.
This type of change is hugely complex. There are many aspects of the business and operating
model to consider and these are encumbered by legacy practices, processes and systems that
frequently represent the cultural core of the organization. Transformational changes to the business
and operating model are rarely undertaken, but the current environment provides a ‘perfect storm’ of the
driving forces behind such wholesale reconstruction: dramatic adverse changes in financial performance,
significant regulatory intervention and substantial changes to the leadership team.
Change in Financial Performance
The period 2001–2007 was one of uninterrupted growth in financial services, underpinned by increasing
gross domestic product (GDP) growth, expansion of global trade, ample wholesale funding and low
inflation. Unprecedented volatility and a sharp downward trend in financial performance from 2007
onwards has prompted an urgent need to restructure balance sheets, reduce costs and improve risk
management, but it has also highlighted the reality of operating performance over the last decade. The initial
findings of PricewaterhouseCoopers research shows that improved operating efficiency – when measured
by cost/income – has been driven by strong income growth rather than significant improvement on the
cost side. Strong levels of GDP growth underpinned the expansion in income, but so too did higher levels
of balance sheet leverage through increased use of wholesale funding. With liquidity risks now better
understood, it is increasingly clear that apparent improvements in operating efficiency over the last decade
were at least in part achieved through increased exposure to liquidity risk. Hence, banks must consider
the structures of their BOM not simply in terms of Efficiency, but the degree to which they can
survive.
Regulatory Intervention
Regulators have discovered that their rules have proved ineffective in both predicting and
preventing the crisis. They have been forced to intervene where an entity is failing or at risk of failing and,
naturally, they have demanded fundamental changes to the organization in return for coming to its rescue.
Most of the big global banks, which have been judged too big to fail, have resorted to support from the
lender of last resort – the government. The larger the intervention, the bigger the changes demanded.
Changes to Leadership
A new team at the top, whether appointed through succession, acquisition or forced change, will want to
establish their own vision for the organization. This new vision then cascades down through the
organization in the form of changes to the business and operating models.
These drivers, particularly when they converge, are a trigger for substantial change. Banks, however, must
consider the structure of their business and operating models, not simply in terms of efficiency, but the
degree to which they can survive.
Banks need to understand clearly all the different aspects of their business and operating model,
because they are intertwined – decisions to change one aspect of the model will have significant
consequences for the other aspects. For example, changes in liquidity regulation and strategy could
require changes to the legal entity structure. Changes in risk appetite could define targeted customer
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segments and the use of low-cost geographies could impact on product and service performance. This
interconnectivity makes structural change highly complex and the process of change can, in itself,
be a cause of operating model failure. With this in mind, banks must be wary of poorly thought through
or knee-jerk reactions. Hence, survivals more than just a short-term problem.
As discussed in the earlier section on strategy, knee-jerk reactions to the current situation can undermine
both the customer and bank proposition. The new financial environment is creating both challenges and
opportunities, but hasty decision-making, either in the form of disposals or acquisitions, can destroy value.
Significant examples of both of these situations have been seen in the past 12 months. Short-term survival
is clearly critical, but, as balance sheet stability is restored, banks need to consider appropriate business and
operating models that will ensure their long-term survival. Replicating the existing model with a few bits cut
away or bolted on will not prove sufficient.
Core verses Non-Core
A number of banks are considering which of their assets are core and which are non-core as part of
a strategy and business model review. But the urgent need to address short-term financial considerations
can lead to longer-term mistakes. Assets considered for disposal are usually identified by the ease with
which they can be carved out, their distance from the centre of the organization and their immediate market
value. The very nature of this decision-making process means the underlying business and operating model
will probably remain unchallenged.
Longer-term core versus non-core decisions need to be derived from basic thinking around the customer
value proposition and the ongoing ability of the bank to derive value from that model. Banks will need to
consider the appropriate mix of products and services they can deliver and manage, where they sit
on the mono-line – universal bank continuum, the balance between distribution and manufacture,
the ability to scale and the effectiveness of embedded control.
Understanding the Customer
Banks need to go back to thinking about customer needs and the way these needs are met. Customer
segmentation models are traditionally broken down by geography, turnover or income, and
industry group or demographic, but this type of segmentation originated from a credit-based
relationship.
As the cost of capital and liquidity increases, a fundamental repricing of balance sheet capital usage will
occur. Sophisticated banks, however, will think beyond repricing and look at the underlying
segmentation of their customers to seek out areas of profitability that are less dependent on capital
consumption. There is a long-term trend in the industry away from net interest income (NII) to non-NII
revenue sources (non-NII revenue rising from about 25% of total revenue in 1980 to 45% in 2000). This
trend is likely to continue and current segmentation and relationship models should be challenged. In a
recent PricewaterhouseCoopers survey3 of corporate treasurers the primary way these key bank customers
measured the value they created for their own institutions was through managing the bank relationship, and
the predominant way they measured the value of that relationship was cost. This suggests that this part of
the business model should have been questioned prior to the current financial crisis.
Manufacturing – Do You Need to Own it?
Banks must also consider the mechanisms through which they deliver the customer value proposition.
Internet banking models have proved that the once-strong link between the size of the branch estate and
market share can be challenged. White-labeling and product-aggregation models have proved that franchise
ownership is not dependent on owned products and operations, while originate-and-distribute models have
demonstrated that a bank need not be constrained by its own balance sheet when servicing customers’
funding requirements.
The future will probably bring changes to whichever part of the value chain banks choose to operate in,
particularly for the universal banking model, where most will recognize they lack the scale and reach to
serve fully their franchise with owned product and infrastructure. The nimble, who have a fully developed,
needs-based customer value proposition will understand that packaging an appropriate set of products and
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services together, some of which may be white labeled from others, adds more value than providing a
limited range of fully owned products and services.
These emerging models will require a different set of skills in terms of managing the delivery
components of the operating model – security of the supply chain will become increasingly central
to operations, while risk management and people and reward programs will need to reflect this skill set
change.
Achieving Scale
Margins in financial services will be increasingly tested. There has been a step change in the available
revenue pool and while pricing and costs are being adjusted, a 300lb man that loses 30lbs is still overweight,
however many notches on his belt he claims to have tightened. Banks will need to look for transformational
cost reduction and this will be found through scale in all aspects of the business. Previously discrete areas
will be deconstructed and synergies sought through shared services in low-cost locations. Coverage models
will need aligning internally and to the customer, while historical branch and subsidiary structures will
require reviewing in terms of regulatory alignment, funding requirements, tax efficiency and contract
efficiency. Every aspect of a bank’s business and operating model will need to be scaled or, if it is
not, have specific and clearly understood reasons why.
Embedding Control
An essential element of the operating model is the efficiency with which it generates value for the bank. The
current financial crisis has highlighted the degree to which banks’ operating models failed to fully control
their businesses as they developed. For example, the way business growth plans were developed and driven
while disconnected from risk appetite models; how control staff was ignored by the business and boards
lacked the confidence, or insight, to challenge the executive. In future, banks will need greater focus on the
sustainability of their business models and that requires clear governance and embedded control.
Overall, considerations around customer value proposition, end-to-end ownership, scale and control, raise
questions about the future of the universal banking model and the degree to which those institutions using
that model can remain focused, scaled and controlled enough to optimize shareholder value.
Risk Management
Risk Management function has acquired a heightened importance. Valuation techniques using historical
data, has proved inadequate. Substantial Improvements through multiple approaches will be required.
Alongside Measurement, the remaining areas of Risk Management framework, e.g. Identification,
Monitoring, and Mitigation will also be given more attention. There will be a need for renewed & greater
emphasize on Liquidity & Operational Risk while making business decisions. Regulatory requirements &
Regulators intervention will assume greater significance forcing Banks management to undertake major
adjustments in their approach.
Complexities of Transformational Programs
The strategy section of this paper identifies the problem of institutions becoming stuck in ‘panic’ mode and
discusses the directionless inertia that it can create. This inertia can be compounded by the scope and
complexity of the change that is required. As organizations set out their plans for the future, both in terms
of positioning (business model) and delivery (operating model), they need to understand the complexities of
achieving their goals. We consider five complexities when undertaking transformational programs:
􀂙 Business model complexity: Understanding the scope of the value proposition and the way it is
delivered
􀂙 Process complexity: Deconstructing business processes to achieve cross-process scale
􀂙 Organizational complexity: Realignment of the organization to new business and operating
models
􀂙 Contractual complexity: Security and optimization of the bank’s supply chain
􀂙 Cultural complexity: Challenging the way things are done and replacing the reference points that
provide day-to-day certainty
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The leadership at banks faces a considerable task in setting out their vision for the future. The first step is to
define the strategic principles of the business and operating model and to understand their impact. The
second step is to ensure alignment and common understanding of the principles across the leadership team,
and the third is to communicate.
Over the past 18 months (since mid 2007) financial services have changed fundamentally and permanently.
Before the crisis, systemic risk was a subject for abstract theoretical discussions and seen as something for
others to worry about. Derivatives, securitization, risk management and the Basel banking regulations were
thought to have made the world a safer place, not a more dangerous one. Then everything changed.
In a previous paper perspective was offered on the global financial crisis in order to examine how the
foundations of financial service institutions have been shaken to their core. The speed and intensity, with
which financial markets changed, combined with the scale and complexity of banking models exposed the
structural weaknesses of major players. Some global institutions have disappeared, while only a few are able
to survive on their own and gain market share. Typical reactions to the crisis have been short-term in
nature, in many cases driven by the need for survival. Short-term actions alone will not suffice and
fundamental questions need to be asked and issues tackled. A few leading institutions are beginning to
address those fundamental issues and prepare themselves to prosper in the new world while most have not
begun the process.
The Key Questions
How will institutions address risk management, capital and liquidity requirements? The need to take risks,
hold capital against those risks and manage mismatches in positions through effective liquidity management
is fundamental to banking. The fundamentals have not changed. Many of the assumptions that were used to
model these fundamentals in the past have changed for good. Businesses that were once seen as profitable
are now uneconomic; businesses once seen as safe are now seen as reckless. Institutions will need to be able
to make robust decisions based on sound understanding of true profitability after having reflected the
return required for the risk and the capital used.
How will Banks Make Money in the Future?
Banking is of vital importance to the global economy; therefore a successful, profitable and competitive
financial system is essential. Banks must determine which customers they will serve, in which markets and
with what products. There is, however, no guarantee that size will be the key to success, or that existing
banks will be able to preserve their franchise. Shareholders have already penalized those banks that built up
poor credit portfolios; they will soon start to reward those banks that can generate profitable revenues
without taking undue risk.
What will the regulatory environment be like and how will individual institutions need to respond? Highprofile
regulatory action has already been taken. This process will continue and institutions will need to
demonstrate a greater degree of compliance with the new regulatory requirements.
Many of the institutions that have failed had comprehensive governance structures. Were these structures
fundamentally flawed? Banks must ask whether those charged with governance have the right skills,
individually and collectively, to be able to challenge constructively and must ensure oversight functions have
access to all the information needed to effectively analyze the risks the business faces.
Finally, how well will business models survive and will they be efficient? The changed market environment
has exposed weaknesses in business models, but while no bank has the luxury of starting from a clean sheet
of paper, maintaining the status quo is also out of the question. Most major banks are a complex web of
geography and culture, as well as products/services. This has resulted from years of organic growth,
mergers and acquisitions, as well as the organization’s response to product innovation, regulatory responses,
tax changes, globalization and regionalization initiatives.
The efficiency of an organization’s business model will be judged by the alignment it has to the strategy and
the way in which it facilitates the most productive use of unique capabilities.
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It is of critical importance to address all of these key priorities, in the right order, and to ensure the
responses are aligned. This is what will differentiate the leading institutions from the second-tier players in
the future, and ensure survival in the new world.
Purpose of this Extended Context and Re-Emphasis on Bank Business & Operating Model is to
remind you to regularly visit and re-visit the concept in order to better understand the dynamics of
Consumer Banking (CB) Business.
Banks vs. Banking
􀂙 Bank is a Form, Banking is a Function (Former is a Noun, later is a Verb)
􀂙 Banks may get deconstructed, reshaped, become redundant, or disappear altogether
􀂙 Many Non-Bank entities will start providing Banking Services
􀂙 On the contrary, Banking as a Function will Survive & Thrive because people’s needs for financial
services & products facilitated by the Banking Function will not disappear
􀂙 Future R&D and Innovation in Financial Services Industry will be geared more towards Banking as
a Function rather than on Banks as an entity
􀂙 While Banking in general has been dramatically impacted by the financial crisis, many areas of
Retail Banking remain inherently highly profitable
􀂙 This fact has not gone unnoticed to Non-Financial Companies with strong brands and resources
􀂙 A number of them will enter the Banking Market/Industry looking to take market Share from
traditional Banks
􀂙 In Pakistan due to Regulatory requirements/constraints this may not seem straightforward
􀂙 However, we, in Pakistan, can’t afford to ignore global trends and remain marginalized in the
international community
􀂙 This may soon lead to Regulators/Authorities reviewing and relaxing concerned rules
Non-Financial Companies threat to Banks: Why/How?
􀂙 Retail Banks management time & energy diverted towards issues of survival, restructuring, &
reducing cost base limiting their response to such threats
􀂙 Many are capital constrained & have significant, costly & time-consuming legacy issues to
overcome if they are to undertake major transformation
􀂙 Enhanced regulation resulting in lower revenues from penalty fees plus scarcity of capital leading to
limiting their response
􀂙 According to a Jan ‘09 survey in UK, Banks reputation is at an all-time low. Some 30% of
consumers are highly unsatisfied with their services
Source/Reference:
1. The Future of Banking
2. PWC Briefing/Report (July 2009)
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LESSON 04
CONSUMER, CONSUMER RIGHTS & PROTECTION
Who is a Consumer?
Consumption is basic to human survival and it must be shared, strengthening, socially responsible and
sustainable. Therefore, we all are consumers, whether of goods or of services, whether purchased or
otherwise, and whether provided by the market or the public sector.
Consumer is somebody who uses a product or service. A consumer may not be the purchaser of a product
or service and should be distinguished from a customer, who is the person or organization that purchased
the product or service.
A Consumer:
􀂉 One that consumes, especially one that acquires goods or services for direct use or ownership
rather than for resale or use in production and manufacturing
􀂉 One that utilizes economic goods; specifically : an individual who purchases goods for personal use
as distinguished from commercial use
Consumer or Citizen
State recognizes people as citizens, whereas markets treat people as consumers and value them as
customers. Even markets are located within the States. And people’s status as citizens is more overarching
than their status as consumers. Thus people’s rights as consumers are interlinked with their rights as
citizens; both need to be pro-actively promoted and protected from predatory factors in the market and the
State. In particular, poorer citizen-consumers, who do not have the “dollars” to make the market respond to
the “one dollar, one vote” principle, do have the right to make the state – and hence the market respond on
the “one person one vote” principle. This standpoint also links up the consumer movement with other
human rights movement. In the age of globalization, this realization has become more important than ever
before. The former President of Consumers International, Rhoda Karpatkin, said that "Consumer activism
is exercising citizenship".
Consumption is basic to human survival and it must be shared, strengthening, socially responsible and
sustainable. Therefore, we are all consumers, whether of goods or of services, whether purchased or
otherwise, and whether provided by the market or the public sector.
While buying in the marketplace is one important form of consumption, it is not necessary to be a customer
to qualify as a consumer. However, the concept has been associated with market so closely that it has
assumed a very restrictive meaning. In a country crippled with poverty, where we pay heavily but indirectly
for goods and services from our State (including infrastructure development, defense, good governance, and
so on), we are citizen-consumers. While the market has at least some level of self-corrective mechanisms to
meet the demands of customers, the State in Pakistan does not have the most basic democratic channels to
meet the demands of its citizens. Therefore, it is crucial to broaden our understanding about consumers in
order to be inclusive of poor citizens and their rights as consumers whom markets can ignore but the State
and the consumer movement cannot.
What are Consumer Rights?
Based on the United Nations Guidelines for Consumer Protection, 1985 (to which Pakistan is a signatory),
the global umbrella body Consumers International articulated a set of eight, internationally accepted
consumer rights that need to be actively protected and promoted.
The Right to Basic Needs means the right to basic goods and services which guarantee survival. It
includes adequate food, clothing, shelter, health care, education and sanitation.
The Right to Safety means the right to be protected against products, production processes and services
which are hazardous to health or life. It includes concern for consumer long-term interests as well as their
immediate requirements.
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The Right to Be Informed means the right to be given the facts needed to make an informed choice or
decision. Consumers must be provided with adequate information enabling them to act wisely and
responsibly. They must also be protected from misleading or inaccurate publicity material, whether included
in advertising, labeling, and packaging or by any other means.
The Right to Choose means the right to have access to a variety of products and services at competitive
prices and, in the case of monopolies, to have an assurance of satisfactory quality and service at a fair price.
The Right to Be Heard means the right to advocate consumers’ interests with a view to their receiving full
and sympathetic consideration in the formulation and execution of economic and other policies. It includes
the right of representation in government and other policy-making bodies as well as in the development of
products and services before they are produced or set up.
The Right of Redress means the right to a fair settlement of just claims. It includes the right to receive
compensation for misrepresentation of shoddy goods or unsatisfactory services and the availability of
acceptable forms of legal aid or redress for small claims where necessary.
The Right to Consumer Education means the right to acquire to knowledge and skills to be an informed
consumer throughout life. The right to consumer education incorporates the right to the knowledge and
skills needed for taking action to influence factors affecting decisions.
The Right to a Healthy Environment means the right to a physical environment that will enhance quality
of life. It includes protection against environmental dangers over which the individual has no control. It
acknowledges the need to protect and improve the environment for present and future generations.
What are Consumer Responsibilities?
Consumers International also articulated five basic responsibilities of all consumers.
􀂙 Critical Awareness – the responsibility to be more alert and questioning about the price and
quality of goods and services we consume
􀂙 Action – the responsibility to assert ourselves by acting to ensure that we get a fair deal. As long as
we remain passive consumers, we will continue to be exploited and manipulated
􀂙 Social Concern – the responsibility to consider the impacts of our consumption patterns and
lifestyles on other citizens, especially the poor, disadvantaged or powerless consumers, whether
they be in the local, national or international community
􀂙 Environmental Awareness – the responsibility to realize the environmental costs and
consequences of our consumption patterns and lifestyles. We should recognize our individual and
collective social responsibility conserve natural resources and to preserve earth for present and
future generations
􀂙 Solidarity – the responsibility to come together and organize consumers in order to enhance the
strength and influence required to promote and protect our interests
Why Consumer Protection?
Citizens need protection of their consumer rights in three ways:
• in the market place against problem goods and services; against bad trade practices; exploitative
prices and unethical marketing;
• from governments as supplier of basic goods and services for poor and vulnerable consumers; as
formulators of public polices so that they are just, equitable and protective; and as provider of good
governance;
• from the State to provide reliable consumer protection structures which ensure safety against
weaknesses of the market and its failures and which ensure good government.
The importance for consumer protection has assumed renewed importance today. Globalization and its
various instruments have posed new challenges for consumer protection especially in poor countries.
The greatest challenge for consumer movement today is to raise cogent and effective voice for bringing
fairness in free market economy at local, national and global levels.
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(Note: These are the Opinions/Views/Comments as expressed by The Network for Consumer
Protection, Pakistan, a not-for-profit, public interest and independent non-government
organization working since 1992.)
Sectoral Challenges Facing Citizen-Consumers in Pakistan
It is well recognized that there is a general lack of awareness among consumers about their legal and civic
rights, due to a number of complex and inter-related factors, including a historically unresponsive state, a
regularly exploitative private sector and the failure of democratic institutions in addressing consumers dayto-
day and policy related problems.
The state has in many cases not protected their right to a healthy life, as guaranteed by Article 9 of the
Constitution or various United Nations declarations, including for Consumer Protection, 1985. Likewise,
the private sector has proved unresponsive to complaints or to the health concerns of consumers,
particularly disadvantaged consumers, making full use of the lack of literacy and awareness in the country.
This is further complicated by a weak regulatory structure in the country, plagued by poor implementation
of social laws even when they are drafted. In addition, most of the civic sector also does not advocate for
consumer rights.
As a consequence, there is little to no demand from citizen-consumers for protection of their rights, and
they have had little stake in the systems and mechanisms introduced by the state, choosing by and large not
to occupy the opportunities legally offered. For example, at one level there are barely adequate statutes to
facilitate redress of consumers’ complaints about products and services (particularly related to government
provision of basic services such as water and health) in a transparent, just and timely manner. At another
level, the historically weak response to the statutes that exist have left consumers cynical, and they mostly
do not appropriately lodge and follow up their complaints, accepting losses and suffering violation of their
rights. As above, this affects already disadvantaged consumers the most.
A growing concern for consumers, particularly in the context of a liberalizing economy, is the information
inequity in the market. The overwhelming bulk of consumers simply do not have access to independent
information about: products and services, government’s performance on protection of their rights, how
their rights are being violated by public and private sectors, and what they themselves are already legally
empowered to do to protect their rights.
Policy Challenges Facing Consumers in Pakistan:
These sectoral concerns highlight the generic, policy challenges faced by consumers particularly that affect
their health.
The role of corporations, especially their lack of responsiveness and ethical behavior coupled with the
inability of the state to check their functioning in Pakistan, is problematic. The fundamental issue is one of
the accountability of most corporations that are primarily in place to make profits, even at the cost of
consumer health. The ways in which corporations are exercising their role is now more complex than ever,
not only through directly unethical and in some cases illegal marketing but also through indirectly
promoting a consumer culture that values purchases more than health.
This culture is instilled in consumers from school onwards, and the role of the media itself commercialized
in this regard also goes largely unchecked. The corporatization of the mind has begun in earnest in Pakistan
and consumers, particularly lower middle class consumers, are increasingly under threat. While calls for
corporate social responsibility abound, these have resulted in little more than “greenwash” in the country;
there are no independent organizations holding corporations accountable.
However, while the problem of corporations is at one level fundamentally problematic, this is a global
phenomenon which many international campaigns are targeting in different arenas. The problem is made
more intense in Pakistan due to the poor state of regulation. The double whammy facing consumers in
Pakistan, as above, comprises absence of appropriately motivated legislation and regulation, and poor
implementation of laws where they do exist. The state of implementation of social laws has been much
commented upon, and while numerous policy initiatives have been announced, none has made much
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difference to the fact that such regulation remains weak while at the same time there are little to no
problems in implementing defense, foreign policy, or macro-finance laws. For consumer health, this
situation is complicated even more because of the intensive role of the State in the provision of social
services, such as drinking water, above, and justice.
This last is the final determinant of consumer welfare, since the justice system is intended to provide an
independent recourse to consumers. When court procedures are lengthy and costly, and justice is neither
accessible nor expected, as in most cases across the country, consumers are left to their own, weak, devices.
In sum, the State problems amount to an issue of social justice.
This issue of social justice is one of democracy, in particular the absence of democratic norms in the
country. From a direct consumer perspective, social justice is neither ensured nor evident in the policy
processes of the country. Meaningful citizen participation in policy processes is negligible, policy processes
(including implementation) are opaque, and policy makers largely unaccountable. In effect, consumers have
little to no forums for raising an effective voice in matters determining their lives. They have, thus, no
demand as above.
The matter of democracy is directly related to consumer rights. While Pakistan is a signatory to the UN
Guidelines for Consumer Protection, 1985, it has yet to submit any report on its compliance with the
Guidelines, or to be held accountable. A basic tenet of the Guidelines is that consumer rights are just that:
rights, not privileges. And, therefore, the State has a basic obligation to ensure that those rights beginning
with the right to satisfaction of basic needs, and moving through the right to redress. A consumer, most
importantly, is not just a customer in the marketplace, but a citizen who uses goods and services not directly
paid for in the marketplace.
While the Guidelines, and subsequent development of a framework by the umbrella body Consumers
International, require the State to ensure these rights, they also recognize that it is unrealistic to expect the
State to intervene in every case. Even a strong judicial system can act better as a deterrent that actual
litigation in every matter, which would cause its own problem. In the final analysis, as understood by
advocates of functional democracy, it is the demand raised by citizens themselves; in this case as consumers,
that determines the efficacy of systems of protection. And for this, consumers need to be critically
informed. Doubtless low literacy levels hamper mass awareness to an extent, but this barrier is neither
insurmountable (given developments in electronic media) nor a deterrent to the awareness of the literate
sections of the population. However, consumers in Pakistan remain unaware both of their rights, and of the
increasingly insidious ways in which those rights are being violated.
These issues reflect a changed landscape since The Network last strategize its future in 1999: the previous
government, the events of 9/11 and their aftermath, a vastly enhanced recognition of NGOs, a further
multiplication of NGOs and donor funds, three new civil society organizations also advocating for
consumer rights, growing levels of “policy advocacy”, and recognition of the role of NGOs “on the table”
with government but repression of a “hard” advocacy role. The Network has been a part of these trends,
and derives its re-strategization from its examination of the context.
Consumer Financial Protection Agency (CFPA) of USA (Proposed)
The Consumer Financial Protection Agency, or CFPA, is a newly proposed (in Aug 2009) independent
federal agency that would, if established, have single, primary authority to protect consumers with respect to
financial products and services, other than investment products. It would have supervisory, examination
and enforcement authority for protecting consumers with respect to credit, savings, payment and other
financial products and services.
The current consumer financial protection is based on disclosure regime and is policed through supervisory
feedback, enforcement actions, and occasionally prohibitions on terms, products, and practices that are
deemed inherently unfair and deceptive. On the federal level, consumer protection in financial services is
divided among a number of agencies. Some of these agencies have the ability to promulgate regulations,
some also exercise supervisory authority over financial institutions, and some may only enforce existing
regulations. Sometimes authority is over a class of institutions, and sometimes it is over a particular type of
product. There are four main structural criticisms of the current regulatory structure: that consumer
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protection is a so-called “orphan” mission; that consumer protection conflicts with, and is subordinated to,
safety-and-soundness concerns; that no agency has developed an expertise in consumer protection in
financial services, and; that regulatory arbitrage of the current system fuels a regulatory race-to-the-bottom.
Consolidation of consumer financial services protection authority could: place all financial services
companies, regardless of the form of their charter, under a single regulator, thus ending its orphan status;
separate consumer protection from safety-and-soundness regulation, thus ending subordination; encourage
the development of a deep bench of regulatory expertise and knowledge, and; end the opportunity for
regulatory arbitrage and any potential race to the bottom.
There are several potential concerns about a CFPA: conflicts with prudential regulators; ambiguity with
respect to Consumer Reinvestment Act authority, and; potential overregulation resulting in higher costs of
financial products, less product availability, and discouragement of innovation. Still, there are compelling
reasons to believe that the present regulatory architecture cannot produce the optimal consumer protection
regime and will continue to fail in its task, resulting in unfair treatment of consumers and a potentially
significant source of systemic risk. To this extent, consideration of a CFPA should strive to distinguish
between the basic thrust of the legislation—a consolidation of the regulatory authority of—and the
proposed new substantive powers granted to the agency.
CFPA Mandate is to ensure that consumers of financial products:
􀂙 Have the information they need to make wise financial decisions
􀂙 Are protected from abuse, discrimination, and unfair and deceptive practices
􀂙 Have access to financial services
􀂙 Ensure the financial services market operates fairly and efficiently
Significance of the CFPA
􀂙 Given the scope and ambition of this proposal, this is a game changer for the financial services
industry
􀂙 The proposal says: consumer protection is a high priority for the federal government, and it will
work in coordination with other agencies and the states to ensure that financial products that are
fair, transparent, and suitable for the consumer
􀂙 Success will depend upon dedicated staff, resources, and enormous coordination throughout the
federal government and the states
The Need for CFPA
􀂙 The old rules to protect consumers don’t work
􀂙 Financial products are too complex
􀂙 The terms and conditions, even the disclosures, are far from clear and transparent
􀂙 The incentives of the provider and the consumer’s needs may be misaligned
􀂙 Consumer often doesn’t have the experience or knowledge to know where to go to get the
information needed to navigate the array of product options
CFPA Authority Will
􀂙 Require that all product disclosures and communications be reasonable, balanced, and clear and
conspicuous - and this would be based on significant consumer research and analysis
􀂙 Define standards for “plain vanilla” products, such as mortgages, bank accounts, and credit cards.
These products would have straight forward pricing
􀂙 Have authority to place tailored restrictions on product terms and provider practices
􀂙 Enforce fair lending laws and to ensure underserved communities and consumers have access to
prudent financial services
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Some of the products CFPA will focus on:
Mortgages
• Consumers face an array of mortgage options that come with wide variations in rates, terms,
penalties, and conditions
• In year’s past, mortgages were originated by banks. But as of late, the majority of mortgages are
sold by mortgage brokers
• These companies have existed largely outside of the banking regulatory system with respect to
consumer protections
• Compounding the issue for the consumer is the fact that mortgage brokers have incentives -the
yield spread premium -to sell the consumer a product that isn’t necessarily the most suitable or
lowest cost for them
• To successfully navigate this maze, consumers not only need to figure out the product options that
suits their need, but also who is selling the product, what motivates that seller, and whether there
are rules to ensure the seller is offering a product that is fair and non deceptive
Bank Accounts
• Even basic bank accounts are commonly fraught with unexpected costs, in the form of surcharges
at ATMs, under balance fees, and the big one, overdraft charges, which cost are on average about
$35 per check
• As overdrafts currently work, an accountholder is automatically over drafted, with the payment
completed and the account debited for the overdraft charge
• These kinds of charges which can rack up to hundreds of dollars in the course of a month can tip a
family that’s just making it into serious financial hardship
Source/Reference:
1. The Network for Consumer Protection, Pakistan, Web Page
2. CFPA, Official Website
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LESSON 05
KEY ISSUES IN CB --- CONSUMER’S PERSPECTIVE
When we talk about Consumer Banking, it means that we talk about facilitating the common and ordinary
people of the society by providing them an opportunity to acquire the necessities and accessories of life that
are needed by them to maintain/sustain an affordable, pleasurable, easy, and comfortable life.
Consumer Banking: Definition
Services provided by commercial banks to individuals (as opposed to business customers) that include
Current Accounts, Deposit and Savings Accounts, as well as Credit Cards, Auto Loans, House Loans
(Mortgages), Personal Loans and Investments. It is also called “Retail Banking” and may be used
interchangeably.
Consumer Banking is the provision of products and services to meet the financial needs of individuals in
order to generate products that will boost the bank’s deposit base as well as quality risk asset portfolio.
The Consumer Banking environment today is changing fast. The changing customer demographics
demands to create a differentiated application based on: scalable technology, improved service and banking
convenience. Higher penetration of technology and increase in global literacy levels has set up the
expectations of the customer higher than never before. Increasing use of modern technology has further
enhanced reach and accessibility.
The market today gives us a challenge to provide multiple and innovative contemporary services to the
customer through a consolidated window as so to ensure that the bank’s customer gets “Uniformity and
Consistency” of service delivery across time and at every touch point across all channels. The pace of
innovation is accelerating and security threat has become prime for all electronic transactions. High cost
structure rendering mass-market servicing is prohibitively expensive.
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Changing Trends
Present day bankers are now more looking at reduction in their operating costs by adopting scalable and
secure technology thereby reducing the response time to their customers so as to improve their client base
and economies of scale.
The solution lies to market demands and challenges lies in innovation of new offering with minimum
dependence on branches, a multi-channel bank and to eliminate the disadvantage of an inadequate branch
network. Generation of leads to cross sell and creating additional revenues with utmost customer
satisfaction has become focal point worldwide for the success of a Bank.
Consumer Financing
Consumer financing is a type of service that is designed to provide the individuals with necessary finance
for personal purchases ranging from buying a car, shopping purchases, to buying a house. The concept of
consumer financing is based on the need for an institutional arrangement that provides consumers with
financing support to enhance their consumption and, as a result, improve their standards of living.
Advantages of Consumer Banking
Consumer banking has inherent advantages outweighing certain disadvantages. Advantages are analyzed
from the resource angle and asset angle.
The Resource/Liability Side:
􀂙 Retail deposits are stable and constitute core deposits
􀂙 They are generally insensitive to profit/return with less bargaining for higher rate
􀂙 They constitute low cost funds for the banks
􀂙 Effective customer relationship management with the retail customers build a strong customer base
􀂙 Retail banking increases the subsidiary business of the banks
The Assets Side:
􀂙 Retail banking results in better yield and improved bottom line for a bank
􀂙 Retail segment is a good avenue for funds deployment
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􀂙 Consumer loans are presumed to be of lower risk and NPA perception
􀂙 Helps economic revival of the nation through increased production activity
􀂙 Improves lifestyle and fulfils aspirations of the people through affordable credit
􀂙 Innovative product development
􀂙 Retail banking involves minimum marketing efforts in a demand driven economy
􀂙 Diversified portfolio due to huge customer base enables bank to reduce their dependence on few
or single borrower
􀂙 Banks can earn good profits by providing non-fund based or fee based services without deploying
their funds
Disadvantages of Consumer Banking
􀂙 Designing own and new financial products is very costly and time consuming for the bank
􀂙 Customers now-a-days prefer net banking to branch banking. The banks that are slow in
introducing technology-based products, are finding it difficult to retain the customers who wish to
opt for net banking
􀂙 Customers are attracted towards other financial products like mutual funds and NSS
􀂙 Though banks are investing heavily in technology, they are not able to exploit the same to the full
extent
􀂙 A major disadvantage is monitoring and follow up of huge volume of loan accounts inducing banks
to spend heavily in human resource department
􀂙 Long term loans like housing loan due to its long repayment term in the absence of proper followup,
can become NPAs
􀂙 The volume of amount borrowed by a single customer is very low as compared to wholesale
banking. This does not allow banks to exploit the advantage of earning huge profits from single
customer as in case of wholesale banking
Challenges to Retail Banking in Pakistan
􀂙 The issue of money laundering is very important in retail banking. This compels all the banks to
scrutinize diligently all the documents which they accept while entering into a relationship
􀂙 Outsourcing has become significant in recent past because various core activities such as hardware
and software maintenance, entire ATM set up and operation (including cash, refilling) etc., are
being handled by outside vendors
􀂙 Banks are expected to take utmost care to retain the ongoing trust of the public
􀂙 Customer service should be at the end all in retail banking. Someone has rightly said, “It takes
months to find a good customer but only seconds to lose one.” Thus, strategy of Knowing Your
Customer (KYC) is important
􀂙 The dependency on technology has brought IT departments’ additional responsibilities and
challenges in managing, maintaining and optimizing the performance of retail banking networks
􀂙 It is equally important that banks should maintain security to the advance level to keep the faith of
the customer
􀂙 The efficiency of operations would provide the competitive edge for the success in retail banking in
coming years
􀂙 The customer retention is of paramount important for the profitability of retail banking business &
increase in the market share
􀂙 One of the crucial impediments for the growth of this sector is the shortage of manpower talent of
this specific nature, a modern banking professional, for a modern banking sector
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Customer Service
Customer service is perhaps the most important dimension of retail banking. While most banks offer the
same range of service with similar technology/expertise, the level of customer service matters the most in
bringing in more business. Perhaps more than the efficiency of service, the approach and attitude towards
customers will make the difference.
Front line staffs have to be educated in this regard. A scheme of entrusting a group of important customers
to the care of each employee/officer with a person to person knowledge and intimacy can be implemented
all sundry advices/notices such as Dr. /Cr. advices. TDR maturity advices, etc. whether signed by
employees or officers should be identifiable by the name of those signing, and inviting customers to contact
them for further assistance in the matter.
A customer centered organization has to be built up, whose ultimate goal is to "own" a customer. Focused
merchandizing through effective market segmentation is the need of the hour. A first step can be the
organization of the various retail branches to enter for different market segments like up-market individuals,
traders, common customers, etc. For the SIB (Small Industry and Business) sector banks, the focus should
be on identifying efficient units and allocations of loans to these units. These banks should try Merchant
Banking services on a small scale. With agricultural output growing at a fast rate and mechanization setting
in, banks should try to cater to the credit needs of the people involved in this profession. A wide network is
absolutely imperative for this sector.
Separate branches/divisions should be opened for traders and similar government businesses. Special
facilities for cash tendered in bulk and immediate issue of drafts, by extending facilities like "guarantee
bond" system, will go a long way in mitigating problems faced by traders who are the major customers for
drafts issue. Provision for cash counting machines in these branches will reduce the monotony of cashiers
and unnecessary delays, thus resulting in better productivity and ultimately in improved customer service.
Operational Excellence in Banking
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The personal segment is however the most important one. With the urban segment moving away because
of disintermediation and competition from foreign banks, retail banks should focus on the rural/semi-urban
areas that hold the maximum potential. In the urban areas, private banking to affluent customers can be
introduced, through which advisory and execution services could be provided for a fee. Foreign currency
denominated accounts can also be introduced for them.
Technology
In the current scenario, the importance of technology cannot be understated for retail banks which entail
large volumes, large queues and paperwork. But most of the banks are burdened with a large staff strength
which cannot be done away with. Besides, in the rural and semi-urban areas, customers will not be at home
in an automated, impersonal environment.
The objective would be to ensure faster and easier customer service and more usable information, instantly,
economically and easily to all those who need it -customers as well as employees. Proper management
information systems can also be implemented to aid in superior decision making.
Communication technology is especially needed for money transfer between the same city and also between
cities. There are inordinate delays in our country because of geographical and other factors. Modern
technology can make it possible to clear any check anywhere in Pakistan within three days. Installation of
FAX facilities at all the big branches will facilitate speedy transfer of payment advices. Computerization will
be of great help in improving back-office operations. At present, 60% of rural branches have PCs. These
can be used for quick retrieval and report generation. This will also drastically reduce the time, bank staffs
spend in filling and filing returns. Housekeeping operations can also be speeded up.
Price Bundling
Price bundling is a selling arrangement where several different products are explicitly marketed together to a
price that is dependent on the offer. As banks are multi-product firms this strategy is more applicable to
retail banking. Price bundling offers several economic and strategic benefits to a bank. It offers economies
of, utilization of the existing capacities and reaching wider population of customers. Bank can get the
benefits of information and transacting. In the process of extending variety of services, banks are acquiring
enormous amount of customer information. If this information is systematically stored, banks can
efficiently utilize this information in order to explore new segments and to cross-sell new services to these
segments. Cross-selling opportunities and larger customer base can also be the motive for merger against
usually stated advantage of cost savings. Price bundling can be used in order to lengthen the relationship
with a customer. It will reduce the need of resources to be put on acquiring new customers and saves time
of the bank. Among the strategic benefits, price bundling may cause less aggressive competition; it
differentiates its products compared to rivals in the same market where the products are sold individually or
in other kinds of bundles.
Retail banking offers many services and it gives an opportunity to the bank to combine different services in
different kinds of bundles. In many cases demand for one service affects the demand for another service,
for example current or savings account and payment services are highly related, and here price bundling is a
better alternative than individual selling. Banks have to analyze the customer segment and bundle products
before applying the pricing strategies.
The first step in price bundling decision is to select the customer segment. The bundle is targeted to choose
a strategic objective. If there are two products (A and B) that are considered to be bundled together, the
comprehensive strategic objectives for the different customer segments are:
􀂃 Cross-selling to customers that only buy one of the products
􀂃 Retaining customers that already buy both of the products
􀂃 Acquiring new customers when they buy neither product for the time being
Innovation
The scope for innovation in financial services is unlimited. Although banks have introduced a variety of
deposit and loan products, the basic features of all these products are almost one and the same. Among the
delivery channels, ATMs have emerged as ubiquitous money centers. Almost all banks have established
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their ATMs. For most of the banks the overhead costs on these ATMs are far higher than the revenue
generated by them. ATM operation costs are largely fixed in nature - the cost of the machine, its
maintenance, replenishment of currency, and the satellite (network) connection. There should be a
minimum number of transactions to cover these costs. Banks have to innovate wide range of services in
addition to cash withdrawals. ATMs should allow customers to buy postal and revenue stamps, payment of
bills, event tickets, sports tickets, etc. Banks can offer ATM screens for slide show advertising also.
However, the advantage of the ATM has always been speed and convenience, probably on introduction of
these new services customer has to spend more time at a point. ATMs can guide the customer also. For
example, if a customer's account balance has reached to bare minimum the ATM can give a helpful
suggestion that "we notice your balance is low, can we help with a loan?" ATMs can be either within the
premises of a branch or at a remote place. On premises ATMs are highly immune to competition, but
branches can reduce the staff, on installation of ATM. The scope for wider services through off-premises
ATMs is very high; it provides great opportunity for fee revenue. The cost of maintenance of off-premises
ATMs is higher in terms of replenishment, cash couriers, armed security etc. In the US, approximately 23
percent of ATMs are offering sale of postage stamps. It is the right time for banks to question themselves
whether ATM is a service channel, sales channel, or branding opportunity.
The future of retail banking lies more in mobile banking. Mobile telephone market is penetrating, and
mobile phones are ideal to utilize Internet banking services without customer accesses to PC.
Smart card revolution will further change the face of retail banking. Smart cards can store information; carry
out local processing on the data stored and can perform complex calculations.
Source/Reference:
www.oppapers.com/search.php
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LESSON 06
EMERGING ISSUES IN RETAIL BANKING
1. Knowing Customer (Commercial/Business Perspective)
􀂙 ‘Know your Customer’(KYC) has also become an important Regulatory Requirement
􀂙 In order that the product lines are targeted at the right customers-present and prospective-it is
imperative that an integrated view of customers is available to the banks
􀂙 The benefits flowing out of cross-selling and up-selling require vital inputs
􀂙 What needs to be done is setting up of a robust data warehouse where from meaningful data on
customers, their preferences, there spending patterns, etc. can be mined
􀂙 Cleansing of existing data is the first step in this direction
2. Technology Issues
􀂙 Retail banking calls for huge investments in technology
􀂙 Whether it is setting up of a Customer Relationship Management System or Establishing Loan
Process Automation or providing anytime, anywhere convenience to the vast number of customers
or establishing channel/product/customer profitability, technology plays a pivotal role
􀂙 The Issues involved include adoption of the right technology at the right time and at the same time
ensuring volumes and margins to sustain the investments
􀂙 It is pertinent to remember that a large international bank, known for its deployment of technology,
took quite a while to make profits in credit cards
􀂙 However, without adequate technology support it would be almost impossible to administer the
growing retail portfolio without allowing its health to deteriorate
􀂙 Further, the key to reduction in transaction costs simultaneously with increase in ability to handle
huge volumes of business lies only in technology adoption
􀂙 Lack of connectivity, stand alone models, concept of branch customer as against bank customer,
lack of convergence amongst available channels, absence of customer profiling, lack of proper
decision support systems, etc., are a few deficiencies that are being encountered
􀂙 The initiatives in this regard should include creating flexible computing architecture amenable to
changes and having scalability, a futuristic approach, networking across channels, development of a
strong Customer Information Systems (CIS) and adopting Customer Relationship Management
(CRM) models for getting a 360 degree view of the customer
3. Organizational Alignment
􀂙 It is of utmost importance that the culture and practices of an institution support its stated goals
􀂙 Having decided to take a plunge into retail banking, banks need to have a well defined business
strategy based on the competitive position of the bank and its potential
􀂙 Creation of a proper organization structure and business/operating models which would facilitate
easy work flow are the needs of the hour
􀂙 The need for building the organizational capacity to achieve the desired results cannot be
overstated
􀂙 This would mean a strong commitment at all levels, intensive training of the rank and file, putting
in place a proper incentive scheme, etc.
􀂙 As a part of organizational alignment, there is also the need for setting up of an effective Corporate
Marketing Division. Most of the banks have only publicity departments and not marketing setup
􀂙 A full fledged marketing department or division would help in evolving a brand strategy, address
the issue of alienation from the upwardly mobile, high net worth customer group and improve the
recall value of the institution and its products by arresting the trend of getting receded from public
memory
􀂙 The much needed tie-ups with manufacturers/distributors/builders will also be facilitated smoothly
􀂙 It is time to break the myth that banks are not customer friendly. The attention is to be diverted to
vast databases of customers lying with them still unexploited for marketing
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4. Product Innovation
􀂙 Product innovation continues to be yet another major challenge
􀂙 What is of crucial importance is the need to understand the difference between novelty and
innovation? Peter Drucker in his path breaking book: “Management Challenges for the 21st
Century” has in fact sounded a word of caution: “innovation that is not in tune with the strategic
realities will not work; confusing novelty with innovation should be avoided, test of innovation is
that it creates value; novelty creates only amusement”
􀂙 Banks need to innovate products suiting the needs and requirements of different types of
customers. Revisiting the features of the existing products to continue to keep them on demand
should not also be lost sight of
5. Pricing of Product
􀂙 The next challenge is to have appropriate pricing policies in place
􀂙 The industry today is witnessing a price war, with each bank wanting to have a larger slice of the
cake, without much of a scientific study into the cost of funds involved, margins, etc.
􀂙 Most of the banks that use rating models for determining the health of the retail portfolio do not
use them for pricing the products. The much needed transparency in pricing is also missing, with
many hidden charges and to camouflage the price
􀂙 The situation cannot remain this way for long. This will be one issue that will be gaining
importance in the near future
6. Process Changes
􀂙 Business Process Re-engineering is yet another key requirement for banks to handle the growing
retail portfolio
􀂙 Simplified processes and aligning them around delivery of customer service impinging on reducing
customer touch-points are of essence
􀂙 A realization has to be drawn that automating the inefficiencies will not help anyone and continuing
the old processes with new technology would only make the organization more inefficient
􀂙 Work flow and document management will be integral part of process changes
􀂙 The documentation issues have to remain simple both in terms of documents to be submitted by
the customer at the time of loan application and those to be executed upon sanction
7. Human Resources
􀂙 While technology and product innovation are vital, the soft issues concerning the human capital of
the banks are more vital
􀂙 The corporate initiatives need to focus on bringing around a frontline revolution. Though the
changes envisaged are seen at the frontline, the initiatives have to really come from the ‘back end’
􀂙 The top management of banks must be seen as practicing what it preaches
􀂙 The initiatives should aim at improved delivery time and methods of approach.
􀂙 There is an imperative need to create a perception that the banks are market-oriented
􀂙 This would mean a lot of proactive steps at various levels, devising appropriate tools for
performance measurement bringing about a transformation ' ‘can’t do' to 'can do’ mind-set change
from restrictive practices to flexible work place:
􀂾 By having universal tellers,
􀂾 bringing in managerial controlling work place,
􀂾 provision of intensive training on products and processes,
􀂾 emphasizing coaching, etiquettes, good manners and best behavioral models, formulating
objective appraisals,
􀂾 putting in place good and acceptable reward and punishment system,
􀂾 facilitating the placement of young /youthful staff in front-line,
􀂾 defining a new role for front-line staff by projecting them as sellers of products rather
than clerks at work,
􀂾 changing the image of the banks from a transaction provider to a solution provider
8. Rural Orientation
􀂙 As of now, action that is taking place on the retail front is by and large confined to major cities
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􀂙 There is still a vast market available in rural Pakistan, which remains to be tapped
􀂙 MNCs, as manufacturers and distributors, have already taken the lead in showing the way by
coming out with exquisite products, packaging and promotions, keeping the rural customer in mind
􀂙 Some FMCGs made available through an efficient network add testimony to the determination of
the MNCs to penetrate the rural market. In this scenario, banks cannot lack behind
􀂙 In particular banks having a strong rural presence, need to address the needs of rural customers in a
big way. These and only these will propel retail growth that is envisaged as a key strategy for
portfolio expansion by most of the banks
9. Financial Exclusion
􀂙 The scope of enhancement of Banking Business in Pakistan is considerable as the level of Financial
Exclusion is exceptionally high despite the growth in Banking
􀂙 Penetration ratio of financial services is low judged by any measures as less than 20% of the
population has access to financial services and number of borrowers are under 5 million (3% of
population)
􀂙 More graphically, there are only 171 deposit accounts per 1,000 people and 30 loan accounts
per 1,000 people
􀂙 Likewise, only 30% of adults have bank accounts
􀂙 Credit/GDP ratio at 27% is low judged by country and sector financing requirements or judged by
levels prevailing in Emerging Markets
􀂙 Consumer financing penetration ratio is 3.9%
Distinguishing Features of a typical Consumer Banking (CB) Segment of a Bank in Pakistan
􀂙 CB is a Scale Sensitive, Mass Market, & Volume business
􀂙 Standardized Processes & Procedures
􀂙 Substantial upfront outlay for Designing, Developing, Marketing, Distributing, & Delivering
various products
􀂙 Adherence to SBP Risk Management Guidelines
􀂙 Separate organizational setup for post-sale issues like Collection, Recovery, Litigation etc.
􀂙 Multiple Delivery Channels/Call Centers/Recorded Phone Lines
􀂙 Enhancing customer experience through effective/efficient management of “Customer Touch
Points”
􀂙 Dedicated Sales & Service teams(Usually contractual)
􀂙 Hiring of external agencies for verifying & documenting details of customer profile and income
source/estimation
􀂙 Professional Property Valuators
􀂙 Customer Segmentations under Life-Cycle parameters
􀂙 Adherence to Transfer Pricing regime for determining true profitability of products/services
􀂙 Innovative personal saving /investment products through Alliances with Insurance Companies &
other financial service providers
􀂙 Service Level Agreements (SLA) with bank own support functions like Operations, IT, HR etc
􀂙 Brand Affiliation/Channel Partnering
New Segmentation Approaches to Drive Product Innovation
Innovation in Segmentation Strategy
Although banks have practiced customer segmentation for the past decade or so, there is room for further
refinement of their strategies. Having moved from a product-centric to a customer-centric approach, banks
continue to employ broad brushstrokes to segment their customer base. In doing so, the risk attributing
common characteristics to a large number of customers who may have been grouped together on the basis
of a single parameter, such as relationship value. More importantly, their product and service offerings are
likely to be tailored to the perceived needs of these segments. At the same time, banking customers
continue to demand more. They are no longer content to be viewed as faceless constituents of a large
group; rather, they expect their banks to recognize their individual needs and offer custom-made solutions
to help them achieve their financial goals. Against this backdrop, banks must become more innovative in
the way they view their customers as well as the manner in which they serve them.
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Beyond Relationship-Value Segmentation
For a start, banks can look at refining customer segmentation by taking a multi-dimensional approach that
goes beyond relationship-value. While segmentation on the basis of relationship value is important in order
to recognize and reward customer loyalty, it falls short of enabling banks to identify and attract new
business opportunities. It is also possible that customers with vastly different relationship-values may be
connected in other ways, and therefore, could be part of the same segment from an entirely different
standpoint. Hence, banks need an in-depth, well-rounded perspective of their customers before they can
categorize them. This perspective must consider various factors besides relationship value including but not
limited to, demography, geography, ethnicity, gender and profession. As a matter of fact, banks are well
placed to do so, since most, if not all of this information would already be available within their database.
Analysis of comprehensive customer data can reveal homogeneous patterns that can be used to create new
and more meaningful customer segments which can be targeted for tailor-made products and services.
New Approaches to Segmentation
Customer segmentation on the basis of homogeneity of behavior, aspiration, value, culture or habit can
bring to light specific opportunities which may not be visible when only relationship value is taken into
consideration. It is intuitive that those who share a common geography, language, profession or social status
will also have, to a certain extent, similar values or behavior. Therein lies vast, untapped opportunity – if
banks can offer products and services that support such homogeneity, they are likely to reap big benefits by
way of new business and cross-sales. This view is best illustrated with some examples:
􀂙 A couple of prominent U.S. banks have gone after the 37 million-strong Hispanic population,
considered an unprofitable customer segment by most of their peers. This group has very specific
requirements – the facility to deposit pay-checks, make money transfers and maintain a zero
balance in their account being the most important. The banks have accordingly introduced
innovative products tailored to these needs. One bank offers more options to move money: as cash
to cash or as cash to accounts or cards, being some of them. They also allow their customers to
cash pay-checks. The other bank has pioneered a special zero minimum balance account just for
Hispanic clients
􀂙 Geographic segmentation is another important possibility. A physical location can be a great
determinant of customer needs – for instance, while all agricultural regions have large demand for
farm loans or short-term trade financing, their demand patterns differ based on the crop and
harvesting cycle. Another example is that of customers on the West and East Coast of the U.S.,
who hold different financial aspirations which cannot be met with the same suite of products.
Although regional and rural banks cater to geographic diversity to a certain extent, national banks
can follow suit by creating location-based sub-segments and targeting them. With different
offerings Segmentation by social strata is gaining currency riding on the concept of financial
inclusion. The world over, banks are innovating their product and channel strategy to reach out to
the unranked population. Going forward, they must attempt to discover subtle patterns within
these segments, so that they can target smaller sections with customized offers
􀂙 Different generations display distinct behavioral patterns. Aging baby boomers may seek personal
guidance while planning their retirement savings; not so the tech-savvy and self-reliant Generation
X. The “digital native” Gen Y is technologically ahead of them all, and is at ease transacting over
the Internet, mobile phone or even social networking platforms
􀂙 Segmentation-driven innovation need not be confined to products alone. Several Canadian banks
have set up multi-lingual branches, where employees speak up to eight languages, to cater to the
vast expatriate community in that country. ATMs in rural India offer screens in vernacular
languages to encourage usage among the resident population
􀂙 Banks can also benefit by segmenting their customer base along unconventional dimensions. An
Australian bank offered a utility bill payment service in the form of a specialized loan to those
customers who had difficulty keeping up with their monthly payments. By doing so, they earned
interest from their customers and commission from the service providers. New methods of
segmentation have also been considered within niche areas such as wealth management, with subsegments
being formed on the basis of source of wealth, customer sophistication, life stage and
geography
􀂙 Another approach advocates the formation of customer groups depending on their banking
behavior – which is either investment or borrowing/transaction oriented. Typically investors
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comprise older, more affluent clients who maintain high balances and are primarily concerned with
growing their wealth for the future. Since this group is not focused on deposit products, it is not
very sensitive to interest rates
􀂙 On the other hand, lower-balance transactions are young and just starting to accumulate wealth
through employer plans, IRAs or similar avenues. Mostly, their needs are immediate – and hence,
they lay greater emphasis on checking, saving and loan products and the interest rates associated
with each
􀂙 Not surprisingly, their channel preferences also differ. High-balance customers want experienced
branch staffers to whom they can turn in case of need. Their low-balance counterparts are happy
using self-assisted channels such as PC/Internet banking, ATMs and call centers
􀂙 Clearly, banks need very different strategies to tackle each of these groups. At the same time, they
must recognize the interplay of multiple factors within each segment – for instance, some members
of the Hispanic segment may have similar social, linguistic and economic characteristics. Another
example of this is evident in the case of the high-balance investors discussed earlier, who, apart
from having common financial goals, may also be at a similar life-stage. Thus, going forward,
banks’ segmentation strategy must create finer “sub- segments” which are homogenous along
different dimensions. This will lead them from customer-centricity to the more desirable state of
customer-specificity or “segment of one”. For instance, of the three broad customer segments,
namely corporate, small business and retail, the latter can be grouped by generation, which in turn
may be segmented according to geography, income, behavior and so on. The corporate and small
business client base can be similarly broken down
Innovating to Create Relevant Products and Services
That being said, a sophisticated segmentation strategy will achieve little unless it is backed up by innovative
products and services relevant to the needs of different groups. Hence, banks need to map their “offerings”
defined by a combination of product, price, channel, timing and human resources to various customer
segments. For instance, they can bundle a set of investment products for their Gen X customers and train a
team of relationship managers to deliver them. Another example is the creation of small savings products to
cater to the new savings consciousness emerging in the aftermath of the global crisis. Banks must also give
due weightage to pricing to ensure that small- ticket vanilla products are not perceived as being expensive
by the target segments. Timing is equally important – Gen Y customers have simpler, frequent needs and
expect instant fulfillment, whereas mature clients are likely to have significant requirements at different lifestages,
such as marriage, parenthood or retirement. A well-rounded segmentation approach must take all
this and more into consideration.
Aligning the Organization with a Robust Segmentation Strategy
While all of this is good wisdom, it is only part of the story. The goal of true segmentation is not merely to
offer innovative products and services, but to ensure that the customer experience is raised to a different
level. Hence, the entire banking organization, including its policies, processes and people must be aligned
with the segmentation strategy. KYC norms are a good example of how policies can be “turned on their
heads” to support segmentation – rather than following these norms purely as a compliance practice, banks
can use the information to strengthen their understanding of various customer segments.
It goes without saying that banks will need resources as well as infrastructure to effect these changes. A
sound technology platform is a necessary enabler at every stage – from segmentation to product innovation
to customer experience delivery. To start with, banks need a 360 degree unified view of their customers
across the organization – only integrated core systems have the capability to consistently deliver this
information, no matter how large the scale. Technology is required to analyze huge volumes of customer
data, discover patterns within them and engender the progression of broad-based segmentation to a
“segment of one”. Again, quick roll-out of new products and services is only possible with the support of
modern core banking systems. The same systems enable banks to optimize their channels and processes,
making them more efficient but not less personalized, all of which contribute to the delivery of good
customer experience. For instance, technology can be used to trigger an investment recommendation
whenever a customer's account receives sizeable inflows as well as alert the concerned relationship manager
so that he may follow it up.
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Summary
Banking customers' demands have kept pace with the rising complexity of their needs. They expect banks to
address their individual requirements with relevant products and services. This implies that banking
institutions must acquire a deeper understanding of their customers at a one-to-one level, and deploy that
insight into product and service innovation. Customer segmentation is central to this objective.
Current segmentation practices are mostly uni-dimensional and based on a single parameter such as
relationship value. Although the relevance of relationship value as a measure of customer loyalty is beyond
doubt, it cannot be the sole criterion for segmentation. Going forward, banks must refine their
segmentation strategy by taking into account a combination of demographic, social, economic, geographic
and linguistic factors. Other innovative approaches to segmentation include grouping customers on the
basis of financial behavior, customer sophistication or life-stage.
As broad customer segments are broken down into finer sub-groups, segmentation strategy shifts from
customer-centricity towards customer- specificity. New business opportunities can be created by offering
tailor-made products to each customer sub-segment. However, none of this is possible without the support
of a strong technology backbone at every stage – whether it is the creation of new customer segments, rollout
of innovative offers or the alignment of processes and channels to provide a great banking experience
across all segments.
Source/Reference:
1. www.oppapers.com/search.php
2. Finacle Product Strategy, Infosys Technologies Limited
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LESSON 07
STRUCTURE OF BANK CREDIT RISK --- AN OVERVIEW
Bank Structure: A Successful Approach
Managers spend hours agonizing over how to structure their organizations (by product, geography,
customer, and so on). Winners show that what really counts is whether structure reduces bureaucracy and
simplifies work.
• Simplify. Make your organization easy to work in and work with
• Promote cooperation and the exchange of information across the whole company
• Put your best people closest to the action
• Establish systems for the seamless sharing of knowledge
Client Pyramid
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Targeting ‘Sweet Spot’:
• In putting this strategy into effect, a Bank serves mid market consumer and commercial clients –
whom it calls the bank’s ‘sweet spot’ client segments
• The Consumer mid-market segment includes mass affluent customers− retail clients with healthy
finances as well as most of higher-end private banking clients
• Commercial mid-market clients include many medium-to-large companies and financial institutions
Serving the Whole Client Pyramid:
• Client base can be represented through the ‘Client Pyramid’ shown in the accompanying illustration
• The strategy identifies sweet spot as being mainly located around the middle of this pyramid
• However, this does not reduce the importance of the top and bottom end of the pyramid
• For example, serving top private banking clients helps to develop innovative investment products
that can later be offered to mid market consumer clients as well
• Similarly, serving large multinational corporations enables to strengthen industry knowledge and
product innovation, both of which will eventually benefit mid market commercial clients
• Both the mass retail segment and the small business segment deliver the scale Bank needs and act
as a feeder channel for future mid-market clients
Strategy, another Perspective:
• Your strategy should be sharply defined, clearly communicated, and well understood by employees,
customers, partners, and investors
• Build a strategy around a clear value proposition for the customer
• Develop strategy from the outside in, based on what your customers, partners, and investors have
to say—and how they behave—not on gut feel or instinct
• Continually fine-tune your strategy based on changes in the marketplace— for example, a new
technology, a social trend, a government regulation, or a competitor’s breakaway product
• Clearly communicate your strategy within the organization and to customers and other external
stakeholders
• Keep focused. Grow your core business, and beware the unfamiliar
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In the Single -Loop learning we apply habitual way of thinking and doing, i.e. re-enacting the past or what is
called “Downloading”. But in Double-Loop learning we reflect and ask the “why not” questions which
could lead to a paradigm shift.
Double loop theory is based upon a "theory of action" perspective outlined by Argyris & Schon (1974).
This perspective examines reality from the point of view of human beings as actors. Changes in values,
behavior, leadership, and helping others, are all part of, and informed by, the actors' theory of action. An
important aspect of the theory is the distinction between an individual's espoused theory and their "theoryin-
use" (what they actually do); bringing these two into congruence is a primary concern of double loop
learning. Typically, interaction with others is necessary to identify the conflict.
There are four basic steps in the action theory learning process: (1) discovery of espoused and theory-in-use,
(2) invention of new meanings, (3) production of new actions, and (4) generalization of results. Double loop
learning involves applying each of these steps to itself. In double loop learning, assumptions underlying
current views are questioned and hypotheses about behavior tested publicly. The end result of double loop
learning should be increased effectiveness in decision-making and better acceptance of failures and
mistakes.
In recent years, Argyris has focused on a methodology for implementing action theory on a broad scale
called "action science" and the role of learning at the organizational level.
Key Regulatory Requirements:
• Know-Your-Customer (KYC) System
• Anti-Money Laundering (AML) Policy
• Audit & Compliance Setup
SBP PRUDENTIAL REGULATION XI --- KNOW YOUR CUSTOMER (KYC)
• In view of heightened global efforts to prevent the possible use of the banking sector for money
laundering, terrorist financing, transfer of illegal/ill-gotten monies and as a conduit for white collar
crime etc., the importance of ‘Know Your Customer (KYC)’/”customer due diligence” has
increased
• To reinforce the checks and controls already developed by banks as also to ensure due diligence is
done while starting relationship with a new customer and maintaining and continuing relationship
with existing customers
GUIDELINES
All reasonable efforts shall be made to determine true identity of every prospective customer. The following
minimum set of documents must be obtained from various types of customers/ account holder(s).
Nature of
Account
Documents/Papers to be Obtained
Individuals i. Attested photocopy of national identity card or passport of the individual.
ii. In case the NIC does not contain a photograph, the bank should also obtain,
in addition to NIC, any other document such as driver’s license etc that
contains a photograph.
iii. In case of a salaried person, attested copy of his service card, or any other
acceptable evidence of service, including, but not limited to a certificate from
the employer.
iv. In case of illiterate person, a passport size photograph of the new account
holder besides taking his right and left thumb impression on the specimen
signature card.
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The Banks shall obtain “Introduction” on the new account to assess the prospective customer’s/account
holder’s integrity, respectability and the nature of business etc. Any laxity in this regard may result in serious
consequences for the banker.
The following guidelines are to be followed in this regard:
i. Where the introducer is an existing account holder of the same branch, his introduction should be
accepted, after due verification of signature by the official of the branch. In case the introducer is
an account holder of another branch of the same bank, the account
ii. should only be opened after proper verification of the signature from the concerned branch
iii. Where the introducer happens to be an account holder of another bank, the introduction should be
accepted after complete verification of the signature and other particulars of the introducer from
that bank
iv. The introduction by the employees of the bank may also be acceptable. However, he or she will
have to establish that sufficient information has been collected on the new account holder for
making the introduction and that they believe that “Introduction” from a person other than the
bank’s employee is not necessary
(The introduction of a person other than by the branch employee is being stressed to ensure
maximum authenticity on the status of the would-be accountholder/customer, beside minimizing
the chances of undesirable accounts which may be opened on the introduction of the bank
employees in their pursuit to achieve targets of opening maximum number of accounts and treating
the “Introduction” a mere formality in the process).
• The Bank/branch shall obtain satisfactory evidence duly verified/authenticated by the branch
manager and shall be placed on record in respect of:
i. the true identity of the beneficial owners of all accounts opened by a person, entity etc,
ii. the real party in interest or controlling person/entity of the account(s) in case of
nominee or minors account
• The Banks are also advised that KYC/customer due diligence is not a one time exercise to be
conducted at the time of entering into a formal relationship with customer/account holder.
KYC/Customer due diligence is an on-going process for prudent banking practices, therefore
the banks are encouraged to: -
i. Set up a compliance unit with a full time Head
ii. Put in place a system to monitor the accounts and transactions on a regular basis
iii. Update customer information and records, if any, at reasonable intervals
iv. Install an effective MIS to monitor the activity of the customers’ accounts
v. Chalk out plan of imparting suitable training to the staff of bank periodically
vi. Maintain proper records of customer identifications and clearly indicate, in writing, if
any exception is made in fulfilling the due diligence procedure
vii. Monitor and check unusually large cash transactions, especially those which are out of
character/ inconsistent with the history, pattern etc of the individual account(s)
• The banks shall develop guidelines for customer due diligence, including a description of the
types of customers that are likely to pose a higher than average risk to a bank
• In preparing such policies, factors such as customers’ background, country of origin, public or
high profile position, nature of business etc should be considered
• Each Bank shall formulate and keep in place, in writing, a comprehensive Know- Your-
Customer policy duly approved by their Board of Directors and in case of branches of foreign
banks, approved by their head office, and cascade the same down the line to each and every
branch/office/ concerned officers for strict compliance
• State Bank of Pakistan, during the course of inspection, would particularly check the efficacy of
the KYC system put in place by the banks and its compliance by all the branches and the staff
• Appropriate action shall be taken against the bank and the concerned staff members for noncompliance
and negligence in this area under the provisions of Banking Companies Ordinance
1962
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A Typical KYC System/Framework (An Example)
Documentary Requirements
1.1 Identification of Client
1.2Verification of Client’s Name (NADRA’s Verification)
1.3Verification of Client’s Address (registered and if applicable operational)
1.4Identification of Ultimate Beneficial Owners with a Controlling Interest of 20% or more (neutral
risk client)
1.5Identification of Ultimate Beneficial Owners with a Controlling Interest of 10% or more (increased
risk client)
1.6Verification of Controlling UBOs
1.7Evidence that Legal Rep is Authorized to Act on Behalf of and Bind the Client in the manner
proposed
1.8Identification and Verification of the Legal Rep’s Identity
1.9Identification of Company Director(s)
1.10Verification of 1 (or 2) Company Director(s)
1.11Evidence of Sanctions Check
1.12Evidence of PEP (Politically Exposed Person) Search
1.13Evidence of Bad Press Search
1.14Evidence of publicly traded and/or regulated status (directly or indirectly)
1.15Verification of Business Activity
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LESSON 08
STRUCTURE OF BANK CREDIT RISK --- AN OVERVIEW (CONTD…)
AML: Some Thoughts
• Money laundering, in general, is the name given to the process by which the origin of illicit funds is
disguised
• The need to indulge in money laundering is primarily to cover up the means by which such funds
have been acquired with the aim of legitimizing them
• According to the United Nations, the term Money Laundering is defined as “Any act or attempted
act to disguise the source of money or assets derived from criminal activity
• It is the process whereby “dirty money”, produced through criminal activity, is transformed into
clean money”
According to Section # 3 of Ant- Money Laundering Ordinance 2007, Government of Pakistan, and
Offence of money laundering:
A person shall be guilty of offence of money laundering, if the person:
a) acquires, converts, possesses or transfers property, knowing or having reason to believe that such
property is proceeds of crime; or
b) Renders assistance to another person for the acquisition, conversion, possession or transfer of, or
for concealing or disguising the true nature, origin, location, disposition, movement or ownership
of property, knowing or having reason to believe that such property is proceeds of crime
According to Section # 4 of the Ordinance:
Punishment for money laundering:
Whoever commits the offence of money laundering shall be punishable with rigorous imprisonment for a
term which shall not be less than one year but may extend to ten years and shall also be liable to fine which
may extend to one million rupees and shall also be liable to forfeiture of property involved in the money
laundering.
Client Acceptance and Anti-Money Laundering Policy (CAAML):
• Standard for Risk Assessment and Client Acceptance
• Standard for Client Identification and Verification
• Standard for Money Laundering Detection
• Standard for Rejection of Clients/Ending Relationships
• Standard for AML Awareness and Training
• Procedures for Identification and Verification
• Procedures for Transaction Filtering
• Lists of Legal Persons and Groups
• Procedures for Handling Suspicious or
• Unusual Activity Details
• Procedures for Waivers
An Example from a Bank Manual on AML Policy:
It is a Policy of the Bank that,
• Statutory and regulatory obligations to prevent ML and TF are to be met in full
• Systems and controls will be implemented in order to minimize the risk of the Bank's services being
abused for the purposes of ML and TF
• A money laundering risk assessment of the Bank’s services and customer base including
correspondent banks and MSBs (Money Service Businesses) will be undertaken and appropriate
policies, procedures and due diligence controls will be applied proportionate to that risk
• Any customer relationship where the customer's conduct gives the Bank reasonable cause to
believe or suspect involvement with illegal activities will be reported to Regulators or relevant
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authorities. Thereafter action will be undertaken in conjunction with the relevant authorities and in
accordance with local practice to avoid any risk of the Bank committing a ‘tip-off’ offence.
Wherever possible, the relationship will be terminated
• In countries where local regulators call for a money laundering compliance reports, respective
country MLRO would be responsible for preparation and submission of these reports. CCO would
submit a quarterly compliance report to Audit Committee and an annually to the Board, as required
under the Compliance Policy
Internal Controls and Communication
It is a Policy of the Bank:
• To institute controls which comply fully with all applicable anti-money laundering laws and
regulations
• To conduct risk assessment and develop risk profiles of the Bank’s products, services and
customers and to apply appropriate policies and procedures to manage such risks. Undertaking
enhanced due diligence for ‘High Risk’ products, services and customers
• To communicate Bank’s policies to management and staff and provide them with written
procedures and control requirements to ensure ongoing compliance with AML laws and regulatory
requirements
Recognition and Reporting of Suspicion
It is a Policy of the Bank:
• To establish and follow procedures that requires employees to refer promptly any suspicious
activity to GCG or respective country MLRO who will review the transaction to determine whether
a report should be filed with the Regulators
• To be alert to unusual or suspicious transactions or other activities that appear not to make good
business or investment sense, or activities that appear to be inconsistent with the counterparty or
customer’s expected activity, including activities that may be indicative of criminal conduct,
terrorism or corruption
• To act competently and honestly when assessing information and circumstances that might give
reasonable grounds to suspect ML or TF
• To provide GCG or respective country MLRO (at request) access to all customers, correspondents
or counterparties information within the Bank
• To co-operate fully with law enforcement authorities in investigations concerning possible ML or
TF within the confines of applicable laws, and in consultation with GCG or respective country
MLRO
• Not to alert or provide any information to any person suspected of illegal activity regarding
suspicion or inquiry on his or her account or transactional activities or any indication of being
reported to Regulators
Awareness Raising and Training
It is a Policy of the Bank:
• To make all management and staff aware of what is expected of them to prevent money laundering
or terrorist financing and to advise them of the consequences for them and for the Bank if they fall
short of that expectation
• To provide initial and annual update training for all appropriate personnel, including all personnel
who set up and manage customer account opening or transactions, correspondent relationships,
and/or are involved in trade finance activity
• That management and staff will be required to sign a memorandum confirming they have read and
understood the Bank’s AML/KYC policies and procedures
Record Keeping
It is a Policy of the Bank:
• To retain identification and transaction documentation for the minimum period required by
applicable Laws and Regulations
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• To retain records of all reports made by staff to GCG or respective country MLRO and all
suspicious activity reports made by MLRO to Regulators for an indefinite period unless advised by
the Regulator otherwise
• To be in a position to retrieve, in a timely fashion, records that are required by law enforcement
agencies as part of their investigations
• To keep records of dates when anti-money laundering training was given, the nature of the training
and the names of staff who received such training
Bank’s Policy on Politically Exposed Persons (PEPs) Policy Rationale
PEPs and related individuals can pose unique reputation and other risks, in particular:
• Some corrupt PEPs around the globe have used traditional banking products and services as safe
havens for misuse of funds, illegal activities and associated practices, including money laundering;
• PEPs enjoy prominence and are therefore under continuous public spotlight. Their financial affairs
are highly magnified and could easily trigger adverse publicity and franchise risks for the Bank;
• There is a growing attention worldwide to the misuse of public funds and increased reaction against
corruption at high government levels;
• There is increasing responsibility and liability for banks and bank personnel to undertake due
diligence for establishing source of wealth and investigate fund flows of PEPs
Definition
PEPs are individuals who are or have been entrusted with prominent public functions, for example Heads
of State or of Government, senior politicians, senior government, judicial or military officials. Senior
executives of state owned corporations, important political party officials, business relationships with family
members or close associates of PEPs involve reputation risks similar to those with PEPs themselves. The
definition is not intended to cover middle ranking or more junior individuals in the foregoing categories.
Reputational Risk:
• Reputation is a key business asset, however intangible. Risks that negatively affect the reputation
and standing of banks have increased considerably in the last decade
• One of the key risks to the bank’s reputation is the risk of the bank becoming involved in, or
becoming a vehicle for, criminal activities, such as money laundering, terrorism, fraud and
corruption
• Many products and services offered by the Bank are attractive to those who would use the financial
services industry and financial systems for criminal purposes
• One important way of mitigating these risks is ensuring that the bank conducts business with
acceptable clients and has adequate policies and procedures to deter criminal activities
• The Client Acceptance and Anti-Money Laundering (CAAML) policy ensures required attention is
paid to a client, in order to establish whether or not the bank wants to do business with the client
and that the bank's clients are of good reputation
• It should be noted that client acceptance includes aspects not covered in the stated policy,
particularly sustainability
Money Laundering and Terrorist Financing:
• Generally speaking, “Money Laundering” is the introduction of illegally gained assets into the legal
financial system with the aim of concealing or disguising their true origin
• The source of illegally obtained funds is obscured through a succession of transfers and
transactions in order that those same funds can eventually be made to reappear as legitimate
income. Terrorist financing is the financial support, in any form, of terrorism or those who
encourage, plan or engage in it
• The common trait between money laundering and terrorist financing is concealment
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What is ‘Compliance’?
Audit & Compliance function’s role is:
To independently oversee the core processes, and their related policies and procedures, that seek to ensure
that the bank is conforming to industry-specific laws and regulations in letter and spirit, thereby maintaining
the bank’s reputation.
SBP PRUDENTIAL REGULATION NO. XXIX – RESPONSIBILITIES OF BOARD OF
DIRECTORS
• The State Bank attaches a great importance to effective corporate governance, clear lines of
responsibility, elaborate mechanism of accountability, and existence of proper checks and balances
in each bank/financial institution
• The corporate governance means the way in which business and affairs of each institution is
directed and managed by their ‘Board of Directors’ and the ‘Management’
• To promote safe and sound banking practices, it is imperative that the ‘Board of Directors’ assumes
its role independent of the influence of the Management
• Members of the Board should know their responsibilities and powers in clear terms
• Further, it should be ensured that the Board of Directors focus on policy making and general
direction, oversight and supervision of the affairs and business of the bank/DFI and does not play
any role in the day-to-day operations, as that is the role of the ‘Management
The Compliance Officers will primarily be responsible for Bank’s / DFI’s effective compliance
relating to:
a) SBP Prudential Regulations
b) Relevant provisions of existing laws and regulations
c) Guidelines for KYC
d) Anti money laundering laws and regulations
e) Timely submission of accurate data / returns to regulator and other agencies
f) Monitor and report suspicious transactions to President / Chief Executive Officer of the bank /
DFI and other related agencies
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LESSON 09
CONSUMER FINANCING IN PAKISTAN AN OVERVIEW
SBP Financial Stability Report 2007- 08:
• Consumer finance is an established financial product across the globe, particularly in mature economies,
where it constitutes a significant portion of banks’ lending portfolios
• In the Pakistani banking sector, however, the evolution of the consumer financing portfolio is a more
recent phenomenon, as banks have traditionally focused on lending to the corporate sector and public
sector entities
• While two prominent foreign banks took the lead in introducing credit cards in the banking sector in
the mid ‘90s, their outreach was limited to the top tier of salaried customers and businessmen
• Emulating the experience of various foreign banks who had a head start in this area, domestic private
banks have exhibited remarkable adeptness in adopting new procedures for credit risk assessment,
setting up the requisite policy and collections units, and upgrading the scope of their IT based systems
• In doing so, they successfully introduced several innovative products for the individual consumer
segment
• On the demand side, the consumer, who previously did not have access to bank credit without
sufficient liquid collateral, responded well to these initiatives?
Factors responsible for the widespread popularity of consumer finance in recent years:
• The financial liberalization process over the last decade or so, has led to the creation of a banking
system which is largely owned and operated by the private sector, and is free to allocate resources in
response to the demands of a market based mechanism,
• Secondly, the influx of liquidity in the banking sector since FY02 motivated banks to diversify and
expand their earnings base by venturing into previously untapped areas,
• Thirdly, the easy monetary policy stance of the central bank from FY02 to FY05 provided eligible
customers with financing options at historically low rates to meet their consumption demand. In this
backdrop, consumer finance has emerged as one of the most promising asset products for banks
• Providing access to purchasing power to the middle class consumer has been the most significant
achievement of this product class
• Not only have people been able to raise their standard of living by purchasing various consumption
goods which were previously treated as luxuries in reach of only a few, demand for these goods has also
led the manufacturing sector to expand its capacity, such that both backward and forward linkages have
contributed to the expansion in economic activities
• Hence, in promoting their consumer financing products, banks have played their due role in promoting
economic development in the country
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Warning Signals:
Abuse in Credit Cards Usage
A FOOD FOR THOUGHT
The Nature of Modern Finance
Is modern finance more like electricity or junk food?
This is, of course, the big question of the day.
If most of finance as currently organized is a form of electricity, then we obviously cannot run our
globalized economy without it. We may worry about adverse consequences and potential network
disruptions from operating this technology, but this is the cost of living in the modern world.
On the other hand, there is growing evidence that the vast majority of what happens in and around modern
financial markets is much more like junk food – little nutritional value, bad for your health, and a hard
habit to kick.
The issue is not finance per se, i.e., the process of intermediation between savings and investment. This we
obviously need to some degree.
But do we need a financial sector that now accounts 7 or 8 percent of GDP?
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CONSUMER FINANCE IN PAKISTAN:
Some Myths and Facts
• Access to, and growth in, consumer finance carries both social and economic significance for the
society
• In the absence of such products from the formal banking sector, people used to borrow from money
lenders in the informal sector at exorbitantly high interest rates
• Banks have now facilitated them in acquiring the necessities of life by providing credit against their
future incomes and cash flows, at rates far lower than those demanded by players in the informal sector
• Since the consumer finance function in itself is quite labor intensive, demand for this product has led
the banking sector to employ a significant segment of the active workforce both on full time and part
time basis
• Banks themselves have also benefited from the diversification of their credit portfolio, as well as capital
savings under the Basel II regime, and consumer finance has brought higher returns and stability in
earnings
The phenomenal growth in consumer finance has also raised a debate regarding its downside risks and
implications.
It is generally perceived that this particular asset product has:
i. Given rise to consumerism in Pakistan, this has contributed to the low level of national savings;
ii. Fueled inflation; and
iii. Led to the rise in speculative activities in asset markets
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An analysis of actual facts and figures, however, dispels these notions
• Consumer Finance has certainly met the individual consumer’s needs for personal expenditures, but in
doing so, it has also generated demand for consumer durables and other goods and services which have
in turn translated into a chain of economic activities
• For the consumer, monthly payments for servicing the loan are a form of forced savings
• Rather than promoting consumerism, this product has contributed in enhancing the standard of living
of the middle class, which is the back bone of any economy
• Moreover, trends in savings of the household sector also do not support the perception of
consumerism, as the average saving rate of the household sector is higher in the post 2000 period as
compared with the ’90s
• An analysis of inflation dynamics does not support the claim that consumer finance is the reason for
the build up of inflationary pressures in the economy
• Core inflation, which is more sensitive to the level of credit and associated increase in demand, has
shown quite contained growth over the last few years (Figure 5.5)
• The recent rise in overall inflation is attributable to factors such as international price shocks, and
anomalies in administrative and fiscal policies
Personal loan is the only product which is not tied to a specific purpose, and thus could potentially be
utilized for speculative transactions in asset markets.
However, its potential for spurring speculative activities is limited because of the fact that:
(a) given its unsecured nature, this loan is priced competitively and is not an attractive funding option for
speculators;
(b) its main target market is mainly the fixed income / salaried segment of individual customers who are
generally risk averse and are not known to indulge in speculative activities;
(c) such loans are relatively smaller in amount (average loan size Rs. 20,000) than other categories of
consumer finance, whereas speculative transactions in asset markets generally require larger sums of
money;
(d) the level and annual growth of this particular portfolio is quite small in comparison with other possible
contributory factors such as the liquidity generated by increased foreign remittances and reverse capital
flight, as well as the easy interest rate regime that prevailed up until a few years back, where disbursed
loans for even small corporate entities and businesses could potentially have been miss-utilized
• Essentially, consumer finance, if utilized judiciously and within prudent limits, is a handy tool for
propelling economic growth, ensuring smooth consumption patterns and improving credit risk
diversification
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• That said, indiscriminate growth in this asset class in an unstable macroeconomic environment,
without a corresponding strengthening of risk management systems, could potentially create
systemic vulnerabilities (Recall Bank Business & Operating Model)
Because the financial system is so integrated — financial institutions borrow and lend large sums with each
other every day in normal times—problems in a few banks can create a systemic risk for the financial
system as a whole.
Paul O’Neill, a former Treasury secretary under President Bush, summarized this risk with a nice analogy:
“If you have ten bottles of water and one is poisoned, but you don’t know which, no one drinks water”.
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LESSON 10
COSTING /PRICING OF CB PRODUCTS
Major Issues and Challenges:
Bank’s efforts to expand their consumer finance portfolio are mainly faced with challenges emanating from
the less than favorable macroeconomic environment. Emerging deterioration in economic fundamentals i.e.
rising inflation rate, a certain degree of slowdown in economic activities, etc. has constrained the
consumer’s debt servicing capacity (Figure 5.6).
• This weakness is further intensified by rising interest rates as a consequence of monetary tightening
by the central bank which, besides dissuading new customers, have also made the existing debt
servicing more costly, given that most of the loans under this asset class are made on a variable or
floating rate basis
• An indication of the manifestation of the macroeconomic environment on consumer finance has
already started to reflect in the deceleration in its growth rate, and a relative increase in
nonperforming loans
• The infection ratio has gradually risen to 5.5 percent of the total outstanding credit in H1 CY08,
though it is still lower than that for the corporate sector at 7.6 and the overall infection ratio of the
credit portfolio at 7.7
• The performance of the different components however varies in this regard (Figure 5.7)
• Mortgage loans, with the lowest infection ratio, have shown relative improvement in disbursements
over the last few quarters, while the biggest impact of the macroeconomic environment has been
observed on the Credit Card, Personal and Auto loans’ portfolio
• Bank wise data shows that consumer loans are more concentrated in around 10 banks
• Notwithstanding, since consumer credit is spread over a large number of borrowers, such risks are
widely dispersed
• Results of a stress testing exercise (based on end June CY08 data) conducted on banks’ consumer
finance portfolio show that even a rise of 10.0 percentage points in the infection ratio will only
reduce the Capital Adequacy Ratio (CAR) of banks by 90 bps
• This is because the share of consumer finance in the overall credit extended by banks is still rather
low at 12.0 percent
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In recognition of the underlying risks, SBP continues to make concerted efforts to strengthen the regulatory
regime, as well as the risk management capacities of banks. The introduction of Prudential Regulations
specifically designed to address the risk factors in the consumer finance portfolio in CY03, and enhancing
the scope of the Credit Information Bureau (CIB) which was first launched in 1992 are some important
measures implemented to ensure prudent growth of the portfolio. The enhancement in scope of the e CIB
database now gives a comprehensive coverage of all borrowers of the banking sector (and some non bank
financial institutions) which has helped banks in ensuring that customers are not over leveraged, and that
the loan to income ratios are managed more prudently. Furthermore, SBP’s regulations and guidelines on
risk management and internal controls effectively delineate the desirable level of internal controls and risk
management capacities which the banks have started to implement for their consumer finance operations.
Banks are building upon the existing capacities and rapidly improving their risk management expertise in
response to regulatory requirements. Their progress along the learning curve suggests that they are now
better placed to handle the challenges related to the operations of the consumer finance business.
Future Outlook
Given that the total consumer financing portfolio currently forms around 12.0 percent of the total loans
and advances of the banking sector in comparison with substantially larger portfolios in peer countries, and
its conducive role in promoting economic development, concerns about the potential risks of this product
need to be viewed in perspective. This is particularly so because the household sector in Pakistan, from
where the demand for consumer finance is generated, is financially sound and under leveraged by
international standards.
Notwithstanding, given the pace of growth of this particular asset class and its increasing popularity,
financial institutions need to carefully plan the expansion of their respective portfolios by minimizing the
impact of the potential risks with adequate systems and resource support, in order to be able to sustain and
positively avail the benefits of its growth.
Notwithstanding these developments, a few initiatives are still crucially needed for maintaining the
stability of the consumer finance portfolio in coming years:
• With the growing exposure against consumer finance, banks would need to implement specific
credit scoring models. These can be based on the information derived from credit history
databases, such as the turnaround time of monthly repayments, level of income and type of debt,
length of credit relationship, in addition to other key pieces of information on social and
demographic factors which help in establishing borrower profiles. The model will help banks in
objectively identifying the credit worthiness of a borrower and the likely credit behavior. However,
for building an effective credit scoring model, the existing databases on the consumer’s credit
history would need significant enhancements;
• The prevailing regime for enforcement of security liquidation and collection of debts needs to be
rationalized in terms of effectiveness and fairness to both banks as well as consumers;
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• Considering the low level of financial literacy of the average consumer, mainly due to the low level
of awareness and the prevailing literacy rate in the country, banks would need to review the
transparency of the pricing mechanism, and offer a choice between fixed and floating rates to the
customers, while informing them of the pros and cons associated with each option. Such initiatives
will also help in improving the ethical standards of banks’ dealing with their customers
Financial Position of the Household Sector:
The household sector is the single largest provider of funding (in terms of personal deposits) to the banking
system. In aggregate terms, it holds 46.0 percent of banking system deposits, while it borrows only 12.0
percent of the total loan portfolio. National Income Accounts also reinforces this assessment, as the share
of personal savings in total national savings is over 80 percent.
While all these figures clearly indicate the household sector’s significant contribution to the financial sector,
a detailed analysis in the context of financial stability is heavily constrained by the lack of appropriate data.
The net wealth, or financial position, of the household sector is therefore estimated on the basis of selected
indicators including trends in personal deposits of the banking system, individual investments in the stock
market, and growth in personal investments in National savings Schemes (NSS). Changes in the consumer
loan portfolio of the banking sector are used as the only available indicator of outstanding debt.
Personal Deposits
Personal deposits of the banking sector registered a YoY increase of 19.9 percent during CY07, compared
to 18.2 percent in CY06, to reach Rs 1.6 trillion. Strong growth in personal deposits in recent years is also
visible from its increasing share in the overall deposits of the banking system. Specifically, the share of
personal deposits in total deposits increased to 45.0 percent by end June CY08, in comparison with 42.3
percent at end June CY07, and 40.3 percent as of end June CY03 (Figure 1). This is an encouraging
development as the overall deposits of the banking system in recent years have also recorded an average
growth of over 18.0 percent during CY03-07. The steady growth in personal deposits is largely attributed to:
(i) record inflows of remittances; and (ii) a sharp increase in per capita income in the wake of strong
economic growth in recent years.
Investments in Equity Market
Another indicator of financial health of the household sector is the individual customer’s investments in the
stock market. According to statistics from the Central Depository Company (CDC), the number of
individual account holders investing in the stock market has reached 41,700 accounts by end CY07,
compared to 10,000 at end CY03. The total value of these individual accounts has also grown significantly
to reach Rs. 331.7 billion inCY07 against Rs 39.9 billion in CY03 (Figure 2). However, the pace of growth in
new individual accounts at CDC has slowed down markedly in CY07, at 6.3 percent in comparison with
13.2 percent in CY06, 121.1 percent in CY05 and 57.0 percent during CY04. Interestingly, despite the lower
growth in the number of accounts during CY07, the volume of accounts grew by 51.3 percent against 28.6
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percent in CY06; showing increased transactional activities in both new and existing accounts, due to both
higher stock prices and increased volume of transactions.
Investments in NSS
The Central Directorate of National Savings (CDNS) offers various types of saving schemes for individuals
and institutional investors. While all the schemes are open to individual investors, statistics on the
proportion of individual investments are not available from CDNS. In order to estimate the growth of
personal investments in these instruments, investments in those savings schemes which are offered to
individuals investors only are taken into account. These schemes are: Bahbood Saving Certificates (BSC),
Pensioner's Benefit Account (PBA) and Prize Bonds. The outstanding amount in these schemes reached Rs
498.0 billion by end June 08, which constitutes 45.9 percent of the outstanding amount in all NSS,
instruments i.e. Rs 1,084.0 billion. In aggregate, these schemes increased by Rs 64.3 billion during FY08,
which was slightly lower than the increase of Rs 67.7 billion in FY07 (Figure 3). In terms of growth rates,
the outstanding amount grew by 14.8 percent during FY08, compared to 18.5 percent in FY07. This slight
decline during FY08 is primarily attributed to the fact that the substantial growth in these schemes when
they were relatively new is now at more sustainable levels. Also, individuals also invest in other schemes, as
BSC and PBA are in particular available for senior citizens/widows/pensioners only. Recent upward
revisions of the rate of return on these schemes are likely to attract more investments into these
instruments.
Following to be discussed in detail in the next lessons
Regulatory Framework for Consumer Financing:
1) Prudential Regulations for Consumer Financing
2) Guidelines for Standardization of ATM Operations
3) Guidelines for Dealing with Customer Complaints
4) Credit Information Bureau
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5) Redress Mechanisms for Consumer Complaints
i. Internal Complaint Units/Sections of Banks
ii. Banking Ombudsman
iii. Consumer Protection Department
iv. Banking Courts for Recovery of Loans
6) The Financial Institutions (Recovery of Finances) Ordinance, 2001
7) The Payment Systems and Electronic Fund Transfers Act, 2007
8) The Competition Ordinance, 2007
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LESSON 11
COSTING / PRICING OF CB PRODUCTS (CONTD…)
SBP PRUDENTIAL REGULATIONS FOR CONSUMER FINANCING APPLICABLE TO ALL
BANKS/DFI’S
MINIMUM REQUIREMENTS FOR CONSUMER FINANCING:
• General requirements laid down here should be followed by while undertaking consumer financing
• These minimum requirements should not in any way be construed to restrict the role of the
management to further strengthen the risk management processes through establishing
comprehensive credit risk management systems appropriate to their type, scope, sophistication and
scale of operations
• The Boards of Directors are required to establish policies, procedures and practices to define risks,
stipulate responsibilities, specify security requirements, design internal controls and then ensure
strict compliance with them
Banking Characteristics Risk Class Risk Category
Environment Environmental Risks
Legislative
Economic
Competitive
Regulatory
Human Resource Management Risks
Defalcation
Organizational
Ability
Compensation
Financial Services Delivery Risks
Operational
Technological
New Products
Strategic
Balance Sheet Financials Risks
Credit
Liquidity
Market
Leverage
• Risk is defined as the volatility of a corporation’s market value. The definition that has been
selected is as broad as possible. What is of interest is all decisions that may impact on a change in
market value
• This is consistent with the view that risk management is about optimizing the risk-reward tradeoff–
not about minimizing the absolute level of risk
• SBP guidelines define financial risk in a banking organization as the possibility that the outcome of
an action or event could bring up adverse impacts
• Such outcomes could either result in a direct loss of earnings / capital or may result in imposition
of constraints on bank’s ability to meet its business objectives
• Such constraints pose a risk as these could hinder a bank's ability to conduct its ongoing business
or to take benefit of opportunities to enhance its business
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PRE-OPERATIONS:
Before embarking upon or undertaking consumer financing, the banks / DFIs shall implement / follow the
guidelines given below:
1) The banks / DFIs already involved in the consumer financing will ensure compliance with these
guidelines within six months of the date of issuance of Prudential Regulations for Consumer
Financing
2) Banks / DFIs shall establish separate Risk Management capacity for the purpose of consumer
financing, which will be suitably staffed by personnel having sufficient expertise and experience in
the field of consumer finance / business
3) They shall prepare comprehensive consumer credit policy duly approved by their BOD (in case of
foreign banks, by Country Head and Executive / Management Committee), which shall interlay
cover loan administration, including documentation, disbursement and appropriate monitoring
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mechanism. The policy shall explicitly specify the functions, responsibilities and various staff
positions’ powers / authority relating to approval / sanction of consumer financing facility
4) For every type of consumer finance activity, the bank / DFI shall develop a specific program. The
program shall include the objective / quantitative parameters for the eligibility of the borrower and
determining the maximum permissible limit per borrower
􀂾 They shall put in place an efficient computer based MIS for the purpose of consumer finance,
which should be able to effectively cater to the needs of consumer financing portfolio and
should be flexible enough to generate necessary information reports used by the management
for effective monitoring of the their exposure in the area. The MIS is expected to generate the
following periodical reports:
• Delinquency reports (for 30, 60, and 90, 180 & 360 days and above) on monthly basis
• Reports interrelating delinquencies with various types of customers or various attributes of
the customers to enable the management to take important policy decisions and make
appropriate modifications in the lending program
• Quarterly product wise P/L account duly adjusted with the provisions on account of
classified accounts. These P/L statements should be placed before the BOD in the
immediate next Board Meeting. The branches of foreign banks in order to comply with
this condition shall place the reports before a committee comprising of CEO / Country
Manager, CFO and Head of Consumer Business
5) The banks / DFIs shall develop comprehensive recovery procedures for the delinquent consumer
loans. The recovery procedures may vary from product to product. However, distinct and objective
triggers should be prescribed for taking pre-planned enforcement / recovery measures
6) The banks / DFIs desirous of undertaking consumer finance will become a member of at least one
Consumer Credit Information Bureau. Moreover, the banks / DFIs may share information / data
among themselves or subscribe to other databases as they deem fit and appropriate
7) The financial institutions starting consumer financing are encouraged to impart sufficient training
on an ongoing basis to their staff to raise their capability regarding various aspects of consumer
finance
8) The banks / DFIs shall prepare standardized set of borrowing and recourse documents (duly
cleared by their legal counsels) for each type of consumer financing
OPERATIONS:
1. Consumer financing, like other credit facilities, must be subject to the Bank’s / DFI’s risk
management process setup for this particular business. The process may include, identifying source
of repayment and assessing customers’ ability to repay, his / her past dealings with the bank / DFI,
the net worth and information obtained from a Consumer Credit Information Bureau
2. At the time of granting facility under various modes of consumer financing, banks / DFIs shall
obtain a written declaration from the borrower divulging details of various facilities already
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obtained from other financial institutions. They should allow fresh finance / limit only after
ensuring that the total exposure in relation to the repayment capacity of the customer does not
exceed the reasonable limits as laid down in their approved policies. The declaration will also help
them to avoid exposure against a person having multiple facilities from different financial
institutions on the strength of an individual source of repayment
3. Before allowing any facility, the banks / DFIs shall preferably obtain credit report from the
Consumer Credit Information Bureau of which they are a member. The report will be given due
weightage while making credit decision
4. Internal audit and control function of the bank / DFI, apart from other things, should be designed
and strengthened so that it can efficiently undertake an objective review of the consumer finance
portfolio from time to time to assess various risks and possible weaknesses. The internal audit
should also assess the adequacy of the internal controls and ensure that the required policies and
standards are developed and practiced. Internal audit should also comment on the steps taken by
the management to rectify the weaknesses pointed out by them in their previous reports for
reducing the level of risk
5. The banks / DFIs shall ensure that their accounting and computer systems are well equipped to
avoid charging of mark-up on mark-up. For this purpose, it should be ensured that the mark-up
charged on the outstanding amount is kept separate from the principal
6. The banks / DFIs shall ensure that any repayment made by the borrower is accounted for before
applying mark-up on the outstanding amount
DISCLOSURE / ETHICS:
The banks / DFIs must clearly disclose, all the important terms, conditions, fees, charges and penalties,
which interalia include Annualized Percentage Rate, pre-payment penalties and the conditions under which
they apply. For ease of reference and guidance of their customers, banks / DFIs are encouraged to publish
brochures regarding frequently asked questions.
For the purposes of this regulation, Annualized Percentage Rate means as follows:
Mark-up paid for the period 360 100
Outstanding Principal Amount No. of Days
REGULATION R-1
FACILITIES TO RELATED PERSONS:
• The consumer finance facilities extended by banks / DFIs to their directors, major shareholders,
employees and family members of these persons shall be at arms length basis and on normal terms
and conditions applicable for other customers of the banks / DFIs
• The banks / DFIs shall ensure that the appraisal standards are not compromised in such cases and
market rates are used for these persons
• The facilities extended to their employees as a part of their compensation package under
Employees Service Rules shall not fall in this category
Utilization of Clean Loans for Initial Public Offerings IPOs:
While the State Bank’s intent is not to create any undue hindrance in the smooth flow of consumer
financing to the borrowers, the banks /DFIs are, however, advised to institute necessary checks, so that
clean loans are not used for subscription in Initial Public Offerings (IPOs). In this connection, SBP suggests
the following two minimum requirements:
(a) At the time of sanction of a clean consumer loan / credit line, they should obtain an undertaking
from the client, that the drawings from the loan account will not be used for subscription in an
IPO
(b) They should introduce an internal system, whereby, no cheques, drafts and / or payment
instructions will be made for an IPO subscription account from a clean personal loan / credit line
account
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REGULATION R-2
LIMIT ON EXPOSURE AGAINST TOTAL CONSUMER FINANCING:
Banks / DFIs shall ensure that the aggregate exposure under all consumer financing facilities at the end of
first year and second year of the start of their consumer financing does not exceed 2 times and 4 times of
their equity respectively. For subsequent years, following limits are placed on the total consumer financing
facilities:
REGULATION R-3
TOTAL FINANCING FACILITIES TO BE COMMENSURATE WITH THE INCOME:
While extending financing facilities to their customers, the banks / DFIs should ensure that the total
installment of the loans extended by them is commensurate with monthly income and repayment capacity
of the borrower. This measure would be in addition to their usual evaluations of each proposal concerning
credit worthiness of the borrowers, to ensure that their portfolio under consumer finance fulfills the
prudential norms and instructions issued by the SBP and does not impair the soundness and safety of the
bank / DFI itself.
REGULATION R- 4
GENERAL RESERVE AGAINST CONSUMER FINANCE:
The banks / DFIs shall maintain a general reserve at least equivalent to 1.5% of the consumer portfolio
which is fully secured and 5% of the consumer portfolio which is unsecured, to protect them from the risks
associated with the economic cyclical nature of this business.
The above reserve requirement will, however, be maintained for the performing portion only of consumer
portfolio.
REGULATION R-5
BAR ON TRANSFER OF FACILITIES FROM ONE CATEGORY TO ANOTHER TO AVOID
CLASSIFICATION:
The banks / DFIs shall not transfer any loan or facility to be classified, from one category of consumer
finance to another, to avoid classification.
REGULATION R-6
MARGIN REQUIREMENTS:
Banks / DFIs are free to determine the margin requirements on consumer facilities provided by them to
their clients taking into account the risk profile of the borrower(s) in order to secure their interests.
However, this relaxation shall not apply in case of items, import of which is banned by the Government.
• Banks / DFIs will continue to observe margin restrictions on shares / TFCs as per existing
instructions under Prudential Regulations for Corporate / Commercial Banking (R-6). Further, the
restrictions prescribed under paragraph 1.A of Regulation R-6 of the Prudential Regulations for
Corporate / Commercial Banking will also be applicable in case of Consumer Financing
• State Bank of Pakistan shall continue to exercise its powers for fixation / reinstatement of margin
requirements on consumer facilities being provided by banks/DFIs for various purposes, as and
when required
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LESSON 12
BANK SCHEDULE OF CHARGES
Guidelines for Standardization of ATM Operations
ATM is among the most important e-banking delivery channels in Pakistan. It is becoming increasingly
popular, as it facilitates accountholders to withdraw fast cash anytime, inquire balance, and transfer funds
throughout the year. The SBP has issued separate guidelines for all the commercial banks and switch
operators in order to curtail any inconvenience to the users of ATM services. The guidelines require the
banks having ATMs to carry out cash balancing and reconciliation on every working day at the time fixed
by their Head Office, other than the peak hours.
According to the guidelines, a process of “automatic credit” is to be carried out on the basis of verified
individual transactions in which a customer’s account has been debited without any cash disbursement.
Moreover, the process of “automatic credit” is to be completed within the timeframe ranging from one to
seven business days, depending on the manner of execution of transaction by a cardholder of a bank. In
order to facilitate the customers and meet the objectives of the ATM, banks are also required to develop a
detailed documented procedure for automatic credit and carry out training of relevant staff members. The
guidelines necessitate Card Facilitation Centre (CFC) in every bank. CFC is a unit responsible for managing
e-banking channels and maintaining database of cases (resolved/unresolved) of its own customers and
balance in suspense account. In this regard, every branch ought to report to CFC the details of claims
settled, outstanding claims and balance suspense account on daily basis, to enable quick response of
queries.
It is mandatory for all the banks to identify at least two key personnel of CFC, who would be responsible
for responding to the queries of customers, and their contact details are to be made available on website of
the bank. Furthermore, customer must be informed in writing about the amount credited to his/her
account by the issuing bank. Besides, the customers are not to be charged for minimum balance when their
account has been debited without cash disbursement and time for which the amount remains payable. For
providing secondary evidence to satisfy the customer against cash claims, banks are required to install
external camera in ATM cabins in a way that PIN may not be captured.
Moreover, the guidelines obligate all banks to report details regarding the nature of transactions (automatic
credit, claims processed or outstanding balance (suspense ATM cash), and total number and amount of
actual transactions to the SBP’s Payment Systems Department (PSD). In addition, every bank is required to
develop a numbering sequence for complaints and every complainant is to be issued a reference number.
These guidelines are applicable only on cards used on ATM machines for local currency transactions, which
are carried out in Pakistan.
Guidelines for Dealing with Customer Complaints:
Keeping in view the complaints received by the SBP regarding financial losses, damage to the businesses,
and delayed response of banks, the SBP has issued guidelines for dealing with the customer complaints.
SBP observed that due to absence of proper mechanism for resolution of public grievances, the banks are
unable to respond to the customer complaints promptly and efficiently. Therefore, these minimum
guidelines require every bank and financial institution to designate a senior officer to deal with all sorts of
complaints, whether they are received directly by the bank or referred to by other institutions including the
SBP. All banks are obligated to provide contact details of such designated officials or any change with this
reference to the SBP.
According to the guidelines, the person and the unit/section appointed for this purpose is responsible for
acknowledging, addressing, handling and investigating all the complaints in a fair and prompt manner. The
reply to the complaints ought to be clear and indicate the reasons of the decisions taken. The complaint unit
is also required to identify complaints of recurring nature for taking immediate corrective measures in the
related area. In addition, the unit has been guided to monitor and analyze the status and data of complaints
for improving the system. Every bank or financial institution is also required by the guidelines to submit a
regular report about the complaints to the management of the bank or financial institution for review.
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The response time for the complaints has been fixed at 10 days under the guidelines. However, an interim
reply can also be sent to the complainant explaining the reasons for delay, but the final reply is to be
transmitted within 45 working days. Like other departments of the bank, the complaints department/unit is
also required to be regularly audited by internal auditors to check the effectiveness and performance of the
unit.
For raising awareness among the customers about the grievance redress procedure and complaint unit, the
banks and DFIs are required to prepare a leaflet indicating the procedure for lodging a complaint and its
resolution, and post the same on the notice boards at each of their branch/office and on the website.
Besides, a copy of the leaflet is to be supplied to customer upon request. Moreover, the bank staff is to be
provided appropriate training to enhance their skills so that an employee who is not directly involved with
the complaint unit may investigate a complaint, if required.
The guidelines specify that the complaints forwarded by the SBP would be handled by the person who is
the contact person for SBP in this regard. Whereas, the SBP would check the performance, effectiveness
and function of the complaint section and strict actions would be taken against the bank or DFI and the
concerned staff members for noncompliance with the procedures or mishandling of complaints.
What is a Grievance?
‘Grievance’ may be defined as a formal statement of complaint generally against an authority, or an
institution. Most often, organizations establish a body or designate an officer who deals with complaints of
the clients. Such a body plays important role for identification, intervention and resolution of issues that
have the potential of becoming a grievance. When the circumstances do not allow prior resolution of issues
and a grievance takes place, the redress forum is responsible for initiating a grievance redress process. The
aim is to protect the citizens’ right to raise a genuine issue, lodge a complaint for a grievance, and have the
grievance redressed in a timely manner.
On line Credit Information Bureau (e-CIB)
While developed countries have a long tradition of maintaining a centralized database of credit history of all
borrowers, in many developing countries it is a relatively new development, given the scope and size of their
lending activities. State Bank considers the functioning of an effective credit information bureau integral in
promoting financial discipline and an essential tool for credit risk management by financial institutions. In
its endeavor to facilitate financial institutions in making prudent lending decisions, the Credit Information
Bureau (CIB) was established in 1992. Due to the rather small and largely secured lending extended to
individual customers at that time, the initial focus of the CIB database was on capturing the negative history of
large and medium sized borrowers, with outstanding loans equal to and above Rs 500,000 only. Over the
years, SBP has significantly enhanced the scope of CIB operations. In April 2003, SBP enhanced the
coverage and effectiveness of CIB by introducing e CIB online facilities, becoming in the process, the first
credit history database of the region to introduce online access to its member financial institutions. This
development enabled financial institutions to upload their data on loans directly into the CIB database and
readily generate customer reports for their credit assessment purposes.
In response to the rapid growth in banks’ credit portfolio, e CIB’s reporting requirements and operational
and IT platforms have been significantly upgraded. The scope of the CIB database was further enhanced
during early 2004 when SBP launched a new project called the “e CIB data lowering limit” with the
collaboration of Pakistan Banks Association (PBA) to achieve the following objectives:
• Abolishing the minimum limit of Rs 0.5 million and above for credit reporting and to expand the
database to cover all loans of member financial institutions
• Changing the composition of the information to include more financial and non financial details
of the borrowers
• Improve the overall operational efficiency of e CIB by upgrading the communication
infrastructure, hardware and software, etc
The project aimed at transforming CIB into a state of the art credit information database with the ability
to minimize the turnaround time of queries from financial institutions and providing a quick source of
information. The project was successfully completed in June 2006 and brought significant improvements in
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the overall operational and technological infrastructure of the CIB. The key improved features of the new e-
CIB system over the old CIB system are summarized below:
• Existing credit reporting limits of Rs 0.5 million has been eliminated. Under the new reporting
system, all outstanding fund and non fund based credit facilities, irrespective of the amount, are
being reported to SBP
• Besides Banks and DFIs, for whom membership in e CIB is mandatory, a large number of
NBFCs are also members of this database
• Product wise availability of loan information. Before implementation of the new system, such
information was available in aggregate form only
• Improved efficiency in terms of speed, reliability and security of CIB data
• Deployment of high capacity servers, security firewalls, broader bandwidth, point to point data
encryption
• Multi user and multi tiered Rich Client Data using latest programming tools, provided to 100
financial institutions. The software has been designed keeping in view the data collection
requirements of all financial institutions and can be customized according to the needs of specific
financial institutions. It can be deployed in both centralized and decentralized environments. The
software is capable to efficiently collect, consolidate and report thousands of records from all
branches of a large bank
• Highly sophisticated and completely automated Back Office (BO) system for processing data. With
the implementation of the BO system the task of data processing has been reduced from 15 days to
3 days only
• Web based interactive data inquiry systems to provide online Credit Information Reports to
financial institutions, and allow online amendment and updates
• Replaced the previous dial up system with a scalable Virtual Private Network (VPN) that allows
financial institutions to connect to the e CIB more quickly and efficiently
• Comprehensive data validation rules implemented to ensure correct entry of records. A validation
rule engine has also been developed for creating and implementing new data validation rules
• A new separate reporting system has been introduced for consumer and commercial borrowers.
The CIB will collect consumer and corporate credit data on two separate specified formats and
provides separate credit information reports for the consumer and corporate borrowers
• The credit report of the consumer also reflects the repayment history for the last twelve months
• Record of last four credit inquiries from the financial institutions has also been made part of the
respective borrower’s credit report
Redress Mechanisms for Consumer Complaints:
Banking Ombudsman
The Federal Government established the Banking Ombudsman in 2005. The principal responsibility of the
Ombudsman is to resolve the complaints through mediation and provide an amicable and acceptable
solution where conciliation is not possible.
Jurisdiction
The Banking Ombudsman has been entrusted with the powers and responsibilities to entertain complaints
lodged by the customer against the scheduled banks or by a scheduled bank against another bank, and
provide the basis for an amicable and acceptable solution after giving hearings to the complainant and the
concerned bank. Moreover, Banking Ombudsman has been given authority to make recommendations, to
be communicated to the concerned bank for considering the issue, and in some cases to pass an order
against the concerned bank. To improve the service standards and effectiveness, and remove the
generalized systematic deficiencies, the Banking Ombudsman can recommend procedural improvements.
SBP can inquire the banks involved in violation of laws and regulations on recommendation of the
Ombudsman.
The authority and powers of Banking Ombudsman have been specified for private and public sector banks.
In relation to all banks, Banking Ombudsman has been given the authority to entertain the complaints
regarding bank’s failure to act in accordance with the laws, regulations, policy directives and guidelines,
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which are time to time issued by SBP and inquire the delays or fraud in relation to the payment or collection
of cheques, drafts or transfer of funds. Moreover, the Banking Ombudsman has also been allowed to
consider the complaints regarding fraudulent or unauthorized withdrawal or debit entries in accounts,
complaints from exporters or importers, complaints related to banking services and obligations including
letters of credit, complaints from holders of foreign currency accounts, whether maintained by residents or
non-residents, complaints relating to remittances to or from abroad and relating to payment of utility bills.
A noteworthy characteristic of the Baking Ombudsman is that it has some special powers, which do not
apply to the private banks. The responsibilities of entertaining the complaints pertaining to corruption,
negligence of duties by bank officers in dealing with customer and excessive delay in taking decisions can be
exercised only in respect of public sector banks.
In addition, Banking Ombudsman has the authority to call for relevant information necessary for disposal
of complaints, receiving evidence on affidavit and issuing commission for examination of witness, given
that confidentiality would not be violated.
Bar on Jurisdiction
However, there are some matters which are outside the jurisdiction of Banking Ombudsman including the
power to direct banks for giving loans and advances to a complainant. Similarly, the Banking Ombudsman
has no authority to consider the complaints regarding the schedule of charges and any other policy matter
of banks. Likewise, complaints pertaining to terms and conditions of service of the bank are not accepted
by the Banking Ombudsman. Moreover, awarding the damages against banks is not within the jurisdiction
of Banking Ombudsman. However, the authority for the compensation of loss suffered by aggrieved
persons in pursuit of justice lies with him.
Complaint Procedure
The complaint handling process of Banking Ombudsman is centralized at the Karachi Secretariat. The
complainant is required to file a complaint to the bank in writing stating the intention to refer the matter to
the Banking Ombudsman if matter would not be resolved satisfactorily. The bank is required to resolve the
complaint within 45 days, otherwise the complainant can file the case to Banking Ombudsman on the
complaint form duly completed, signed and attested by an Oath Commissioner, attached to the letter of
complaint. Moreover, the complainants are required to make sure that copies of all documents and relevant
correspondence with the bank are also attached along with the form and letter of complaint.
The Banking Ombudsman entertains those complaints, which are filed by a customer against scheduled
bank or by a scheduled bank against any other bank. Further, the rejected complaints, which have not been
barred by time or have not been destroyed by the bank, are also entertained by the Banking Ombudsman.
In this regard, the complainant has to send all related correspondence along with the complaint form
without giving 45 days notice to the concerned bank.
When a complaint is lodged to the Banking Ombudsman, first all procedural requirements are confirmed
and both parties may be required to provide additional information, if necessary. Informal complaints (i.e.
walk in, e-mail, copies of letters or via telephone) are resolved by providing procedural guidance to
complainant. In case of formal complaints, the banks are formally informed where necessary. Regarding
informal complaints, the law allows to entertain only those complaints, which have been filed directly to
Banking Ombudsman and made under oath.
The Banking Ombudsman may also visit the concerned bank to examine their books, procedures and
processes relating to complaints. The case is closed if found unjustified. However, if a case is found to be
genuine, then it would be resolved through mediation. The situation where conciliation is not possible, the
Banking Ombudsman passes an order asking the bank to rectify the situation or compensate the loss of
aggrieved.
The Banking Ombudsman solves the complaint within two months. However, some complaints may take
longer to resolve if they are complex or information and copies of documents are not provided by the
complainant. Therefore, a complainant is required to make sure that the complaint form has been filled in
with clarity and copies of all the relevant documents are attached.
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The Right to Appeal
The law provides the right to appeal to parties, the complainant and the bank. A complainant, dissatisfied
with the decision of Banking Ombudsman, has the right to appeal to the Governor SBP within 30 days
from the date of order of the Ombudsman. Moreover, a complainant, dissatisfied with the decision of SBP,
has also been given the right to go to a court of law. However, the Ombudsman’s decision would be final,
operative and binding upon the bank, if no appeal is filed or SBP does not uphold the appeal.
Several changes have been made in the Banking Companies Ordinance, 1962 through the Finance Act, 2007
empowering the Banking Ombudsman to issue commission for the examination of witnesses. In
consideration of the changes, Banking Ombudsman does not entertain those cases, which have already been
decided or handled by the SBP.
The time allowed to banks, to send the complaint to the Banking Ombudsman if not resolved, is reduced to
45 days from three months. Earlier, there was no time limit for disposal of an appeal filed with SBP against
any order by the Banking Ombudsman, which has now been limited to 60 days. Unless an appeal is referred
to the Governor SBP, the time limit for implementation of an order passed by the Banking Ombudsman
has been increased to 40 days and submission of compliance report is compulsory, which was not required
previously.
Consumer Protection Department:
• Keeping in view the growth in consumer banking and related consumer complaints, SBP has issued
a circular on January 30, 2008 for the establishment of new department, namely Consumer
Protection Department (CPD)
• The Department would resolve consumer complaints dealing with banks
• All banks and financial institutions would submit complaints and appeals against the orders passed
by the Banking Ombudsman to the Consumer Protection Department
Banking Courts for Recovery of Loans:
• Under the Recovery of Finances Ordinance, 2001, the Federal Government has been entrusted
with the authority to establish banking courts, appoint judges for each of such courts, and specify
the territorial limits to exercise its jurisdiction
• Federal Government has established 29 banking courts throughout Pakistan for quick recovery of
bank loans from defaulters
• The order of banking court would be final and no other court or authority would have power to
revise, review or call, into question any proceeding, judgment, decree or order of banking court
The Financial Institutions (Recovery of Finances) Ordinance, 2001:
• The new recovery law provided a mechanism for expeditious recovery of stuck up loans, e.g., the
law provided a comprehensive procedure for the foreclosure and sale of mortgaged property
without the interventions of a court of law, and automatic transfer of all cases pending in any other
courts to the banking courts for their early resolution
• Under the new legislation, banks may recover debt through summary procedure, and sell
mortgaged property without intervention of the court
The Payment Systems and Electronic Fund Transfers Act, 2007
With the rapid development in technology, like other spheres of human life business and trade are also no
more limited to traditional modes of delivery of products and services, as well as, purchase and payments in
cash. A person sitting at one place can buy any product from another place through internet and can pay
through secured online electronic channels like credit cards. Many countries around the world have
formulated laws, rules and documentation procedures for secure fund transfer through electronic means.
The Government of Pakistan promulgated the Payment Systems and Electronic Fund Transfers Act, 2007
in order to encourage documentation of economy, supervise and regulate such payments and fund transfers,
provide standards for protection of the consumer and to determine respective rights and liabilities of the
financial institutions and other services providers, and their consumers and participants. The Act is aimed at
providing regulatory framework for the electronic fund transfer services. Under the Act, the SBP has the
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authority to designate a payment system as a designated a payment system and/or revoke designation of a
designated payment system.
Under the Act, the SBP is also empowered to issue rules, guide lines, circulars, by-laws or directions as it
may consider appropriate. A bank, financial institution, clearing house, service provider or any person
authorized by the SBP to transact business under the Act and providing funds transfer facility is required to
retain complete record of electronic transactions in electronic form and ensure secure means of transfer
consistent with international standards. Clause 8 and 9 of the Act describe the reasons for disqualification of
staff of a designated payment system and its effects respectively. According to the Act, the operator of a
designated payment system is obligated to establish adequate governance arrangements which are effective,
accountable and transparent or which may be required by the SBP to ensure the continued integrity of such
system.
The SBP is empowered under the Act to nominate one or more clearing house to provide clearing or
settlement services for a payment system and to formulate ‘settlement rules’ relating thereto. Besides, certain
conditions have been imposed in the Act for the issuance of a designated payment instrument. The financial
institutions and other institutions providing Electronic Funds Transfer (EFT) facilities are required to
ensure that secure means are used for transfer of funds which are compliant with current international
standards. In respect of each EFT initiated by a consumer, the financial institution holding such consumer’s
account is required to provide documentary proof to the consumer of such transfer.
The Act further requires the financial institution to provide periodic statement of account to each consumer
in respect of each electronically accessible account. It also lays down the procedures to be followed in case
of errors or omission in electronic fund transfer (EFT) and the respective liabilities of the financial
institutions and consumers in such circumstances. Under the Act, a consumer may also complain to the
SBP regarding EFT in case of not being satisfied with the outcome of a complaint made to financial
institution without prejudice to any right to seek any other remedy under the law.
The Competition Ordinance, 2007
The Government of Pakistan, in a bid to strengthen the competition policy and law, constituted
Competition Commission of Pakistan. The Commission is responsible for promotion of competition and
fair trade practices. The legal mandate comes from the Competition Ordinance, 2007. All regulated sectors,
including the banking sector, fall within the purview of the Ordinance.
Section 4 and 10 of the Ordinance are particularly relevant in the context of banking sector, as they deal
with prohibited agreements and deceptive market practices. Section 4 lays down that no undertaking or
association of undertaking shall enter into any agreements or, in the case of an association of undertakings,
shall make a decision in respect of the production, supply, distribution, acquisition or control of goods or
the provision of services which have the object or effect of preventing, restricting or reducing competition
within the relevant market unless exempted under the ordinance. Such agreements includes, but are not
limited to fixing the purchase or selling price or imposing any other restrictive trading conditions with
regard to the sale or distribution or any goods or the provision of any services.
Such agreements also include those, which involve dividing or sharing of markets for goods or services,
whether by territories, by volume of sales or purchases, by type of goods or services sold or by any other
means; fixing or setting the quantity of production, distribution or sale with regard to any goods or the
manner or means of providing any services; limiting technical development or investment with regard to the
production, distribution or sale of any goods or the provision of any service; or collusive tendering or
bidding for sale, purchase or procurement of any goods or services; applying dissimilar conditions to
equivalent transactions with other trading parties, thereby placing them at a disadvantage; and make the
conclusion of contractors subject to acceptance by the other parties of supplementary obligations which, by
their nature or according to commercial usages, have no connection with the subject of such contract.
Section 10 of the Competition Ordinance 2007 prohibits deceptive marketing practices (which are common
in the banking sector). The law provides that no undertaking shall enter into deceptive marketing practices.
The deceptive marketing practices shall be deemed to have been restored to or continued to or continued if
an undertake restores to the distribution of false or misleading information that is capable of harming the
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business interests of another undertaking; the distribution of false or misleading information to consumers,
including the distribution of information lacking a reasonable basis, related to the price, character, method
or place of production, properties, suitability for use, or quality of goods; false or misleading comparison of
goods in the process of advertising or packing; fraudulent use of another’s trademark, firm name, or
product labeling or packing.
The above review indicates that a number of mechanisms exist for dealing with public complaints and
concerns that are associated with consumer financing. Still, the number of complaints is rising every year.
While this trend can be measured in proportion to the increasing number of borrowers and overall
consumer financing portfolio, lack of consumer education and weaknesses in the grievance redress
mechanism are among the major reasons for rising customer dissatisfaction. The Banking Ombudsman is a
case in point. The complex complaint procedure and limited powers of the Ombudsman do not provide an
incentive to many aggrieved customers to approach this forum against banks. The regulatory framework
needs to be reformed keeping in view the emerging issues and challenges in consumer financing.
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LESSON 13
CONSUMER FINANCING IN PAKISTAN ISSUES, CHALLENGES AND WAY FORWARD
STUDY / REPORT
Published by
Consumer Rights Commission of Pakistan (CRCP)
Website: www.crcp.org.pk
Pakistan Consumer Banking Landscape
Issues/Concerns from Consumers Perspective:
1. High Interest Rate Spread
2. Variable Interest Rate
3. Increasing Inflationary Impact
4. Deteriorating Quality of Services
5. Unsolicited Financing
6. Lack of Consumer Education
7. Poor Information Disclosure Practices
8. Loosing Competitiveness in International Trade
9. Intimidating Recovery Practices
10. Weaknesses in Regulatory Framework
1. High Interest Rate Spread:
Low interest rate spread is an important indicator of the efficiency and competition in the financial systems
and helps in economic growth through increased investments. In the national context, the most important
issue in consumer financing from the standpoint of national economy as well as individual consumers is
that Pakistan has one of the highest interest rate spread in the world.
An analysis of the interest rate behavior in Pakistan reveals that the spread has vacillated between 5.95%
and 9.58% during the period from 1990 to 2005. This indicates that average deposit rates have been very
low, as compared to average lending rates. One could have expected a decrease in spread as a potential gain
of competition among the increasing number of banks in the post-2001 period. However, little change has
been observed in average spread, which points towards a cartel-like behavior of the banking sector.
If we look at the nominal and real interest rates, it becomes evident that consumers have had suffered a
great deal at the hands of banks. From 1990 to 2004, the nominal weighted average lending rate has always
been higher than inflation rate. The real lending rates averaged between 1.98% and 9.69%, which means
that the banks earned net profits on lending in all these years. In contrast, the average deposit rate was
slightly higher than inflation rate in four years only (1999-2002). The real deposit rates were negative in 11
years. It partly explains the impact of inflation on interest rate spread. The banks keep the lending rate high
enough to ensure that the real lending rate is almost always positive.
In recent years, the spread has exceeded 7% on the average. The high difference between lending and
deposit rates indicates that the depositors are not getting due returns, as compared to huge profits being
earned by the banks. Indeed, the lending rates have increased and deposit rates have decreased over the last
few years.
In February 2008, the weighted average lending rate was 11.23% whereas the weighted average deposit rate
was 4.17% resulting in high interest rate spread to the tone of 7.04%. In terms of average interest rate
spread of banks in South Asia, Pakistan has the highest spread. From 2003 to 2005, its average spread has
remained between 6.33% and 7.79%. Whereas, during the same period, it ranged between 4.50% and 6.9%
in India, 4.34% and 5.99% in Sri Lanka, and between 5.27% and 6.11% in Bangladesh (Table 4).
While the spread is higher in South Asian as compared to other regions, Pakistan stands out distinctively
due to huge difference between lending rate and rate of return on deposits. The spread in Pakistan is much
higher than average rates in many countries around the world. Chart 2 shows average interest rate spread in
13 countries, which ranges between minimum 1.71% (Japan) and maximum 4.5% (Italy). This is evident
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from these statistics that average interest rate spread in Pakistan exceeds the regional as well as international
average rates.
.
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High interest rate spread indicates that competitiveness in the banking sector in Pakistan is either absent or
is very poor. A cartel-like behavior in banks appears to have taken place within the policy space provided by
SBP. In April 2006, the present Governor of the SBP had said that banking spread was very high in the
county and termed it an inefficiency of banks. In December 2006, she said that spreads were high because
the sector was not facing competition and it was hurting the economy. However, she said that time was yet
to come when SBP should exercise its powers.
This issue is largely attributable to weak SBP regulation of interest rates despite that it has the powers to
bring down the spread through monetary policy. While non-operating loans and high administrative costs
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could be considered as the major reasons in countries where spread is high. These reasons cannot be said
true of Pakistan because banks are earning huge profits at the cost of savings of the depositors.
2. Variable Interest Rate:
A variable interest rate moves up and down based on factors including changes in the rate paid on bank
certificates of deposit or treasury bills. From a consumer’s standpoint, it makes a huge difference whether
the bank is charging variable or fixed rate on credit. If a consumer enters into an agreement with the bank
on the basis of fixed interest rate, the bank cannot change the overall payable interest during the entire
tenure even if interest rates go up in the market. In contrast, when the interest rate is variable, the bank ties
the rate with an index. The interest payable by the consumer varies as the index changes.
In Pakistan, almost all consumer loans are on the basis of variable mark up rates. This policy is attributed to
two reasons. First, variable rates are in the larger interest of banks due to high probabilities of increase in
rates in the future. Second, a long term debt market has yet to be developed to provide term funding to the
banks. However, banks also offer loans in which borrowers are given the choice of fixed or variable mark
up. If the borrower chooses fixed mark up, the rate offered is generally higher than the variable mark up
rate at the time of the contract. Therefore, borrowers most often choose variable mark up, without realizing
their future financial liability, in the hope that the rates will fall in the future. This has seriously affected the
loan servicing capacity of the borrowers with deleterious effects on their savings.
Some countries have determined fixed or variable interest rate for each sector depending on specific needs.
In the United States, for example, the interest rates on education loans were changed from variable rates to
fixed rates in 2002. In addition, there are examples of discount periods for variable interest rates. Such
practices need to be introduced and scaled up in Pakistan in order to serve the interests of small borrowers.
3. Increasing Inflationary Impact:
• Easy bank credit by the household consumers has spurred the demand for many essential and
luxury items
• Ultimately, the increase in demand has not only escalated the prices of essential items, but has also
stimulated hoarding and black-marketing thus multiplying the problems for poor consumers. (Unintended
Consequences)
• Similarly, the demand for road networks and fuel imports has increased due to growth in auto
financing
• These developments have an overall inflation impact, which is affecting the purchasing capacities of
the poor
4. Deteriorating Quality of Services:
As the consumer financing portfolio is increasing, quality of related banking services is becoming a serious
issue. Processing delays, service inefficiencies, unauthorized debits and non-compliance with requirement of
providing monthly bank statements are few examples of poor quality of banking services. Other issues such
as non-transparent advertisements, violation of agreed terms and conditions, levy of unjustifiable charges,
and arduous complaint redress mechanism, etc. also reflect upon the poor quality of consumer services.
The press frequently reports such complaints, which speak of the issues in quality of banking services. For
example, some banks are involved in charging late payments penalties despite payment on time. Similarly,
many credit card users complain about service charges appearing on their credit statements, which make no
sense to anybody. The number of complaints is increasing every year. For example, in the first eight months
of the operation of Banking Ombudsman in 2005, about 40 per cent complaints filed with the Ombudsman
were related to consumer products, and among these complaints, 30 per cent were related to credit cards
alone.
In 2006, Banking Ombudsman received 215 complaints out of which 18 were rejected, 71 were declined
and 90 complaints were granted. There were 36 complaints related to internal banking fraud scam, still
being investigated by the Banking Ombudsman. The complaints received at Banking Ombudsman were
related to service rules, service inefficiency, and loan remission of mark-up waiver, frauds and consumer
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products. However, it is observed that percentage of complaints received regarding consumer products was
46%, much higher than other type of complaints received.
The complaints related to consumer products included credit cards, small loans, auto loans, undertake mark
up, processing delays and ATM’s complaints. Magnitude of credit card complaints was much more than all
other complaints, nearly 40% of total complaints.
5. Unsolicited Financing:
• Aggressive marketing campaigns launched by the banks are targeting the consumers and repeatedly
encouraging them to purchase a loan or credit card
• Misleading phone calls are made to the consumers with false promises
• The supply driven approach is creating artificial consumerism on one hand, and is limiting the
choices for consumers, on the other
• For example, auto leasing makes a fit case of banking sector’s dominance over customers
• A car lessee, for instance, is bound to insure the car from an insurance company of the bank’s
choice
6. Lack of Consumer Education:
• Most of the consumers do not have enough understanding of the very basic rules and terms and
conditions
• Documents prepared by banks are usually technical and the information which may affect financial
rights of the consumers is never stated clearly and plainly in these documents
• Need to focus on public awareness about the financial rights of the citizens, and the forums
available to them for accessing justice, if these rights are violated (Example; Proposed CFPA in
USA)
7. Poor Information Disclosure Practices:
• Access to information related to consumer financing remains a critical issue
• A strong culture of secrecy prevails in the banks, as they avoid providing even ordinary and
insensitive data
• Apart from reporting requirements laid down in the SBP regulations and contracts, there is no law
in Pakistan, which entitles the consumers to access information from private banks as a legal right
• The existing freedom of information laws are applicable to only public sector banks, and do not
extend to private banks and DFIs
8. Loosing Competitiveness in International Trade:
Banking sector has assumed greater importance due to liberalization of trade under the General Agreement
on Trade in Services (GATS). Pakistan has opened up the financial sector and made a number of
commitments under GATS without performing any Economic Needs Test (ENT). The impact of such
decisions needs to be ascertained keeping in view the contribution of financial services in services trade.
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The imports of financial services have remained substantially higher than exports. Estimates suggest that the
imports in financial services were US$ 77 million in 2003-04 and 2004-05, and US$133 million in 2005- 06.
In comparison, exports in financial services stood at US $21 million, US$ 39 million, and US$ 70 million
during the same years.
The challenge for Pakistan is to increase exports in financial services in a manner that has least impact on
low income customers. Given the huge spread in interest rates, the local banks have no incentive to
improve internal efficiencies to become competitive in the international market. Therefore, urgent steps
including reduction in spread need to be taken to create competitive financial environment in Pakistan.
9. Intimidating Recovery Practices:
Recovery of dues from borrowers is the responsibility of the ‘collection department’. However, when a
borrower does not clear all his dues, the case is transferred to the loan recovery department. Legally, under
Section 15 (sub-section 2) of the Financial Institutions (Recovery of Finances) Ordinance, 2001, the banks
are required to send three legal notices to the borrowers for payment of dues within the specified time
periods. If the borrower fails to pay the dues even after third legal notice, only then the bank has the
authority (under sub-section 4 of section 15) to sell the property of the mortgagor, without the intervention
of any court, which was kept on mortgage as a security for the bank.
Keeping aside the law, the banks have constituted recovery teams who use strong-arm tactics to harass the
borrower and make threatening calls. Despite the fact that bank’s recovery teams have no legal authority to
visit the borrower’s residence; sometimes, recovery teams reach the borrower’s house to intimidate and
pressurize them for payment of dues. In some instances, they illegally coerce and misbehave the borrowers,
and, in desire of earning more commission, cross the limits by abusing, brutally beating, showing guns,
locking in the house and threatening to dreadful consequences.
Second annual report (2006) of the Banking Ombudsman stated a rise in the unrestrained action by the debt
collectors; cases have also come to light where innocent people have been accost and maltreated as well as
cases where borrowers with up-to-date payment record have been needlessly harassed. The report
mentioned that in most countries, debt collection is regulated by the law. In the US, to prohibit certain
methods of debt collection and treat borrowers fairly, the “Fair Debt Collection Practices Act” was
incorporated in the “Consumer Credit Protection Act” in 1977. According to Banking Ombudsman Report
(2006), some banks in Pakistan have developed guidelines applicable to debt collection but these are not
strictly followed by external recovery agencies engaged for the purpose. To protect consumers from abuse
by debt collectors, it was recommended that Pakistan Banks Association be asked by SBP to draft suitable
set of instruction for compliance by external debt collection agencies.
10. Weaknesses in Regulatory Framework:
The frequent violation of financial rights of the consumers is attributed, mainly, to weaknesses in the
regulatory framework governing the banking sector, and low level of consumer education about the relevant
policies and rules. The existing regulations do not capture the full range of problems being faced by the
users of consumer financing services. For example, the regulations do not restrict the banks to levy
unjustified service charges such as high fee on depositing cash in one’s own account. Another case in point
is the Credit Worthiness Reports maintained by the Credit Information Bureau (CIB). According to the
rules, these reports are confidential documents for the borrowers, and amount to denial of the right to one’s
own personal information.
On the top of it, whatever regulations exist, they are yet to be fully implemented. As a matter of fact, the
banks enjoy a great degree of freedom for formulating their own policies and procedures regarding credit
cards, automated services, loans, interest rates, etc., which suit their interests best. These missing links, if not
abridged adequately, would continue to harm the interest of the consumers on one hand, and affect the
potential of banks to serve as a strong base of economy in the longer term, on the other hand.
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LESSON 14
CODE OF CONSUMER BANKING PRACTICE: THE ASSOCIATION OF BANKS IN
SINGAPORE
• This Code of Consumer Banking Practice represents the collective and concerted effort of banks in
Singapore in reaching out to their customers
• The Association of Banks in Singapore has spearheaded this voluntary initiative and has worked
with member banks with retail customers to crystallize for the first time, and on an industry wide
basis, the minimum standards of service and conduct, which you, the customer can expect in dealing with
your bank
• Like other organizations and corporations, banks in Singapore face some challenging times ahead
• Foremost is the preservation and enhancement of the banks’ relationship with their customers
• We believe that the four principles on which this Code is premised:
􀀹 Fairness
􀀹 Transparency
􀀹 Accountability
􀀹 Reliability
• Will establish the bedrock for building a trusting and open relationship between you and your bank
Objectives:
The Code of Consumer Banking Practice for retail banking customers has been developed to:
1. Promote good banking practices by setting minimum standards in dealing with you;
2. Increase transparency so that you can have a better understanding of what you can reasonably
expect of the services;
3. Promote a fair and cordial relationship between you and your bank;
4. Foster confidence in the banking system
Key Commitments:
Your bank’s relationship with you will be guided by four key principles:
Fairness:
Your bank commits that it will:
• act fairly and reasonably in all its dealings with you;
• ensure that all the products and services offered are in line with the Code;
• establish a clear and common set of procedures to ensure that any disputes between you and your
bank will be resolved fairly and quickly
Transparency:
Your bank commits that it will:
• Provide you with relevant and useful information that will help you arrive at informed decisions
about its products and services;
• Provide clarification, highlighting major points that impact the products and services that you are
interested in buying;
• Inform you of the range of products and services offered through various delivery channels (e.g.
over the Internet, telephone or in branches)
Accountability:
Your bank commits that it will:
• Explain and help you understand the financial benefits of its products and services that you are
interested in buying, how they work and the risks involved;
• Ensure that the procedures laid down for the bank’s staff reflect the commitments set out in the
Code;
• Ensure that all products and services meet relevant laws and regulations of Singapore
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Reliability:
Your bank commits that it will:
• Have a secure and reliable banking system;
• Ensure your records and transactions are kept confidential and accurate;
• Maintain a reliable system of security controls for the bank’s self-service banking channels;
• Ensure that the information provided is up-to-date
Service Standards:
Your bank will ensure that:
• Its staff are trained to provide prompt and efficient service, so that your transactions will be
handled promptly and your queuing time minimized;
• ATMs and other self-service banking channels, if offered, will be available both day and night to
serve you; however, please note that the machines maybe temporarily inaccessible when they
undergo regular servicing and maintenance;
• Information on its products and services will be updated and current. It will be made easily
available at bank branches, through your bank’s website and other appropriate channels;
• Its internet banking and e-banking services will comply at all times with the MAS guidelines issued
on 12 Nov 2001 on “Responsibility for Internet Banking Security”;
• You will be informed 30 days in advance before implementation of any changes to the Terms and
Conditions, fees and charges and discontinuation of services/relocation of premises. Its officers
will handle and respond to your feedback;
• Your complaint will be acknowledged within 2 business days of receipt and will be investigated;
• We will respond to you on the status of the investigation within 14 business days. (For complaints
requiring investigation by a third party this may take more than 14 days.)
Marketing and Promotions:
a) Your bank will exercise care in the use of direct mail:
i. where customers are less than 16 years of age;
ii. when promoting loans, overdrafts and other credit facilities
b) The bank will also ensure all advertising and promotional materials are not misleading and comply
with all relevant and applicable legislation, codes and rules
c) Plain language will be used to the extent that it is consistent with the need for legal certainty. Legal
and technical language will be used only where necessary
d) All printed advertising and promotional materials for banking services which include a reference to
an interest rate, will include the Effective Interest Rate (EIR), other relevant fees and charges
Complaints - Dispute Resolution Process:
Your bank is committed to providing you with a high level of service. However there may be occasions
when complaints and disputes arise. In this instance, the Code specifies a structured process for your
complaint to be dealt with.
Principles:
􀀹 Sincerity - your complaint is important feedback and the bank will treat it seriously
􀀹 Transparency - the procedures for handling complaints are documented and apply to all customers
􀀹 Effectiveness - the procedures will provide for a speedy resolution
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The Geography of Trust:
The most successful leaders understand that trust is a function of relationships as well as integrity and
expertise. And they know that relationship-based, “structural” trust changes depending on where people
stand on the organizational map.
Personal Trust:
• Based on faith in a person’s integrity, is trust at its most fundamental and widely understood
• It is the trust of confidences shared without thought of betrayal, ideas revealed without fear of
appropriation, and tasks doled out to teammates with the assurance that they will try hard not to let
you down
• Personal trust develops in the workplace through shared experiences and knowledge of colleagues’
characters. From such crucibles as impossibly tight deadlines or shop-floor emergencies, we quickly
learn on whom we can rely
High Personal Trust exists when we answer yes to the following questions:
• Is this person honest and ethical?
• Will she/he make good on her/his word?
• Is she/he basically well intentioned?
• Will he/she handle confidential information with care and discretion?
• Will he/she be straightforward about what he/she doesn’t know?
• Leaders may persevere in relationships based on personal trust no matter how exalted they become
in their leadership roles
• But such relationships are unlikely to remain static
• They are also unlikely to provide the kinds of deep, often specialized knowledge leaders need
• In circumstances where advisers’ competence matters as much as their character, expertise trust
enters the picture
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Expertise Trust:
• It is reliance on an adviser’s ability in a specific subject area
• In our daily lives we show expertise trust every time we board a plane or schedule surgery
• In organizations, leaders develop expertise trust by working closely with people who consistently
demonstrate their mastery of particular subjects or processes
• Or, lacking personal experience with qualified people, leaders seek out those with the strongest
reputations
• Unlike with personal trust, the parameters of expertise trust tend to be limited to a particular
content area
High Expertise Trust exists when we answer yes to the following questions:
• Is this person expert in her field?
• Is her knowledge up-to-date?
• Does she present credible information to support her positions?
• Is she able to apply her expertise to our specific situation?
• Can she offer sage advice on risks, options, and trade-offs?
Structural Trust:
• It reflects how roles and ambition color insight and spin information
• High structural trust provides leaders with a channel for pure insight and information
• Advisers in positions of the highest structural trust generally reside outside organizations to prevent
not only self-interest and self-serving agendas but also cultural assumptions from tinting their views
• Of course, externality doesn’t automatically translate into objectivity: Not all outside advisers are in
positions of high structural trust
• But strong outside advisers provide leaders with a resource that their organizations cannot
High Structural Trust exists when we answer yes to the following questions:
• Given this person’s role and responsibilities, can he offer judgment untainted by his goals or
interests?
• Is he in a position to be fully loyal?
• Is he unlikely to spin or filter information?
• Is it reasonable to assume he will not move into a role that places structural constraints on our level
of trust (for example, will we someday compete for the same position or for the same client)?
Consulting and Professional-Service Firms:
What they offer:
Lawyers, accountants, management consultants, and other professional-service providers promise a very
high level of expertise trust; otherwise, you wouldn’t be paying them. They also possess experience with
many companies and consequently have a broad frame of reference.
What to consider:
Many firms generally offer reliable, replicable products and services. But their ability to offer structural trust
is limited to the two to three ranges by their business models, which require them to leverage their senior
people and continue to increase their work for you. For high structural trust, look for firms that don’t rely
on these models.
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LESSON 15
GROWTH STRATEGY IN RETAIL BANKING STRUCTURED RELATIONSHIP
APPROACH
• After an early part of the decade focused on cost-cutting, retail banks have reaped most of the easy
wins and adapted their organizations to a faster pace of change
• Most banks now feel that while continuing to monitor costs closely to avoid any slippage, they now
need to concentrate on growth
• We interviewed twenty-three banks in mature banking markets, as well as four Chinese banks
• The four Chinese institutions were predominantly focused on growing through client acquisition
• For the twenty-three other banks, revenue growth was the focus: those institutions estimate that 72
of their profit growth in the next three years will come from revenue growth, and only 28% from
cost-cutting (see Figure 10)
• In mature markets, excluding mergers, 80% of future revenue is expected to come from existing
clients, and only 20% from new client acquisition
• Banks can generate more value from existing customers by raising prices, expanding product lines,
or increasing share of wallet.
• In mature markets, therefore, most well-established banks recognize that growing share of wallet is
their primary objective
• As a result of this finding, spotlight falls on how banks
• Can extract more value from existing customers by increasing share of wallet
• After interviews with bank executives and industry experts
• We concluded that a relationship approach is critical to meeting this goal
• Our interviews focused on their institutions’ experience with the relationship approach
• This helped us determine where banks stand in implementing such an approach, recognize the
difficulties they encounter in implementing it profitably, and identify best practices and lessons
learned from those experiences
Beyond “Product Push”:
• Conventional banking wisdom holds that a relationship strategy that goes beyond a traditional
product-push approach can capture untapped client potential
• Banks have successfully leveraged push approaches to increase sales effectiveness
• As Figure 11 suggests, this push approach was successful in capturing market share of high-value
and easy-to-please customers
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• These segments are currently either very or somewhat profitable to the banks, so there is no reason
to change approaches with them
• Some clients, however, are unreceptive to the product-based push approach commonly used by
retail banks, because their needs are not fully identified in that way
• They feel they receive low value, and finally end up making themselves unavailable to their banks’
advisors
• This group represents an “untapped gold” client segment
• Despite computing advances, complex customer needs cannot be well predicted by automated
systems
• Understanding client needs requires a perspective no automated solution can offer
• Client needs frequently originate with events that systems cannot predict (weddings, major
purchase decisions, deaths of relatives, divorces)
• Because sales forces are often compensated on the basis of number of products sold, and because
advisors are too often unprepared to give advice that goes beyond a product’s generic benefits,
advisors typically seek out easy-to-sell-to clients rather than clients with more complex needs
• Ignored clients soon begin to distrust their bank, and do not maintain contact with their advisors
• The traditional product-push approach is ineffective with this group, because they often regard
such efforts as “pushy,” and it is inadequate in meeting their more complex needs
A relationship-based approach for these high-potential clients—who may not yet qualify for private banking
services— could create a virtuous circle through a win-win relationship in which the customer’s perception
of increased value generates more share of wallet, which gives the bank a better view of the client’s needs,
resulting in better advice, which increases still further the customer’s perception of value.
• A survey indicated that 70% of clients would want to use a single institution if it were able to serve
all their financial needs well
• Another survey found that 64% feel that having companies collect information on their individual
interests and lifestyle in order to better personalize services is a good thing
• A relationship approach is one where the bank “invests in obtaining customer-specific information,
often proprietary in nature, and evaluates the profitability of these investments through multiple
interactions with the same customer over time and/or across products”
• The objective of a relationship approach is to understand client needs and meet them, and to
develop such strong trust that the client does not even consider moving to another provider
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• Creating such a relationship is an iterative and progressive process, is long-term, is personalized,
and requires the client to share information with the advisor
• A relationship approach only matters to clients who are either expert comparatists or loyal-to-abrand,
and will recognize the value of the bank’s efforts
• The alternative to a relationship model for capturing the untapped potential is to satisfy pricefocused
customers by adopting the lowest price position
• In banking, self-service is a good option for many people not wanting a relationship: their
expectation is seamless transactions that can be carried out at low cost
• Capturing those clients requires a well-thought-out multi-channel customer experience, and robust
and cost-efficient systems to meet service-level expectations at minimum cost
A Structured Approach:
• Many banks are attempting to implement relationship strategies, but few are adopting structured
approaches covering the full scope of retail banking
• Of the twenty-seven banks we interviewed for this study, twenty-two had adopted or were adopting
a relationship approach
• After developing a framework with the essential components of such a strategy, we mapped the
components in each bank’s approach, gained in the interviews, against our framework (see Figure
12)
Five levels of maturity in the relationship approach emerged from our interviews:
Stage 1: No relationship approach strategy
Stage 2: The relationship approach is a promise, but the institutions are only partly aligned to deliver on it
Stage 3: A structured, assisted approach is in place, but only for savings and investment products
Stage 4: A structured, assisted approach encompasses all banking products and services, but further efforts
are needed in one or two aspects of the operating model
Stage 5: All components of a relationship approach are optimized
Stage 1 banks
Five of the banks we surveyed, representing approximately 20% of the sample, did not have any component
of a relationship approach in place. Their perspective was different in that they were either targeting pricefocused
or transaction-oriented clients, or did not feel the market situation required them to adopt such an
approach yet. One bank said it did not believe in a relationship approach and thought its success factor of
the future was self-service and reactivity.
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Stage 2 banks
Just over half of the banks we surveyed were in Stage 2, promising a relationship approach but only partly
aligned to deliver it. These banks have developed a relationship approach as a reaction to the trend of
weakening relationships with clients due to branch automation, deskilling of bank manager tasks, and quality
issues arising from multiple channels. These banks recognized that they needed to take better care of their
most important clients, and launched relationship programs, typically adapting the elements of
segmentation, organization structure, some tools supporting the advisors, and marketing planning, but too
often neglecting changing ways of working, performance management, and processes.
Banks segmented their clients according to a mix of present and potential value and established levels of
service, including frequency of client contact, depending on client segment. For those clients identified as
high-potential, they have assigned specific advisors and reduced the number of clients per advisor to
improve availability. In terms of tools, a few banks have given their advisors an extended view of their
clients, developed automated ways to identify product opportunities, and created contextual scripts to help
them present product benefits to clients. Marketing plans have been adapted by segment, and multi-channel
customer solicitation has been developed to generate opportunities for advisor contact with clients.
In the process, however, many banks have neglected key aspects necessary to move toward a more
relationship-based approach, especially in the ways their advisors work and are managed. Available tools
have failed to provide holistic advice or establish a diagnosis of each client’s situation and needs .As a
consequence, retail advisors still often lack the ability to give substance to their client relationships and lack
good reasons to call clients. Without this necessary advice-product architecture, advisors find it difficult to
recognize client needs. And they are encouraged to stay product-and campaign-centered because their
performance is still measured by number of products sold. Having only partly aligned the organization to a
relationship approach, success remains out of reach.
Stage 3 banks
A smaller proportion of the banks we interviewed—approximately 20%—have developed a structured
relationship management approach, but only for their savings and investment products. These banks believe
that cross-selling savings and investment products to banking clients will generate significant profits. This is
especially true in such countries as the Netherlands and Sweden, where day-to-day banking is a loss-leader,
with profit made on savings and lending products.
The European banks that have universal banking models have traditionally excelled in delivering savings
products to their clients. As customers became more sophisticated and the number of products expanded, a
need for better advice emerged that some banks chose to address with a structured advisory process,
especially in Belgium, the Netherlands, and Sweden.
Establishing a structured process for savings and investment products can deliver excellent results, as
specialized institutions in wealth management have shown. Yet the downside of having a structured
approach limited to savings and investment products (or other specific products) includes the inability to
gain a complete understanding of a client’s overall needs and financial situation. It can also cause client
frustration if it involves a very professional but unstructured process, and can translate into the client
perceiving the bank as a partial solution provider. Our research indicates, therefore, that only a structured
relationship covering the complete set of retail banking products and services can generate a strong increase
in client satisfaction and a bank’s share of wallet.
Stage 4 banks
Only two banks, in our survey, one in North America and the other in Europe, representing less than 10%
of the sample, have implemented a robust relationship approach. Our interviews revealed that executives at
both banks believe they have not yet achieved Stage 5 status, and have further improvements in the
pipeline. As noted previously, these banks have already benefited from a very positive impact on their share
price, having increased both revenue growth and profitability by adopting a structured relationship
approach.
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LESSON 16
GROWTH STRATEGY IN RETAIL BANKING STRUCTURED RELATIONSHIP
APPROACH (CONTD…)
• Interviews with executives in these top banks also identified several best practices involved in
implementing and growing a relationship approach that increases revenue and improves the profit
margin
• These managers have repeatedly reaffirmed their commitment to a comprehensive relationship
approach, and have implemented it over time; progressively aligning its key components (see Figure
13)
1. Client Understanding and Segmentation:
Measuring client potential
Potential includes all assets and debts. Most banks have developed measures of potential, but many banks
are not yet comfortable that their measure is accurate enough. Methods used to assess potential include
compiling data on average assets of inhabitants of neighborhoods, employing statistical methods based on
similar client profiles, and offering sales force incentives to capture and update client potential. In Germany,
more and more banks are using external providers to establish accurate figures of client potential. In France,
one bank decided to provide a better base for analysis by paying its advisors a bonus based on their
completing client data in the information system.
Understanding client trigger points
There are right and wrong moments to start a relationship with a client. And once the relationship is going,
there are key points in this relationship when the advisor—and the bank in supporting him or her—has to
take special care to avoid client disappointment and seize a development opportunity. One North American
bank we surveyed has focused substantial energy on better meeting its clients’ needs by identifying “reasons
for defection” and ensuring their advisors and the institution succeed in what that bank calls “the moments
of truth.” It has established a customer service blueprint to capture the emotional responses of clients to
rational experiences with the bank. Advisors are trained to identify those moments of truth and react
appropriately.
Building loyalty through trust
Clients are looking for advisors they can trust, and banks should also be looking for their advisors to be
trusted. A recent Forrester study demonstrated that customer loyalty was most correlated to trusting one’s
advisors, and that trust resulted from clients feeling that their advisor was honest and open and an advocate
of their interests. Good relationship advisors understand clients’ desire for these traits, and do everything
they can to ensure they adopt them.
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Advisor/client dialogue
The prerequisite for an effective advisor/client dialogue lies in the advisor’s ability to frame a holistic view
of the client’s situation. The client will soon be aware of whether the advisor has such a view, and will make
critical relationship decisions based on this perception.
Clients know themselves better than strangers or systems do, especially when it comes to assets they hold
outside the bank. Once an advisor wins the client’s trust, it becomes much easier to ask the key questions
about the client’s current situation and understand his or her needs. It is also the most effective way to
establish a client’s true potential.
Clients have expectations and preferences, which advisors should learn. There is no point in repeatedly
telephoning someone who does not like to be called. However, that same client may be comfortable
exchanging emails. The best advisors ask clients at the outset what their expectations and preferences are.
2. Product and Service Offerings
A needs-advice-product architecture
A critical component of a relationship approach is the matching of client needs with advice and finally with
products. To help ensure they fully capture client needs, advisors often develop and administer
questionnaires.
At one European financial institution, advisors are trained to identify and work into predefined scenarios
based on combinations of client needs, and to suggest solutions that bundle products to meet those needs.
Another European bank has created packaged products to fit points in the client life cycle, so advisors can
readily match their clients’ needs. Some banks have experimented with a central support center to assist
advisors in customizing their proposals.
3. Organization Structure:
Sales force specialization and branch sizing
A single bank employee cannot operate effectively in two different modes, applying a relationship approach
to some clients and a push-based approach to others. Too many differences in terms of time allocated
yearly to a client, performance management, tools to be used, and so on, can make it a no-win situation.
In a Benelux financial institution, for example, two categories of customer are recognized, each with a
specific approach and type of advisor. Mass consumers are offered an event-driven push approach. Affluent
customers are offered a financial advice approach managed by a financial advisor. Relationship managers
usually handle from 100 to 300 clients, and this bank has merged some branches so each has over 100
affluent customers. This ensures that the presence of a financial advisor is profitable.
4. Ways of Working:
The people factor
Ensuring that people change their ways of working and managing, and fully adhere to the relationship
approach, is essential. Our interviews suggest that change involved in implementing a relationship approach
faces some resistance at all levels, from central teams, to branch management, to the advisors themselves.
Central teams sometimes resist changing their management style from measuring performance based on
campaigns and product sales objectives. Advisors might not believe the institution will provide an approach
to help them better understand their clients, could worry about the amount of time and effort required to
learn the new way, and are often very cautious about the impact on their compensation. Approaching the
move to a relationship approach as a major change program is the most effective way to overcome this
potential resistance.
At a large European financial institution, for example, the most critical success factor identified was “the
attitude of the branch manager.” During the change process, 25% of the branch management work force
was progressively replaced to enable the necessary change in culture.
Other methods used by banks include identifying specific employee concerns and addressing them, rolling
out a comprehensive communication plan to alleviate fears and align employees, identifying change agents
at all levels that are willing to endorse the change, lead by example, and conduct pilots to obtain positive
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results. Pilot programs can both motivate others and help gain a better grasp on potential implementation
issues, which can be mitigated when the program is rolled out later across the branch system.
Developing an entrepreneurial culture at the branch level can also generate positive results. Encouraging
and rewarding employees for teamwork and for going the extra mile to satisfy their clients’ needs is a
proven way to change mindsets. Top banks use these incentives to motivate their branch managers, and
make sure they recognize high-performing branches that accept change and adopt a client-focused
relationship approach.
A rigorous, iterative, standardized process
The structured process should be geared toward a recurring effort to match client needs and build a positive
customer experience. From the client perspective, as illustrated earlier in Figure 13, it can be a four-step
process: (1) understand; (2) propose; (3) act; (4) review. This process begins with a dialogue between the
client and the advisor to ensure the client’s overall situation, needs, and preferences are understood. Second,
the advisor develops a proposal and discusses it with the client to ensure the proposed solution addresses
those needs. Third, the client lets the bank act on the agreed solution. Then, after some time, comes the
review to ensure the solution is serving the client’s evolving needs.
A few banks interviewed in Europe are currently rolling out such advice-oriented processes. Their purpose
is to ensure clients receive high-quality service and advice while the banks’ commercial efficiency improves.
Such guidance and support brought to the advisor is key to maximizing the bank’s profitability.
Internal recruiting and competence management
These new ways of working need to be learned. Most banks recruit their relationship managers from the
existing sales force based on their ability to listen, react, and have a broad perspective on customers’
financial needs. Even then, strong training efforts are a must. Both of the top-performing banks in our
survey relied on excellent training programs to ensure their personnel developed a complete understanding
of the portfolio of products and services and the structured advisory process.
Some Additional Thoughts on Customer-Led Growth:
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How to pinpoint your problem
Where are your most profitable customers and how can you deepen your relationship with them? Where are
your problem customers? The chart shows the level of customer advocacy as measured by Net Promoter
Score on the horizontal axis, and the level of customer profitability on the vertical.
Let’s consider the key boxes:
● Beginning in the upper right, this group of customers is a company’s natural design target, its core,
the segment that should be the prime focus of the Three D’s described in this brief. You want to
keep them, find more like them and explore what additional products or services they need. They
are your prime source of new innovation, so listen to them
● In the upper left box are the “false profits,” customers who are “buying but mad”— they are
profitable right now but in fact are sticking around only because they have no good alternative.
You must address this group urgently, either by moving them to the right set of products or by
fixing delivery issues. They are turning the market against you
● In the lower left are the “unhappy and unprofitable”—the buyers who are not a natural fit with the
company and who are not happy anyway. Helping them migrate to other providers makes sense
● We have found companies routinely surprised by which customers are high-profit promoters, how
much potential for cross-sell exists among low-profit promoters and how many detractors lurk in
their portfolio
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LESSON 17
GROWTH STRATEGY IN RETAIL BANKING STRUCTURED RELATIONSHIP
APPROACH (CONTD….)
5. IT and tools:
Adapting tools to a relationship approach
To provide effective advice, advisors need a complete, integrated view of the client’s situation, a good
measure of client potential, and an accurate record of the client’s past interactions with the bank, including
through other channels.
Advisors also need tools supporting the structured process to guide dialogue, enable rapid advicegeneration,
and develop customized solutions. Questionnaires can help guide dialogue. For rapid advice,
tools replicating the need-advice-product architecture are very helpful. To customize solutions, advisors
should be able to group products and be guided through the pricing process so they can adjust the price
based on the value perceived by the client, within acceptable boundaries of profitability for the bank.
Managers also need monitoring tools to help them know where to direct their efforts and whom to coach.
The best tools provide an aggregated and detailed view of how advisors follow the structured process as
well as the benefits obtained.
An adaptive IT architecture
In a client-needs-driven relationship, flexibility and a holistic view are essential. Flexibility is necessary to
enable customization of product bundling and pricing, and to allow for accessing products across all
product lines based on identified client needs.
A holistic customer experience is a key concept. It refers to customers having access to online channels,
which empowers them to get advice and act on their own. This requires an adaptive architecture for
synchronized data exchange. Advisors also need a readily accessible view of all the client’s interactions with
the bank (including self-service). In this way the advisor can ensure the client does not become frustrated
with the bank’s service, and instead gives the client the feeling that the advisor has a firm grip on his or her
banking matters.
Developing customer insight and “institutional memory” is also critical. This includes records of processes
executed for the client, and a record of client preferences and past interactions through all channels. The
prerequisite is an advice-offering database architecture that enables advisors to react to client needs quickly
and effectively, and to conduct analyses that produce better targeted offerings.
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A Multi-Channel Customer Experience: (See Figure 14)
A relationship is about the bank viewing the customer as an individual (and the customer perceiving it that
way) with a specific situation and needs, and how to meet those needs with a broad spectrum of offers—
not by pushing products in campaigns or boxing them into a segment category, even a small one. The bank
can be represented by a human advisor or a technology interface. In Nordic countries we found the concept
of a relationship through technology interfaces more advanced than elsewhere.
A multi-channel focus can help considerably by:
1. Lowering the cost of providing a relationship approach, albeit through technological means, to
satisfy lower segments of revenues
2. Providing a multi-channel relationship that enhances the customer experience to satisfy higher
standards of more affluent client segments that either prefer self-service to people-based service or
are very active users of all channels
As a Nordic banker we interviewed put it, “This personalized approach can be achieved through people, or
systems, or a combination.” His bank has decided to drive up its share of wallet by lowering the cost of
personal service. Its goal is to provide relationship-based approaches to less-affluent segments, and offer its
affluent clients a multi-channel relationship that includes self-service, not one restricted to the branch
advisor. This approach recognizes that self-service is as much a part of the relationship approach for
affluent clients as it is for the less-affluent segments.
The bank’s key objective is that every customer be treated on an individual basis. All activities toward a
customer, in whatever segment, are generated on an event basis, so people in the branch have a stack of
activities toward customers every day, with individual assignments of bank employees for each customer.
Events are logged in all channels. Records, or institutional memory, are the key; systems can help organize it
and leverage it through analysis for human-machine interaction, or provide the information in an organized
way for an advisor to be more effective.
However, this same leading Nordic bank recognizes its human advisors are still the critical success factor.
Despite its efforts with technology, it insists that clients with a contact person are distinctly more satisfied
and more loyal; hence clients have a named contact person they can reach out to when they want and most
of the time they do so by email or chat.
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6. Performance management:
Alignment with a relationship approach:
● The relationship approach’s objective is to match each client’s needs with the bank’s products, and
thereby increase the bank’s revenue stream
● Unlike a product-push approach, where employees’ performance is measured by the number of
products they sell, a relationship approach takes a broader view
● It encompasses all revenue generated for the bank and also a view over time of the revenue/profit
contributed by the client accounts
● A large part of the relationship approach’s success is based on advisors’ efforts to be close to their
clients
● Advisors' efforts are, therefore, broken down by steps in the process and tracked, including number
of first-step meetings with clients, number of proposals submitted, number of proposals accepted,
timeliness of review meetings, and so on
● A good example is the performance measurement approach of the European bank in our sample
that we judged to represent best practice
● It tracks its advisors’ efforts against short-term and long-term profitability metrics
● All employees in the branch are assigned personal objectives in terms of number of specific
interactions, depending on their role
● Profitability performance is measured by a mix of financial results, customer satisfaction, quality of
credit portfolio, and volume of long-term savings and lending products
Benefits tracking through internal benchmarking
• The best benefits-measurement programs track benefits at the branch level and fine-tune them
through internal benchmarking
• Such programs focus on measurable results
• A good way to stimulate change is to compare these results between branches to highlight best
practice, recognize top performers, and motivate laggards to catch up
Key learning points on the relationship approach:
• Measuring client potential accurately to focus the relationship effort and ensure its profitability
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• Recognizing the client’s trigger points in his or her relationship to the bank in light of the multichannel
customer experience, so the advisor can provide informed support at those critical times
• Building customer loyalty through trust that the advisor is the client’s advocate and that the bank
offers clear pricing and excellent service
• A relationship is a two-way dialogue: listening to what customers have to say about themselves,
their objectives, their preferences, and their needs, and taking it truly into account when proposing
a solution
Developing a specialized sales force for the relationship approach through internal recruiting, appropriate
training, ongoing competence management, and a long-term effort to ensure people change and adhere to
the new approach:
• Aligning performance measurement and incentives with the relationship approach
• Establishing a rigorous, iterative, standardized relationship process—one supported with tools that
develop a holistic view of clients, while providing guidance in the diagnostic and solution phases of
the relationship (through an architecture encompassing situation, needs, and products)
• Establishing an IT architecture reflecting the business architecture of a closed-loop relationship
approach
Growth Agenda in Financial Services Industry
Are Surveys relevant to our study?
• Some findings from another survey (Conducted prior to Mid-2007 Financial Crisis) by a
leading International Consulting/Accounting Firm
• Executives from 201 institutions in Asia, Europe & North America participated in the survey
• Opportunities & Challenges
• Six Imperatives
Growth stands high on the financial services agenda. After a period of conserving and building their
resources and boosting returns to shareholders, financial services institutions around the world are shifting
up a gear. From insurance to banking and asset management, companies are eyeing opportunities inside and
outside their existing sectors, overseas as well as at home. No fewer than 65% of the 201 financial services
executives surveyed for this briefing agreed that managing for growth had become a higher priority over the
last 12 months.
Economic growth is expected to drive much of this expansion. Interest rates are still low by historical
standards and the world economy is growing at a reasonable pace. Demography is providing a following
wind, at least in terms of retail savings. As baby boomers in developed countries near retirement, demand
for wealth management and investment advice is expected to surge. At the same time rising standards of
living are leading to faster rates of growth in both savings and consumer lending in developing countries
too.
It will not all be plain sailing, however: a third of survey respondents believe that the growth targets they
have been set are optimistic as opposed to realistic or conservative. Challenges to the agenda for growth
vary from region to region, sector to sector. But three stand out:
• Asked to identify the principal impediments to the growth strategies that their organizations will
face this year, the survey respondents put competition top. Despite respondents’ expectations that
organic growth will be the primary driver of expansion at their organization, new business models
And products are required to break the mould in many saturated, mature markets. In emerging markets,
although growth is relatively easy to come by, the smartest organizations will work both to carve out a place
in the market and then to erect barriers to entry around it so that, as competition intensifies, the benefits of
fast-growing economies continue to flow.
• Risk, both economic and political, casts a shadow over growth prospects in several markets.
The sliding dollar, rising interest rates and the possibility of a sharp reduction in China’s rate of
growth all have the capacity to undermine the macroeconomic balance. The possible impact of a
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slowdown in consumer spending in the US and the UK is also a worry. West European economies
will continue to disappoint
• Mounting regulation, and the fear of failing to comply fully, could distract management,
complicate acquisitions and stifle entrepreneurialism. For institutions operating in multiple
territories, putting in place local and regional governance structures to meet the wishes of various
regulators can add additional costs and soak up senior management time. A majority of
respondents also agree that a sharper accent on compliance, governance and risk management is
dampening the appetite for risk at their organizations. Creating an entrepreneurial culture is seen as
one of the key challenges of moving from a focus on value to one on growth
Faced with these challenges, institutions are not about to spend massively on strategies for growth. In line
with their emphasis on organic growth, sales, marketing and customer-service capabilities are regarded as
the most critical enablers by survey respondents. Whether developing new products or building on existing
ones, whether seeking out new customers or selling more to existing ones, growth will largely depend on an
organization’s people. From improving the skills of customer-facing staff to nurturing risk appetite, the
quality of management and of employees will be critical in determining success.
A tight focus on costs and efficiencies will also be essential. It is striking that performance improvement
comes high in the hierarchy of drivers for growth identified by respondents to the survey, and that twothirds
rate cost efficiencies as either critical or very important in driving growth over the next 12 months.
‘Successful firms will not abandon cost control as a way of creating value’. ‘But the income side of the
equation will definitely become more important during the coming months as companies get closer to their
customers and look for ways of growing in innovative ways.’
No fewer than 65% of the 201 financial services executives surveyed for this briefing agreed that managing
for growth had become a higher priority over the past 12 months, and the majority is expecting revenue
growth this year of more than 10%.
The reasons for this shift in emphasis from cutting costs towards growth are not hard to find. Though
rising, interest rates are still low by historical standards and the outlook for the world economy remains
relatively bright. By and large, provisions for bad debt are down and interest income remains strong. The
increasing use of derivatives is spreading risk and making capital more mobile. Asked to identify the most
significant drivers of growth at their institution this year, more respondents pick economic growth than any
other option.
Demographic forces – particularly the graying of the baby boomer generation – will also fashion significant
opportunities for growth in wealth and investment management over the coming years. In the US alone, an
estimated US$10trn or so in funds could flow into the investment management industry as baby boomers
approach retirement (although in the longer term, of course, they will run down these savings to provide
retirement income). This is equivalent to about half the amount currently managed by the top five
investment managers in the US.
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LESSON 18
GROWTH AGENDA IN FINANCIAL INDUSTRY
Not only is the number of people nearing retirement starting to swell, but governments are also starting to
push the responsibility for providing pensions back to individuals. As a result, the amount of money going
into savings schemes in the private sector is likely to grow significantly.
The growing cost of healthcare is likely to have a similar effect. The more the state steps back from
providing universal healthcare, the more individuals will be forced to take out insurance, in both developed
and developing markets. In the US, for example, financial institutions in all sectors are exploring the
potential impact of the expansion of Health Savings Accounts, investment vehicles which are designed to
help individuals save for future qualified medical and retiree health expenses on a tax-free basis.
To take another example, China’s central government now covers only 10% of the operating costs of urban
hospitals there. The rest comes from patients drawing on savings to pay their bills and from rising levels of
health insurance, opening up a fast-growing new area for insurers. The pay-off could be twofold: as
insurance replaces bank savings as a means of covering the costs of healthcare, then a proportion of these
savings can be directed into other forms of more sophisticated investment or into higher spending on
consumer goods and the like.
The premium end of retail banking, where margins are greatest, will also benefit from more active wealth
management on the part of individuals. As baby boomers help to swell the number of people in this
category, so the business will grow. CIBC, the largest issuer of credit cards in Canada, has built a successful
business around its ‘Imperial Service’ brand which is aimed at the country’s growing population of mass
affluent, for example.
European banks are also in good shape and ready to grow if the right conditions materialize. With their
revenues rising faster than their costs, many have posted double-digit increases in operating income for
2004. As a result, says Standard & Poor’s, a rating agency, the average cost of generating revenues for
Europe’s 50 largest banks is close to a 10-year low. This bodes well for future profits if the economies in
which they operate continue to expand and if the lurking threat of windfall taxes on hefty profits comes to
nothing.
The pressure on banks to expand will intensify, especially for second-tier institutions in the US and Europe.
But the potential for explosive growth is most obvious in emerging markets.
Asia grabs most of the headlines: China is where survey respondents expect to see most growth this year,
though the pace of expansion may be tempered by restrictions on the ground. Regulators there take the
view that there are already enough national banks in the market and international banks are restricted at the
moment to buying only minority stakes. So, high hopes of growth may prove illusory, at least for the time
being. Other growth markets, such as India, are also attracting keen interest, though similar constraints
apply there too.
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One area that is set to keep expanding in both markets is wealth management. As the middle class swells,
Justin one expects to see more acquisitions of companies in this sector in India, South Korea and China.
Lending to consumers in these markets is also expected to pick up significantly.
As developing economies grow, demand for ordinary non-life insurance also tends to grow
disproportionately faster. This is because insurance awareness and the rapid acquisition of new assets drives
demand to protect both cash flow and lifestyle from unexpected events.
China’s non-life market grew at an average rate of 16% over the past five years against a backdrop of GDP
growth of around half that level.
Other regions beyond Asia are also alluring. Take Mexico, a market that has been rocked by more than one
crisis over the past couple of decades. After years in the doldrums, the banking market there has suddenly
begun to grow again as the necessary ingredients – economic expansion, financial stability and a stronger
regulatory framework – have fallen into place. The result was a 15% rise in corporate lending in 2004 and a
30% increase in the number of mortgages created. An analyst with Moody’s Investors Service, reckons that
growth is starting from such a low base that lending could continue to expand at a similar rate for several
years before credit worries began to surface.
Asia figures
are key for
our purposes
Six imperatives for the growth-orientated institution:
For their strategies to succeed, financial services firms cannot sit back and wait for the pie to grow. Leading
institutions can improve their chances of sustainable growth through the following courses of action:
1. Invest time in careful planning and communication of strategies.
The fact that a substantial minority of survey respondents said their targets for growth is optimistic suggests
that executives at many institutions are not fully convinced of the strategies they are expected to execute.
Proper quantification of risks and financial outcomes, and the use of a range of analytical techniques, are
essential in formulating strategy. In emerging markets in particular, this means selecting the right geography
or segment to achieve and sustain profitable growth. Proper planning does not mean slow execution,
however: successful institutions are capable of testing new ideas and adjusting to market feedback at speed.
2. Be realistic about where and how you want to grow.
Growth can be defined in a number of ways: respondents to our survey mainly target revenue, followed by
operating income and assets under management. Managers must consider the impact that rapid growth can
have on the quality of customer service, on performance levels and on profits. Reputational issues also need
to be considered, particularly as institutions expand into markets where business practices may differ from
those at home.
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3. Get close to the customer.
Survey respondents place great emphasis on the performance and quality of front-office functions, not just
in applying local knowledge to service customers but also in leveraging their insights into customer needs
and behaviors in order to improve their products and services. They also recognize the value that high
satisfaction levels among existing customers can bring as a source of referrals and of opportunities to
extend sales. Closeness to the customer also implies the flexibility to change offerings to suit local market
conditions: what works in, say, the Netherlands may or may not work in India. Sometimes it also means
learning from successful business models employed by other highly responsive industries.
4. Use technology appropriately.
If people are critical to growth, technology is close behind. Electronic distribution channels can be a
significant enabler of cost-effective growth, as ING has proved in Europe and elsewhere with its one-sizefits-
all IT model; they can also help international firms vault barriers to entry in new markets. Technology is
critical to the effective management of customer relationships and to the measurement of companies’
performance. Whether, integrating legacy systems or simply updating their own applications and
infrastructure, controlling the cost of IT can also make a material contribution to the bottom line. But the
value of technology will vary between markets and customer segments: CRM in some emerging markets is
more likely to depend more on personal relationships than data analysis, for example.
5. Innovate in areas of strength.
When asked to assess their own capabilities with regard to an array of growth enablers, survey respondents
ranked innovation bottom of the pile. Yet whether they are dealing with new products or old, virgin
markets or existing ones, institutions must be prepared to innovate, not just to grow but also to create and
raise barriers to entry. Many global companies have achieved growth in markets such as China, for example,
but have neither innovated nor distinguished themselves significantly from their local competitors. The key
is leveraging those skills and technologies in which the organization is best-in-class in order to build a
differentiated platform for growth. In mature markets, too, an enterprise-wide culture of innovation is
essential to unlock pockets of growth – witness the huge success that Canada’s CIBC has enjoyed by
offering Aeroplan frequent flyer miles on its credit cards.
6. Invest in, develop and reward the right talent.
When asked to identify the biggest challenges associated with the shift from focusing on value to focusing
on growth, survey respondents plump first for finding the right people and, second, for creating a more
entrepreneurial culture. Growth strategies will require greater numbers of talented people with a global
mindset, a relentless focus on the customer and innovative skills, as well as flat decision making structures
that are capable of incentivising staff and enabling innovation.
Enablers of Growth:
The survey shows that firms are ruling out nothing when it comes to identifying where the growth is most
likely to come from. Over a third of respondents to our survey expected new geographical markets to be
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their primary sources of growth, and more than half (53% and 60% respectively) thought that attracting
new customers and launching new products would be the main engines of expansion. But whether
branching out into new areas or consolidating positions of strength, the firms that will successfully deliver
on their growth targets will share a number of attributes.
Be Prepared
The first is proper planning. The survey evidenced poor planning of growth strategies at a number of
institutions. A sizeable minority of respondents, the overwhelming majority of them at smaller institutions,
admitted to using no formal model for measuring the risks and possible outcomes of various strategies for
growth. Curiously, too, a surprising number of those questioned said they did not quantify the likely
financial outcomes of growth strategies.
At leading institutions, by contrast, the accent is on striking the right balance between risk and reward. In
Canada, CIBC has taken steps to tilt its business more towards its retail operations, which now account for
72% of its economic capital. Having been stung by the fallout from Enron, among others, it is keen not to
expose itself in future to the possibility of large losses from wholesale lending. For this reason, CIBC is in
no hurry to expand either geographically or into new sectors. Any expansion in investment banking, for
instance, would have to reinforce specific business lines.
In the investment management sector, the expected influx of money and assets into the private sector is
likely to create a greater degree of specialism and more alliances within the industry. Firms that lack
expertise in, say, real estate investment may team up with one that does, and investment managers will
become more willing to outsource those functions that are neither crucial to their business nor add any
value to the proposition they make to customers.
In the insurance sector, too, following a raft of new regulations as well as changes to the way insurance
companies report, most insurers are also taking a more systematic approach to risk and the allocation of
capital than they did, say, five years ago. Insurers are gradually beginning to integrate techniques such as
enterprise-wide risk management into their businesses. This is expected to promote a better understanding
of the trade-off between risk and reward and therefore of the speed with which they can grow. The more
sophisticated such models become and the more that regulators allow their use in allocating capital, the
faster insurers are likely to be able to grow.
Customers Come First
Assuming that a realistic growth strategy is in place, what are the enablers that will help organizations to act
on it? Perhaps the biggest challenge for financial services organizations, particularly those in mature
markets, is delivering a good enough level of service to satisfy customers, be they wholesale or retail. Even
in developed markets in Europe, customers are still getting poor service. Until the standard improves across
a range of channels, from call centers to physical branches, many firms will continue to see customers desert
them for competitors.
Survey respondents are under no illusion that their capability to service customers, as well as sales and
marketing skills, will be among the most important ingredients in delivering growth in the future. Asked to
identify which enablers of growth will be most important over the next 12 months, these capabilities rank
top. Human resources, whose most important facets include the quality of customer-facing staff, comes
next, while brand, reputation and customer satisfaction, rank third.
Retail banks in North America are stepping up their efforts to segment their customers. Being able to
identify customers with a higher net worth and doing a better job to keep them and expand the amount of
business done with them is critical. Many retail banks are also thinking harder about ways to integrate their
systems to enable them to respond more quickly to marketing opportunities and to be on target when they
do so. Speed to market and speed in reacting to feedback from the market are both vital – something that
retailers in other industries, such as fashion and music, have long known.
What works in one country will not necessarily work in another, of course. Simply transferring customer
facing techniques that have been tried in the West to emerging markets is rarely straightforward.
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The distribution of non-life insurance products in China through direct sales over the telephone and the
Internet is one example. China’s consumers are certainly price-conscious enough and the market is poorly
segmented when it comes to price. Yet the limited awareness of such an approach among consumers,
weaknesses in payment systems and limited credit-card use, which restrict efficient premium collection, and
regulatory hurdles have so far prevented firms from exploiting the market. In time, however, it is likely to
take off, at which point the limited number of companies around the world who have perfected this
technique in other markets (such as Directline in the UK) will be able to establish a position and secure
sustainable growth provided they can adapt their business models to local culture and consumer
preferences.
Employees Come Close Behind
People remain critical in underpinning successful growth strategies. Asked to identify the biggest challenges
associated with the shift from focusing on value to focusing on growth, people to deliver growth and,
second, for changing the culture of their organization to one that was more entrepreneurial.
Forward-thinking firms are beginning to think differently about people – asking not how they can prune
more costs but whether they should be investing more in their people, and particularly their client-facing
staff, in order to get a better return.
No One said it was Easy
Of the growth enablers that respondents were asked to rank in order of importance, only negotiating and
integrating acquisitions came lower than innovation. And asked to assess their own capabilities with regard
to each enabler, respondents ranked innovation bottom of the pile.
It may be that respondents are simply conceiving innovation in narrow terms. Innovation is not only about
new products and services but also about new ways of marketing, of organizing, of distributing, and so on.
From Barclaycard’s use of CRM systems to ING Direct’s virtual business model, the institutions that
achieve the highest growth are the ones that are prepared to think and act differently. The fact that even
established companies, such as ING and CIBC – through its alliance with Aeroplan, Canada’s leading
frequent-flyer program – have had such an impact in developed markets by doing something quite different
and supporting their activities with clever marketing shows the potential of innovation. At the same time,
new business models and the application of leading-edge capabilities will always need to be adapted to local
environments – to the state of market readiness and to the availability of appropriately skilled people.
To build and sustain a growing business in financial services, institutions need a combination of vision and
pragmatism. They must have the courage to expand but clearly define the perimeters of sustainable growth.
They must grasp opportunities but have a sophisticated appreciation of the risks involved in establishing a
new venture. They must encourage entrepreneurialism but focus on areas of existing excellence. And they
must be able to identify areas of high potential but also choose a market niche, a means of distribution or
some other differentiator which insulates them from the competition.
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LESSON 19
CAPTURING CONSUMER FINANCE OPPORTUNITIES IN EMERGING MARKETS
NOTE:
This article was published in Dec 1998. As such numbers/data may not be relevant.
However, the purpose of sharing its contents is to undertake a comparison with current situation in
the Emerging Markets (especially concerning Pakistan) and to learn about some basic themes &
concepts as well as the evolving trends/patterns.
For most banks, selling consumer finance products in emerging markets has seemed like more trouble than
it’s worth. In these markets, incomes are low, transactions are small, and relatively few people use banking
services of any kind. Add to that the recent economic weakness in Asia, Africa, and Latin America, and the
prospect of making money on consumer finance in emerging markets seems doubtful at best.
In reality, the opportunity to create profitable consumer-finance businesses in emerging markets is much
more attractive than it appears. But to take advantage of that opportunity, banks and other financial services
institutions must develop new business models and find ways to team up with new partners.
Sizing Up the Market:
Although the volume of consumer finance business in emerging markets is extremely low, the population’s
appetite for debt to enable purchases of common items such as televisions, refrigerators, and motor
scooters is growing fast. In Mexico, for example, consumer finance assets, at around U.S. $1.5 billion,
represent about 1 percent of the country’s total loan portfolio. These loans, however, are projected to
increase 10 to 15 percent per year for at least the next five years. And even at the current level, consumer
finance loans provide approximately 8 percent of Mexico’s total net-interest margin because of the wide
spread―up to 10,000 basis points―between consumer interest rates and the cost of capital to financial
institutions.
What’s more, operating costs and default rates for consumer finance loans in emerging markets are
generally low, making these loans extremely profitable. In Latin America as a whole, for instance, the
operating costs on the roughly U.S.$6 billion in consumer finance loans account for only 50 percent of the
net interest margin of U.S.$4.2 billion―a considerably lower percentage than that in most other finance
businesses. With default rates a surprisingly low 3 to 5 percent of total assets, net profits before tax total
approximately U.S.$1.8 billion―a profit margin of 36 percent.
The trends are similar in Asian emerging markets, despite the recent downturn in many of those economies.
Thailand, Malaysia, and Indonesia, for example, consumer credit volumes are still likely to triple over the
next ten years. And in India, which has yet to be affected by the economic crisis, the annual net-interest
margin from consumer credit is expected to grow from U.S.$630 million to as much as U.S.$3.2 billion by
the year 2010. Although net interest margins in Asian emerging markets tend to be lower than those in
Latin America (in the neighborhood of 15 to 20 percent), operating costs are lower as well (roughly 30
percent of net interest margin). Estimates put current net profits before tax for India, Malaysia, Thailand,
and Indonesia combined at U.S. $530 million. Those profits should continue to grow at double digit rates.
Where’s the Catch?
Despite the expanding opportunity, however, few of the existing players―whether banks, local
moneylenders, or retailers―are well positioned to exploit it. Traditional banks are significantly over
engineered for the needs of consumers in emerging markets. Their methods for assessing credit, approving
loans, and collecting payments are costly and ill suited to populations lacking traditional credit information.
In addition, low-income consumers are often intimidated by the procedures of the typical bank branch.
Independent moneylenders are generally more accessible, but they have their own liabilities. Their cost of
funds is high, and they do not have easy ways of identifying prospective customers or an economic means
of leveraging their credit experience beyond their narrow customer base. In theory, retailers are well
positioned to address consumers’ credit needs, since they “own” customers at the point of sale. However,
only the large chains have the scale to justify investing in the necessary credit-appraisal and loan-processing
systems.
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What’s needed is a new approach to consumer finance that draws on the financial and distribution strengths
of different types of players in emerging markets and delivers credit economically, efficiently, and in ways
that are acceptable to consumers.
􀂋 Because many of their customers have no banking relationships, retailers could be a steady,
low-cost of new consumer-finance clients. Retailers could work closely with banks, other
financial companies, and manufacturers of big-ticket items such as appliances to originate
installment loans
􀂋 Credit assessment in emerging markets must rely on the available consumer data. In markets
where standard information, such as salary documentation and utility bills, does not exist or is
difficult to obtain, credit officers must be prepared to make lending decisions on the basis of
less tangible information, such as a consumer’s standing in the community and personal
guarantees
􀂋 Local stores are well suited to be loan-payment locations in emerging markets. When
consumers are delinquent on payments, however, the best method of collection will be door to
door. Whereas approach is too expensive to pursue in developed countries, it is much less
costly in emerging markets. Moreover, it is extremely effective with low-income consumers,
who don’t want to jeopardize their ability to borrow in the future. In fact, if the collection
process is managed properly, default rates can be held to less than 5 percent
Assembling the Right Lending Capabilities
Banks and other financial-services companies that wish to pursue consumer finance opportunities in
emerging markets can consider a variety of approaches.
Some banks will enter the business by adjusting their existing systems, cost structures, and cultures.
However, most will find it easier to create a separate company or to team up with finance companies that
already have low-cost systems for acquiring customers, assessing credit, and collecting payments. That
approach enables banks with high credit ratings to take advantage of the efficiencies of finance companies
while capitalizing on their own ability to access funds at competitive rates.
ICICI, one of India’s largest banks, recently adopted this strategy with its acquisition of Anagram Finance, a
domestic finance company with 60 branches. And in Brazil, Unibanco has joined forces with Fininvest, a
leading Brazilian finance company with receivables of roughly U.S.$1 billion and a client base of several
million. Fininvest targets low-income consumers by financing specific items in stores through agreements
with retailers. The company has developed sophisticated systems for risk assessment and customer
management: Credit assessment is centralized, closely controlled by the corporate center, and completed
before any loan is approved. The company also regularly screens transaction histories, purchasing patterns,
and payment records in order to identify cross-selling opportunities.
Banks that join forces with finance companies may reap other benefits as well. As finance-company
customers become more affluent, banks can provide them with accounts and other financial products.
Large retailers may establish their own consumer credit businesses to increase their customers’ purchasing
power and generate additional profits for themselves. For example, Elektra, a major retailer of furniture and
appliances in Mexico, is also the country’s leading consumer lender: some 60 percent of its profit in the year
came from its finance activities. However, developing the necessary capabilities for credit assessment, loan
underwriting, and collections is not for everyone. Many retailers will opt in favor of negotiating partnerships
with manufacturers and finance companies that already have the required skills.
Even global finance companies are identifying opportunities to leverage their product and credit knowledge
in emerging markets. Rather than venturing on their own, though, some elect to team up with local lenders
and retailers. GE Capital, for example, has recently purchased several local finance companies in Asia and
has acquired controlling stakes in the private-label credit-card business of Thailand’s largest retailer and in a
new credit-card venture of State Bank of India.
As long as the demand for consumer finance was barely measurable in emerging markets, most traditional
financial players were content to wait on the sidelines. As the potential for the business comes into focus,
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however, those hoping to participate must begin to determine precisely what kind of role they want to play.
Companies that act early have an opportunity to lay the foundation for an exciting―and profitable― future.
2009: A year in Emerging Markets
The problems facing the global economy emanate from the developed markets, not the emerging
world. Although the news from emerging market economies has deteriorated – like everywhere else
– they will withstand the global recession better than developed markets, and much better than
they would have done themselves in the past. Yet this is not yet reflected in markets, which appear
too cheap.
The ‘credit crunch’ – the virtual freezing up of lending by banks – is primarily a developed market problem,
created in the developed world. In the last six years, for example, personal debt in the US grew by as much
as it had in the previous forty years. Too much cheap lending has now resulted in a complete and dramatic
reversal of this trend, with banks unwilling to lend to other banks, unsure of their financial solvency.
The upshot is that expectations for global economic growth have deteriorated sharply in recent months. In
this environment, growth in the emerging world will also slow next year. Just like everywhere else in the
world, more difficult times are ahead.
The only place to go for growth
Newspapers are filled with stories every day now about the slowdown in economic activity in countries
around the world. India and China – where manufacturing activity has slowed, along with other emerging
markets, have been no exception. The difference is, we believe, that overall economic growth will remain in
positive territory – unlike the US, UK and Europe, where the process of debt reduction is likely to be
protracted and will dampen spending and investment.
Schroders is forecasting economic growth at 3.5% in emerging economies in aggregate next year, versus a
fall of 1% in the OECD. In fact, emerging market economies should be at the forefront of global economic
recovery when it comes – albeit gradually – in 2010.
Economic decoupling
Emerging economies are less dependent on the developed world for growth than they were a few years ago.
Strong demand from within their own growing economies, and trade with other growing emerging market
countries (particularly China and India), make these economies much more self-sufficient. Once they would
have been the worse hit in a global recession; now they are able to withstand a US-led downturn better than
markets like the UK.
Across the region, revenues from exports to other emerging markets have now overtaken exports to the
industrial nations, and domestic demand in many countries is growing at a very fast pace. This is particularly
the case in China, where demand for Chinese products provided around four times more contribution to its
domestic economic growth than total exports did in 2007. That trend is expected to continue. Of course,
exports from China to the developed world will inevitably slow, but planned increases in Chinese
government spending should help to offset this: the government announced a national stimulus package,
totaling $586 billion, this November, which should see more infrastructure spending on roads and other
projects.
Emerging markets are not borrowed up to the hilt
Local banks have little exposure to the toxic assets that have been part of the reason for the meltdown in
the global financial system. Furthermore, debt levels in these economies are generally modest. While
emerging markets will suffer in the short-term from the global liquidity squeeze, they will not suffer the
same issues that developed markets are currently going through in terms of long and painful period of
reducing debt.
The chart below shows household debt as a percentage of the total economies in emerging market regions
compared to the developed world.
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In fact, there is actually potential in emerging markets for household debt to rise further, which will support
future growth in consumption. Public sector debt in emerging markets is also low compared to developed
markets.
Other economic fundamentals are good compared to developed markets. Foreign reserves are at a record
high and foreign debt has declined sharply – resulting in a dramatic turnaround in the net trade balance.
Markets are cheap relative to developed markets
Despite the extent of economic decoupling, these stock markets have been at the sharp end of the sell off in
global equities this year. As investors have reacted to a more gloomy global environment, they have written
off emerging markets as too risky and taken profits on extremely good returns in the previous few years.
Record inflows from foreign investors in 2005, 2006 and 2007 became record outflows this year.
This can have some knock-on effect on economies themselves, of course, as large outflows of foreign
investment takes its toll on companies.
But this does not reflect the underlying economic picture relative to the developed world. Recent underperformance
does not mean that emerging market economies and developed economies have re-coupled, it
simply means that investors’ perceptions of what is ‘risky’ and what is not have yet to catch up.
There could continue to be more volatility and disappointments in the short term as more companies issue
results; investors are arguably still a little unrealistic in their company profit expectations. Even so, the
current price/earnings ratio across emerging markets is 7.5 times next year’s corporate earnings. This
compares to a longer-term average of around 13 times for the region. The p/e of the US market and the
average p/e for global markets are now both over 9 times. Valuations may be flattered by overly optimistic
company earnings forecasts, but even if downgrades are factored in and the ‘e’ part of the p/e equation
falls, these markets are still likely to offer much better value.
The best place to be
Of course, uncertainty on a global basis is dominating stock markets at the moment – no one is sure how
long before we see the shoots of economic recovery, or how many more bank bailouts there will be. This
means we are seeing sharp swings in markets on a daily basis everywhere, but also that investors have lost
their sense of perspective on emerging markets’ prospects for the longer term. But given that economic
fundamentals in these markets are stronger and that they will be able to withstand the global economic
downturn, yet still offer more attractive valuations, we think they are the best place to be.
A Food for Thought:
There is a great deal of research that finds finance is positively correlated with growth, but this work has
a couple of serious limitations – if you want to derive any robust implications for policy.
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First, it is about the amount of financial aggregates (e.g., money or credit, relative to GDP) rather than the
share of financial sector GDP in total GDP. I, (The Author), know of no evidence that says you are better
off with a financial sector at 8% rather than, say, 4% of GDP.
Second, the research shows correlations not causation. So all we really know is that richer countries have
more financial flows relative to GDP, not that more finance raises GDP in any linear fashion.
Attempts to dig into causation tend to show that financial development is not the bonanza that it is
cracked up to be.
Third, we know finance can become “too big” relative to an economy. The work in this area is still at any
early stage. Given what we’ve seen since Mid-2007 crisis, which way should we lean: towards believing in
the positive power of finance, until the opposite is proven; or towards being skeptical of finance in its
modern form, until we see evidence that this actually makes sense?
Surely our skepticism should extend to financial innovation. Show me the evidence that this kind of
innovation really adds value, socially speaking – rather than providing a very modern way to extract
amazing “rents”
An Alternate View on Financial Innovation:
􀂋 Even if financial innovation does not boost growth, it is a good thing if it improves welfare
􀂋 Modern finance improved people’s access to credit
􀂋 Computers enabled lenders to use standardized credit scores, and the risk-spreading from
securitization made it safer to lend to less creditworthy borrowers
􀂋 This “democratization of credit” let more people own homes (and even after 1&1/2 year post Mid-
2007 financial crisis, it is worth remembering that most subprime borrowers are keeping up with
their payments)
􀂋 It enabled more households to smooth their consumption over time, reducing their financial
hardship in lean times
􀂋 Studies show that consumers in Anglo-Saxon economies cut their spending by less when they
suffer temporary shocks to their income than those in countries with less sophisticated financial
systems
􀂋 Smoother household consumption often means a smoother economic cycle, too
􀂋 Many economists believe that financial innovation, including easier access to credit, is one reason
for the “Great Moderation” in the business cycle in the past few decades
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LESSON 20
INDIA CONSUMER BANKING LANDSCAPE
India: Credit where it’s due
Emerging markets often offer greater growth potential than developed markets but they also pose a
different set of challenges. Take India, where the burgeoning middle class, especially the young, is rapidly
becoming accustomed to credit and to replacing bank notes with plastic. ‘People used to say ‘save now buy
later’. Now it’s all about affordable indulgence,’ says Chanda Kochhar, head of consumer banking at ICICI
Bank, one of the country’s largest banking groups.
‘Until three or four years ago, the 25-30 age group of young working couples with no kids wasn’t taking out
loans. Now they are behaving differently from their parents and earlier age groups,’ says Rajiv Jamkhedkar,
head of Citibank’s personal loans business in India. It is not just televisions, scooters and cars that such
people are buying on credit. They are also borrowing to pay for such things as holidays, marriage
celebrations (which couples sometimes help their parents to finance) and homes (as upwardly mobile
couples break with tradition and move away from their parents).
All this is helping India’s market for consumer finance to grow at an annual rate of 40%. Social change is
not the only thing that is driving the market. There has been a rapid growth in incomes too: the number of
households earning over Rs 80,000 a year (US$1,860 at current values) has raised by 20 million since 1996
to a current figure of 60 million.
Yet consumer loans worth US$15 billion (excluding secured mortgages) still account for only 3.5%-4% of
India’s gross domestic product. Government-owned banks tend to lend only to existing retail customers, so
those in the private sector, which market aggressively to new customers, account for most of the expansion.
The market leader is ICICI, which offers consumer finance in 1,000 cities, up from as few as 15 as recently
as 2000. This is followed by foreign banks such as Citibank, HSBC and Standard Chartered, which face no
barriers to entering the market but which tend to focus on the large metropolitan areas where credit risks
are lower.
Despite recent growth, credit and debit cards still account for only about 0.6% of consumer spending. From
three million credit cards in 1998, the market has grown to a combined total of 44 million credit and debit
cards in 2004, worth around US$23bn, according to a study by Visa International and India’s National
Council of Applied Economic Research.
Competition for market share is intense. Consumers are offered a range of inducements including interest
rates on credit cards as low as 0.99% and free holidays as rewards for accumulated points. Standard
Chartered has broken new ground with a card called Manhattan that offers ‘lifestyle’ packages, allowing
users to redeem points against activities that range from a visit to an Indian vineyard or a spa to white water
rafting and previews of films.
An impediment to growth in both consumer loans and cards is the lack of credit bureaux, identity cards or a
social security system that would enable applicants’ identities and creditworthiness to be checked.
Understandably, this makes most foreign banks concentrate on the safer end of the market. ‘We currently
focus on self-employed professionals and salaried individuals who make up 80% of our customers, so there
is still a big untapped market among self-employed proprietors and small businesses,’ says Citibank’s Mr
Jamkhedkar. A list of defaulters, started by MasterCard in the late 1990s, now covers all banks and cards.
Rival banks are also beginning to co-operate more on defaults, partly through CIBIL, a credit bureau set up
in 2000.
Another obstacle to growth is a resistance to the use of credit and debit cards by merchants such as
shopkeepers, and from self-employed professionals like doctors. Even the owners of schools are reluctant
to accept cards. Like others, they baulk not just at the cost of merchant fees and card-processing equipment
but also at anything that would involve them in having to add sales tax and so helping the authorities to
track the flow of money. Government departments and public utilities are even more resistant to change
because it would mean abandoning hand-written or typed files that provide employment for clerks.
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India’s Leading Bank
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India’s Leading Bank
Consumer Finance Strategy
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The Online trading platform caters to more than 1.4 million customers handling about 350,000
trades a day
To achieve market leadership in consumer finance in India
• Do these details/facts about Indian Consumer Finance Industry have any
Relevance/Significance for our purposes in the context of Pakistan?
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• Can we put these details/facts into some perspective by applying the “Learning
Process” we discussed in our first lecture?
• Let’s try by considering yet another analogy!
Learning is the acquisition of data, information, knowledge, understanding, and wisdom.
And what are those things?
• Data consists of symbols that represent objects, events, and their properties. For example, the
speedometer in a car presents data
• Information is data that has been made useful. Information answers who, what, where, when, and
how many questions. Information is helpful in deciding what to do, not how to do it. For example,
the information that you are driving at 120 mph will help you decide whether to speed up or slow
down. But information won’t tell you how to do it
• Knowledge consists of instructions and know-how. Knowledge answers how questions. For
example, your driving knowledge tells you how to control the car’s speed
• Understanding consists of explanations. Understanding answers why questions. For example, you
understand why you are in the car in the first place: because you are driving your kids to school
• Wisdom is the ability to perceive outcomes and determine their value. It is useful for deciding what
should be done. For example, the wise may decide that driving recklessly may lead their children to
do the same in the future
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LESSON 21
THE NEXT 4 BILLION MARKET SIZE & BUSINESS STRATEGY AT THE BASE OF THE
PYRAMID AN IFC/WORLD RESOURCES INSTITUTE REPORT (2007)
Four billion low-income people, a majority of the world’s population, constitute the base of the economic
pyramid. New empirical measures of their behavior as consumers and their aggregate purchasing power
suggest significant opportunities for market-based approaches to better meet their needs, increase their
productivity and incomes, and empower their entry into the formal economy.
The 4 billion people at the base of the economic pyramid (BOP)—all those with incomes below $3,000 in
local purchasing power—live in relative poverty. Their incomes in current U.S. dollars are less than $3.35 a
day in Brazil, $2.11 in China, $1.89 in Ghana, and $1.56 in India. Yet together they have substantial
purchasing power: the BOP constitutes a $5 trillion global consumer market.
The wealthier mid-market population segment, the 1.4 billion people with per capita incomes between
$3,000 and $20,000, represents a $12.5 trillion market globally. This market is largely urban, already
relatively well served, and extremely competitive.
In contrast, BOP markets are often rural—especially in rapidly growing Asia—very poorly served,
dominated by the informal economy, and, as a result, relatively inefficient and uncompetitive. Yet these
markets represent a substantial share of the world’s population. Data from national household surveys in
110 countries show that the BOP makes up 72% of the 5,575 million people recorded by the surveys and an
overwhelming majority of the population in Africa, Asia, Eastern Europe, and Latin America and the
Caribbean—home to nearly all the BOP.
Analysis of the survey data—the latest available on incomes, expenditures, and access to services—shows
marked differences across countries in the composition of these BOP markets. Some, like Nigeria’s, are
concentrated in the lowest income segments of the BOP; others, like those in Ukraine, are concentrated in
the upper income segments. Regional differences are also apparent. Rural areas dominate most BOP
markets in Africa and Asia; urban areas dominate most in Eastern Europe and Latin America.
Striking patterns also emerge in spending. Not surprisingly, food dominates BOP household budgets. As
incomes rise, however, the share spent on food declines, while the share for housing remains relatively
constant—and the shares for transportation and telecommunications grow rapidly. In all regions half of
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BOP household spending on health goes to pharmaceuticals. And in all except Eastern Europe the lower
income segments of the BOP depend mainly on firewood as a cooking fuel, the higher segments on
propane or other modern fuels.
That these substantial markets remain under-served is to the detriment of BOP households. Business is also
missing out. But there is now enough information about these markets, and enough experience with viable
business strategies, to justify far closer business attention to the opportunities they represent. Market-based
approaches also warrant far more attention in the development community, for the potential benefits they
offer in bringing more of the BOP into the formal economy and in improving the delivery of essential
services to this large population segment.
A BOP Portrait
The development community has tended to focus on meeting the needs of the poorest of the poor—the 1
billion people with incomes below $1 a day in local purchasing power. But a much larger segment of the
low income population—the 4 billion people of the BOP, all with incomes well below any Western poverty
line—both deserves attention and is the appropriate focus of a market-oriented approach.
The starting point for this argument is not the BOP’s poverty. Instead, it is the fact that BOP population
segments for the most part are not integrated into the global market economy and do not benefit from it.
They also share other characteristics:
􀂋 Significant unmet needs
Most people in the BOP have no bank account and no access to modern financial services. Most
do not own a phone. Many live in informal settlements, with no formal title to their dwelling. And
many lack access to water and sanitation services, electricity, and basic health care.
􀂋 Dependence on informal or subsistence livelihoods
Most in the BOP lack good access to markets to sell their labor, handicrafts, or crops and have no
choice but to sell to local employers or to middlemen who exploit them. As subsistence and smallscale
farmers and fishermen, they are uniquely vulnerable to destruction of the natural resources
they depend on but are powerless to protect (World Resources Institute and others 2005). In effect,
informality and subsistence are poverty traps.
􀂋 Impacted by a BOP penalty
Many in the BOP, and perhaps most, pay higher prices for basic goods and services than do
wealthier consumers—either in cash or in the effort they must expend to obtain them—and they
often receive lower quality as well. This high cost of being poor is widely shared: it is not just the
very poor who often pay more for the transportation to reach a distant hospital or clinic than for
the treatment, or who face exorbitant fees for loans or for transfers of remittances from relatives
abroad.
Addressing the unmet needs of the BOP is essential to raising welfare, productivity, and income—to
enabling BOP households to find their own route out of poverty. Engaging the BOP in the formal
economy must be a critical part of any wealth-generating and inclusive growth strategy. And eliminating
BOP penalties will increase effective income for the BOP. Moreover, to the extent that unmet needs,
informality traps, and BOP penalties arise from inefficient or monopolistic markets or lack of attention and
investment, addressing these barriers may also create significant market opportunities for businesses.
Perhaps most important, it is the entire BOP and not just the very poor who constitute the low-income
market—and it is the entire market that must be analyzed and addressed for private sector strategies to be
effective, even if there are segments of that market for which market-based solutions are not available or
not sufficient.
Some Additional Comments on BOP by World Economic Forum:
Although individual incomes of the BOP are low, the aggregate market is large: in 2008, their income pool
totaled slightly more than US$ 2.3 trillion. Since some of them have already begun to accumulate disposable
incomes to spend on goods beyond basic necessities, they present an attractive opportunity for marketbased
interventions.
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Incomes for the BOP have been growing rapidly at around 8% per annum. Even in the context of a global
economic downturn, this market is likely to see some continued growth. If growth was to continue at the
rate of 8% per year seen in recent years, by 2015 the aggregate income pool of today’s BOP could increase
to approximately US$ 4 trillion.
The BOP can be divided into three income segments – lowest, middle and top. The lowest level consists of
about 1 billion people who live below the poverty lined and struggle to make ends meet. The middle
segment constitutes the largest group, with approximately 1.6 billion people. Although they have little
discretionary spending power, they are generally able to support their basic needs and will require
intervention only to improve the level and consistency of their existing incomes.
The top segment – which comprises around 1.1 billion people – has sufficient disposable income to
purchase nonessential products, yet they receive little attention from most businesses, because their incomes
are still relatively low and tend to fluctuate.
This group may be easiest to engage with, since they have surplus incomes and already spend on
discretionary items. However, engaging the lower income ranges of the BOP is also feasible and important.
If businesses and organizations help to increase capacity and income among all ranks of the BOP, they will
foster broad-based growth throughout the market.
In many countries, women undertake most of the farm labour, as well as food collection or purchasing and
preparation. Yet, women often have less access to information, credit and services than men do, which
constrains their capacity as producers and consumers. Companies could pay special attention to women as
an under-served segment and address their needs, preferences and constraints in the design of products and
services. For example, micro-farm equipment can be designed to be affordable and require less intense
manual labour, and food products can be targeted to household nutritional needs. Since women reinvest
most of their income into the family, they are a powerful avenue for value creation at the household and
community level. Companies that recognize and invest in this opportunity could help strengthen
community-level productivity and enhance long-term market growth.
Where does the BOP live?
People living at the BOP can be found all over the world, yet they are particularly concentrated in a few
areas. India and China alone account for 60%. Asia, Africa and Latin America together account for 94% of
the total BOP population. Africa has the highest share of the poorest segment – only 65% of Africa’s BOP
population is above the World Bank’s US$ 1 a day poverty line, compared with more than 86% in Latin
America. The majority of the BOP live in rural areas (68% globally), which adds to the complexity and costs
of reaching them.
Some salient characteristics
Although it is difficult to generalize about a group as varied as the BOP, it is important to understand the
characteristics that distinguish them from other groups.
They manage low and fluctuating incomes
The burden of low incomes is compounded by the fact that income streams for BOP households are
unpredictable. As customers, therefore, they resist large up-front outlays and recurring expenses in the form
of installments. In addition, most lack access to affordable credit which would enable essential purchases or
business investments. Therefore, companies might look for ways to align their prices and financing for
consumers with incomes that ebb and flow. They might also design financial incentives that provide a stable
income and encourage entrepreneurship when engaging with the BOP as producers.
They cope with domestic constraints and difficult living conditions
The living spaces of BOP households are typically quite small. Furthermore, conveniences that more
affluent households take for granted – such as uninterrupted electricity and clean running water – have yet
to reach many BOP households. These conditions impose constraints on both the type of products that the
BOP can produce and consume and their level of productivity. Companies engaging with the poor could
strive to deliver business and product solutions that address these constraints.
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They are smart shoppers and investors
Since every cent counts for low-income households, they are unlikely to spend money on products they
don’t understand or trust. However, they don’t necessarily prefer cheaper or stripped-down versions of
more expensive offerings. They want high-quality products, even if they have to ration their use.
Therefore, they prefer products that are known to be reliable or are demonstrably superior. For example,
despite cash constraints, farmers will often pay a premium for high productivity seeds that other farmers
have used and profited from.
They are unfamiliar with many products, technologies and procedures
At the BOP, communication channels are scarce, literacy rates are low, and many consumers are often firsttime
users. These factors increase the need for consumer education, product trials and demonstrations to
explain product benefits and usage. Producers and entrepreneurs also lack crucial information. Therefore,
companies sourcing from the BOP must be willing to invest in educating their suppliers as well.
They look for trusted advice
Because the BOP are new to many products and have limited access to information sources, they are more
likely to rely on the opinions of people they know and trust. Advertisements can help raise awareness, but
they seldom address all the barriers to purchasing a product. The experiences of friends and relatives – good
and bad – as well as direct experience through product testing and demonstrations, strongly influence the
BOP’s choice of products and brands. For that reason, encouraging local groups to advocate products and
services to friends and creating networks for educating first-time users is a valuable tool in many business
models.
They demand respect
Surveys of low-income households elicited statements such as: “We need to be well dressed and look good.
Otherwise, people will not take us seriously. And at school, the teachers will write my children off as poor
and not deserving of a good education.” Being treated equitably and with dignity also influences where the
BOP shops. They often prefer neighborhood shops– which are familiar and offer personalized service –
over supermarkets, which may require more travel time and seem intimidating. Companies should consider
such sensitivities and treat the BOP – whether as consumers or employees – with respect.
They face disadvantages in the market
Because BOP consumers’ spending power is limited, and the costs to reach them are high, they tend to be
served by inefficient supply chains. That often results in their paying higher prices for inferior goods,
compared to wealthier members of their societies – an inequity often referred to as the “BOP penalty”. This
cost dynamic presents a tremendous opportunity for organizations and businesses to offer better quality and
more affordable options to the poor. But realizing that opportunity will require: uprooting entrenched
stereotypes and being open to new ways of engaging with this segment.
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LESSON 22
MARKET-BASED APPROACH FOR POVERTY REDUCTION
Analysis of BOP markets can help businesses and governments think more creatively about new products
and services that meet BOP needs and about opportunities for market-based solutions to achieve them.
For businesses, it is an important first step toward identifying business opportunities, considering business
models, developing products, and expanding investment in bop markets. For governments, it can help focus
attention on reforms needed in the business environment to allow a larger role for the private sector.
BOP market analysis, and the market-based approach to poverty reduction on which it is based, are equally
important for the development community. This approach can help frame the debate on poverty reduction
more in terms of enabling opportunity and less in terms of aid. A successful market-based approach would
bring significant new private sector resources into play, allowing development assistance to be more
targeted to the segments and sectors for which no viable market solutions can presently be found.
There are distinct differences between a market-based approach to poverty reduction and more traditional
approaches. Traditional approaches often focus on the very poor, proceeding from the assumption that they
are unable to help themselves and thus need charity or public assistance. A market-based approach starts
from the recognition that being poor does not eliminate commerce and market processes: virtually all poor
households trade cash or labor to meet much of their basic needs. A market-based approach thus focuses
on people as consumers and producers and on solutions that can make markets more efficient, competitive,
and inclusive—so that the BOP can benefit from them.
Traditional approaches tend to address unmet needs for health care, clean water or other basic necessities
by setting targets for meeting those needs through direct public investments, subsidies, or other handouts.
The goals may be worthy, but the results have not been strikingly successful. A market-based approach
recognizes that it is not just the very poor who have unmet needs—and asks about willingness to pay across
market segments. It looks for solutions in the form of new products and new business models that can
provide goods and services at affordable prices.
Those solutions may involve market development efforts with elements similar to traditional development
tools—hybrid business strategies that incorporate consumer education; micro loans, consumer finance, or
cross-subsidies among different income groups; franchise or retail agent strategies that create jobs and raise
incomes; partnerships with the public sector or with nongovernmental organizations (NGOs). Yet the
solutions are ultimately market oriented and demand driven— and many successful companies are adopting
such strategies.
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Perhaps most important, traditional approaches do not point toward sustainable solutions—while a marketoriented
approach recognizes that only sustainable solutions can scale to meet the needs of 4 billion people.
Growing Interest, Growing Success in BOP Markets:
Business interest in BOP markets is rising. Multinational companies have been pioneers, especially in food
and consumer products. Large national companies have proved to be among the most innovative in
meeting the needs of BOP consumers and producers, especially in such sectors as housing, agriculture,
consumer goods, and financial services. And small start-ups and social entrepreneurs focusing on BOP
markets are rapidly growing in number. But perhaps the strongest and most dramatic BOP success story is
mobile telephony.
Between 2000 and 2005 the number of mobile subscribers in developing countries grew more than
fivefold—to nearly 1.4 billion. Growth was rapid in all regions, but fastest in sub-Saharan Africa—Nigeria’s
subscriber base grew from 370,000 to 16.8 million in just four years (World Bank 2006b). Household
surveys confirm substantial and growing mobile phone use in the BOP population, which has clearly
benefited from the access mobile phones provide to jobs, to medical care, to market prices, to family
members working away from home and the remittances they can send, and, increasingly, to financial
services (Vodafone 2005).
A strong value proposition for low-income consumers has translated into financial success for mobile
companies. Celtel, an entrepreneurial company operating in some of the poorest and least stable countries
in Africa, went from start-up to telecom giant in just seven years. Acquired for US$3.4 billion in 2005, the
company now has operations in 15 African countries and licenses covering more than 30% of the continent.
Not all sectors have found their footing in BOP markets yet. Privatized urban water systems, for example,
have encountered financial and political difficulties in developing countries, and the result has been neither
better service for low-income communities nor success for the companies. The energy sector has similarly
had only limited success in providing affordable off-grid electricity or clean cooking fuels to rural BOP
communities. But even these sectors have seen encouraging new ventures, and further development of
technology and business models may expand BOP markets.
Moving towards a more hospitable environment for business:
The operating and regulatory environments in developing countries can be challenging. Micro and small
businesses especially face disadvantages. If they are informal, they cannot get investment finance, participate
in value chains of larger companies, or sometimes even legally receive services from utilities. Condemned to
remain small, they cannot generate wealth or many jobs. Nor do they contribute to the broader economy by
paying taxes.
Most, face barriers to joining the formal economy in the form of antiquated regulations and prohibitive
requirements—dozens of steps, delays of many months, capital requirements beyond attainment for most
of the BOP. In El Salvador, for example, starting a legitimate business used to take 115 days and many
separate procedures—until recent reforms reduced the effort to 26 days and allowed registration with four
separate agencies in a single visit. But even for legitimate small businesses, investment capital is generally
unavailable and supporting services scarce.
Fortunately, there is growing recognition of the importance of removing barriers to small and medium-size
businesses and a growing toolbox for moving firms into the formal economy and creating more efficient
markets. And as the World Bank and International Finance Corporation (IFC) show, in their annual Doing
Business reports, there is also mounting evidence that the tools work. In El Salvador five times as many
businesses register annually since its reforms. Many countries, including China, have dropped minimum
capital requirements. The pace of reform is accelerating, with more than 40 countries making changes in the
most recent year surveyed. Coupled with reform is growing attention to enterprise development initiatives
focusing on BOP markets and investment capital for small and medium-size businesses. Several
international and bilateral development agencies are launching investment funds to support the growth of
small and medium-size enterprises across the developing world. These efforts, and the growing private
sector interest in investing in such enterprises in developing countries, explicitly recognize that an expanded
private sector role and a bottom-up market approach are essential development strategies.
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What BOP markets look like?
Total household income of $5 trillion a year establishes the BOP as a potentially important global market.
Within that market are large variations across regions, countries, and sectors in size and other
characteristics.
Asia (including the Middle East) has by far the largest BOP market: 2.86 billion people with income of
$3.47 trillion. This BOP market represents 83% of the region’s population and 42% of the purchasing
power—a significant share of Asia’s rapidly growing consumer market.
Eastern Europe’s $458 billion BOP market includes 254 million people, 64% of the region’s population,
with 36% of the income.
In Latin America the BOP market of $509 billion includes 360 million people, representing 70% of the
region’s population but only 28% of total household income, a smaller share than in other developing
regions.
Africa has a slightly smaller BOP market, at $429 billion. But the BOP is by far the region’s dominant
consumer market, with 71% of purchasing power. It includes 486 million people—95% of the surveyed
population.
Sector markets for the 4 billion BOP consumers range widely in size. Some are relatively small, such as
water ($20 billion) and information and communication technology, or ICT ($51 billion as measured, but
probably twice that now as a result of rapid growth). Some are medium scale, such as health ($158 billion),
transportation ($179 billion), housing ($332 billion), and energy ($433 billion). And some are truly large,
such as food ($2,895 billion).
Evidence of BOP penalties emerges in several sectors. Wealthier mid-market households are seven times as
likely as BOP households to have access to piped water. Some 24% of BOP households lack access to
electricity, while only 1% of mid-market households do. Rural BOP households have significantly lower
ICT spending and are significantly less likely to own a phone than rural mid-market households or even
urban BOP households—consistent with the broad lack of access to ICT services in rural areas.
BOP business strategies that work:
Why are some enterprises succeeding in meeting BOP needs, and others are not? Successful enterprises
operating in these markets use four broad strategies that appear to be critical:
1. Focusing on the BOP with unique products, unique services, or unique technologies that are
appropriate to BOP needs and that require completely re-imagining the business, often through
significant investment of money and management talent. Examples are found in such sectors as
water (point-of-use systems), food (healthier products), finance (micro-finance and low-cost
remittance systems), housing, and energy.
2. Localizing value creation through franchising, through agent strategies that involve building local
ecosystems of vendors or suppliers, or by treating the community as the customer, all of which
usually involve substantial investment in capacity building and training. Examples can be seen in
health care (franchise and agent-based direct marketing), ICT (local phone entrepreneurs and
resellers), food (agent-based distribution systems), water (community-based treatment systems), and
energy (mini-hydropower systems).
3. Enabling access to goods or services—financially (through single- use or other packaging
strategies that lower purchase barriers, prepaid or other innovative business models that achieve the
same result, or financing approaches) or physically (through novel distribution strategies or
deployment of low-cost technologies). Examples occur in food, ICT, and consumer products (in
packaging goods and services in small unit sizes, or “sachets”) and in health care (such as crosssubsidies
and community-based health insurance). And cutting across many sectors are financing
strategies that range from micro loans to mortgages.
4. Unconventional partnering with governments, NGOs, or groups of multiple stakeholders to
bring the necessary capabilities to the table. Examples are found in energy, transportation, health
care, financial services, and food and consumer goods.
5. Enterprises may—and often do—use more than one of these strategies serially or in combination.
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New Perspectives --- Challenging Deep-Seated Beliefs:
Much of the conventional wisdom about business operations in emerging economies stands in the way of
further growth and opportunity among the BOP.
There could be five ways of reframing the problems that have challenged conventional solutions:
• Affording access rather than ownership
• Monetizing hidden assets
• Bridging the gap in public goods through private enterprise
• Scaling out versus scaling up
• Governing through influence rather than authority
Affording Access Rather than Ownership:
A person doesn’t have to own a product in order to benefit from it – he or she just has to use it. Yet,
companies tend to measure a product’s market potential in terms of the number of people who can afford
to buy it. Given the relatively low and volatile incomes of the BOP, this mindset severely restricts the
perceived potential of these markets. If organizations think about “who can use the product” rather than
“who can buy it,” they will find a much larger and potentially profitable opportunity.
Reframing this problem requires new kinds of metrics to measure market potential and affordability. What
if companies were to measure “access” to their products rather than ownership? Such access could be
provided through a shared-usage model or through an entrepreneur who “leases” the product to customers.
This way of thinking has opened up valuable markets for a number of companies.
In Bangladesh, for example, Grameen Telecom equipped village women with mobile handsets and, for a
small fee, the women make the handsets available to others for both incoming and outgoing calls. Over
time, many of these customers have bought their own mobile handsets – often choosing a Grameen phone;
since it is the brand they have become familiar with and have grown to trust. As a result, the mobile phone
sector in Bangladesh has been growing rapidly: from only 200,000 subscribers in 2001 to more than 42
million at the end of May, 2008. Nearly half of those 42 million subscribers use Grameen Phone. At the
same time, numerous women have become entrepreneurs and improved their incomes, thereby reducing
poverty and expanding opportunities. Other organizations around the world have adopted and extended the
Grameen shared-access model for mobile phone usage, including offering additional services Kenya
Agricultural Commodity Exchange (KACE) and Safaricom Ltd combined the shared-access model with a
new application that offers a valuable information service to farmers and traders. The service provides
information on the prices of specific commodities via SMS messages – by typing in “beans”, or “maize”, for
example, to find the going price in the capital. As a result, farmers can access vital pricing information to
target their sales to the best buyers, and improve their negotiating position with traders and middlemen. It
costs only 15 shillings (20 cents) per use, and the costs can be shared among the farmers.
To challenge conventional wisdom about product ownership, consider the following questions:
􀂙 “How can a company change from a “selling” mode to one that “deploys” products for use
without requiring ownership?
􀂙 How would this new approach affect its revenues?
􀂙 Does such an approach change how the company thinks about realizing further value from existing
assets and customers?
􀂙 What new business models might this new approach require?”
Monetizing Hidden Assets:
There is a wealth of potential capital residing within BOP communities, but these assets are often hidden
from formal markets. The term “assets” refers to a broad array of resources that can generate economic
value. This includes undocumented capital, which is capital that individuals have used historically or
traditionally, but for which they do not have formal ownership rights.
Undocumented capital could include property for which a family has tenancy rights but no legal title; or
unincorporated businesses that aren’t funded by a bank or other traditional investors. The second type of
capital is personal and community resources that can be leveraged to enable business transactions produce
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or sell goods. It includes the collective power of a community, which is often informally used for contract
enforcement. Even a good personal reputation – a prized asset that allows access to local credit – could be
considered a source of capital. The third kind of capital is underutilized assets, such as civil society
organizations and small and medium enterprises (SMEs). Many of these entities already have strong
networks within the community and a deep knowledge of where their untapped sources of value are. It also
includes people with entrepreneurial or other skills that have yet to be developed.
Leveraging the economic value of these hidden assets can potentially unlock significant market growth.
Indeed, the aggregate value of such capital is potentially enormous. Consider the money that Mexican
immigrants earn in the United States and send back to families in Mexico through informal remittance
channels, or the extraordinarily high interest rates charged by village money lenders in India for low-income
people with no access to formal credit. Companies should look beyond the official models to learn how
local communities bring capital into the system “unofficially”, and seek to leverage that capital to catalyze
further value creation.
In fact, mobilizing the community is a good entry point for identifying hidden assets, since the BOP
maintain strong community ties. For that reason, companies have integrated local community entrepreneurs
into their value chains, in addition to serving them as customers. Not only does this broaden the customer
base for these companies, it can also generate higher profits, since the local entrepreneurs are willing to pay
more for resources they had no access to previously. Lastly, it removes market inefficiencies and thus
creates an economic multiplier. For example, Mibanco (Banco de la Microempresa S.A.) in Peru has loaned
more than US$ 1.6 billion in amounts ranging from US$ 100 to US$ 1,500 to low-income households and
their micro and small enterprises. Mibanco’s innovation was to design special banking products to be used
for the purposes of housing, agriculture, working capital, and other necessities. To ensure that the loans
would be paid back, they instituted personal incentives, such as awards and public recognition.
As a result, they were able to offer credit to people who never had access to the formal banking system in
Peru. Human resources, which include the large pools of people who might become producers or
entrepreneurs with adequate training, are another form of hidden assets. Yet, conventional methods of
developing their skills and collecting the goods they produce in distant villages are expensive. Another
deterrent is the reluctance of many businesses to invest in training when the benefits might be shared by
competitors. For example, companies often need raw materials from farmers in a particular region, but they
avoid sourcing from them because the products are often poor in quality. Although the company and the
farmers would both benefit if the company would help to improve the quality of produce, the company is
reluctant to make such investments because it has no way of ensuring that the farmers won’t begin selling to
other companies as well.
Uncovering hidden community resources will require companies to collaborate with other organizations and
possibly even competitors to share community skills, knowledge and training. But the benefits of gaining a
more skilled, productive and accessible workforce often justify the effort and cost.
The potential for companies to unlock hidden assets by collaborating with local communities and
integrating new models with their current ways of doing business is substantial. To challenge conventional
wisdom about capital assets, consider the following questions:
1. What hidden assets does the target community have, and how does the community leverage their
value?
2. How could the hidden capital that exists in informal arrangements be brought into formal systems?
Bridging the Gap in Public Goods through Private Enterprise:
Developing nations face major infrastructure gaps. Organizations that set out to engage low-income groups
as customers or producers are often constrained by the lack of basic infrastructure they take for granted
when serving current mass markets. This greatly increases the costs of engaging with the poor, designing
products for them, and collaborating with them for the purposes of production and sourcing. The missing
infrastructure can include “hard” infrastructure, such as roads, warehousing, logistics facilities and public
utilities for water and electricity.
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It can also include “soft” infrastructure, such as producer organizations, educational and training programs,
and basic information on consumers, including individual identification and credit histories that allow
companies to target them for specific products and services.
Hard and soft infrastructures enable market activity and value creation, and they are largely considered the
responsibility of the public sector (such as governments or development agencies). Organizations that seek
to do business with the BOP overcome infrastructure constraints in two ways: they can form active
partnerships with the public sector to improve the circumstance of the BOP, or they can find innovative
ways – often in collaboration with others – to bridge the gap in public goods.
Consider the example of Pésinet Health Care, which funded an innovative initiative to reduce infant
mortality in Mali. Instead of setting up clinics in rural locations, the company trained qualified local
representatives to perform basic check-ups and communicate the information electronically to doctors in
the cities. Patients visited doctors only when they needed hands-on attention. That made the service more
affordable for patients and helped to reduce the country’s infant mortality rate. For the program to become
self-financing, the company needed to achieve economies of scale that required treating 1,200 to 1,500
children. The costs of the project were recovered by revenues generated by subscription charges, which
were US$ 1.05 a month per child and included visits to the doctor and basic medicines. In a similar project
rolled out in Saint-Louis, Senegal, the infant mortality rate fell from 120 per thousand to only 8 per
thousand. The new model has made basic healthcare more accessible to low-income people and, because it
generates sufficient revenues in subscriptions, its operations are sustainable.
Another obstacle, companies face is a lack of information about the choices and constraints in the daily
lives of the BOP. Indeed, some companies even find it difficult to identify which groups of consumers
belong to this segment. Government data is often inaccurate or nonexistent, and many workers lack official
salary records. This can be a particular challenge for banks. By insisting on official records, banks lose not
only potential customers, but also the opportunity to catalyze growth and reduce poverty by providing
essential financial services.
Organizations could work towards improving financial information systems through tools such as credit
bureaus and smart cards. Better, more accurate ways of identifying low-income consumers and determining
their qualifications and needs could be achieved through a consortium of companies that stand to benefit
from this effort, rather than a stand-alone organization. For example, A Little World, a technology company
based in Mumbai, India, launched a project in which a consortium of six banks provide biometrics-based
identification cards and RFID smart cards and near-field-communication mobile phones to people without
bank accounts. Not only has the consortium made it possible to offer banking services without the expense
of building branches, it has also built some invaluable soft infrastructure in the form of credit information
that can be used by many other industries over time to accurately identify and track their customers. That
allows companies to expand their boundaries and partner with companies in other industries to share
investments and returns.
Private intervention can support the creation of public goods – not just for philanthropic reasons, but also
to ensure long-term profitability in low-income markets. Interventions in the public domain by many
companies around the world have demonstrated that they can add value for customers as well as producers.
To challenge conventional wisdom about investing in public goods, consider the following questions:
1) Will investing in a public good that also benefits competitors actually improve near-term profits?
2) Who will decide how much each partner will gain from opportunities and how much each could
invest?
3) How can the organization create an open partnership model to facilitate entry and exit of partners
over time?
Scaling Out versus Scaling Up:
To serve customers efficiently, companies often work to reduce the unit costs of products and achieve
economies of scale through centralized production in large factories. But this model has two problems
when it comes to the low-income market. First, it increases the costs of serving and sourcing (warehousing
and distribution) since producers and customers live far from central factories. Second, centralized factories
often produce standardized products for global or regional markets, which is often not what low-income
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consumers need or want. The BOP’s requirements for locally-targeted products often cannot be met with
standard low cost production models. Companies therefore need to rethink strategies or scaling in this
market.
What’s more, companies often attach hierarchical structure to large-scale operations. As they seek to “scale
up” an innovation, they standardize structures in the forms of decision rules, measurement systems, and
organizational models. While these can boost efficiency in large-scale standardized markets, they can also
limit innovation – a key quality for success in diversified BOP markets. Companies should instead seek to
replicate innovation, constantly adapting it along the way, in order to expand their market and offer a new
pathway to growth.
One of the problems with large-scale sourcing and production schemes is that they are designed for highdensity
areas. The traditional concept of economies of scale often fails when it comes to serving the lowincome
markets. Although demand and supply in this market is potentially very large in the aggregate, these
consumers buy and sell locally because they live primarily in small, scattered groups. The alternative to
scaling up is to scale out: create experiments that can be adapted and rolled out to increasing numbers of
markets. That involves the low-income people as producers and distributors, as well as consumers, and it
minimizes overhead.
Yet, scaling up and scaling out are not mutually exclusive. Instead, organizations need to balance scaling up
(through centralization) with scaling out (through localization) to achieve the right combination of low costs
and customized solutions. To accomplish this, organizations could deconstruct their value chains and for
each step consider the trade-off between centralization and localization. The resulting model could reduce
costs and enhance customer appeal, reach, and credibility.
Aravind Eye Care in India exemplifies such a model in using metrics in initial examinations to triage patient
needs. Its staff of local entrepreneurs examines patients at low-cost community centres, which are located in
remote towns and villages. Basic examination, screening and preliminary diagnostic procedures can be
carried out by these entrepreneurs with minimum training. Cases requiring consultation with an expert are
dealt with by e-mailing patient-exam reports to doctors in cities. These doctors are highly trained and form a
costly resource in the treatment chain. Only patients that need hands-on treatment are referred on to select
hospitals. Each small community centre is self-sustaining, because it uses local resources and inexpensive
basic instruments. The organization has grown by leaps and bounds and that has given many more people
access to good eye-care services. It has also made Aravind a huge success.
A recent study conducted by a hospital showed that after treatment, 85% of the men and 58% of the
women who had lost their jobs due to sight impairment were reintegrated into the workforce. Rethinking
business models can create considerable benefits not only for companies, but also for individuals. By
starting with a few trials, then replicating the innovation and adapting it along the way, companies can
eventually reach markets sufficiently large to ensure profits. In traditional large-scale production models,
everything from procurement to production, processing, packaging and marketing is standardized. That
works efficiently when companies can use established channels for supply and sourcing, and they are
targeting middle- and high-income consumers.
However, production costs increase when demand is broadly dispersed and volumes vary, as is the case at
the BOP. In these settings, localized production centres can be a more effective approach. The French
company Nutriset S.A., which manufactures Plumpy’Nut, a fortified food for extremely malnourished
children, has adopted such a strategy. The company sought to lower manufacturing and delivery costs, allow
flexible production schedules, and maintain high quality standards by introducing a tailored licensing
system. It outsources production to local franchisees, some of which operate as mini manufacturing units,
in Malawi, Niger, Ethiopia and the Democratic Republic of Congo, and plans expansion to other regions.
Nutriset works intensively with franchisees on quality control and monitoring. This makes it possible for
local production to significantly reduce delivery costs, while creating jobs and capacity.
Although the pursuit of economies of scale has been a central tenet of conventional business models for a
long time, the means to achieve it are different for BOP markets, where scale is often better understood and
evaluated at the micro, rather than the macro, level. To challenge the conventional wisdom of economies of
scale, consider the following questions:
1. Where should the company scale up and where should it scale out?
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2. Can the company balance both kinds of scale simultaneously?
3. How will the company adopt a decentralized system, encourage innovation, and still ensure product
quality and effective management?
Governing through Influence Rather than Authority:
As companies grow, the natural inclination is to exert more control on decision-making and tighten
monitoring and audit systems. Yet, at the BOP, information gathering and control has to happen through
collaboration and with local partners. Given the wide dispersion of villages and communities in emerging
markets, it is crucial to retain a high degree of flexibility and decentralization, in order to adapt to local
changes and control costs. To reduce the overall costs of monitoring when enlisting the BOP as consumers
and co-producers, companies must first align their goals with the community’s interests and then introduce
local checkpoints. Organizations that have managed to link their interests to those of their local partners
have found that they can deliver more value at significantly lower cost. This is also true for partnerships
with different organizations.
When considering doing business with BOP communities, companies are often concerned about the
substantial monitoring costs that might be required to ensure compliance with quality standards. A better
approach is to reduce the need for monitoring by aligning the interests of the employees with those of the
company so that employees are motivated to deliver better results. This can be achieved by developing
shared aspirations and values, leveraging incentives such as profits so that employees benefit when the
organization benefits. In order for this to work, however, companies will need to rethink their business
models and current shareholders will need to relinquish some rights in exchange for broadening the range
of benefits.
One organization that has succeeded with such a partnership approach is Child and Family Wellness Shops
in Kenya. They have adopted a franchise model to deliver healthcare, and offered the nurses who run their
local clinics shares in the company. That motivates the nurse-owners to provide high quality healthcare and
reach out to the community with information and education. Not only has providing nurses with better
remuneration improved health in the community, it has also helped to retain local talent, which addresses
the problem of “brain drain” – the out migration of skilled professionals – that affects many developing
countries.
Even after aligning with the interests of local partners, companies will still need to ensure that standards,
payments and other requirements are met. Some companies appoint an “aggregator”, who serves as a point
of contact for accountability and fee collection from the community. For instance, rather than trying to
collect money from individual customers in a village for using its services, a company could consolidate
payments using a commission-based local entrepreneur who collects payments from individuals, thereby
reducing the collection costs for the company and ensuring timely payments.
Some companies partner with communities for the purposes of governance. That’s what the Manila Water
Company Inc. did when it established a community-based collection program for water consumption. To
assess and collect fees, it installed a “mother” meter for the whole community, which was responsible for
jointly paying the bill. The community now employs local checkers to ensure individual payment, which
saves the company from having to employ additional resources. As a result, the program has become a
source of local employment, generating more than 10,000 jobs since it started operations in 1997.
Besides working with local players, businesses can partner with other organizations to create and share
assets. But these organizations should be viewed more as a network of peers, rather than vendors. One of
the main challenges with such arrangements is the establishment of clear governance standards. Often
partnerships have broken down because the partners didn’t share common goals. Even when aspirations
and values are shared, the partnership must still create an open architecture for organizations to enter and
exit on the basis of their capacity to operate in the market. For example, if there is an arrangement among
financial sector companies to create a common customer-credit database, each of the players ought to be
able to contribute and benefit. There should be clear guidelines for how various organizations will
participate and how their contribution will be valued, if they choose to exit.
There is authoritative power in the social forces that bind communities together, and the key to success
among the BOP is to tap into it. Companies that have aligned the interests of communities, and then
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allowed individuals and other partner organizations to manage them, have unlocked great potential, while
reducing the overhead costs of monitoring.
The key to making partnerships work lies in aligning the interests of all stakeholders towards a common
goal. That calls for viewing community members as partners, not just salaried employees. To ensure quality
control, companies can engage managers at the community level and design incentives for the communities
to manage themselves. To challenge conventional wisdom about governance, consider the following
questions:
􀂙 What partners – with whom the company might share responsibilities and profits – can help it
achieve its goals? Will the organization be willing to relinquish its power in order to lower
monitoring costs?
􀂙 How can the company align incentives to reinforce accountability and trust with the community?
􀂙 How can the company establish clear governance standards and an open architecture where
partners can enter and exit freely?
􀂙 How will the company value their contributions despite its focus on long-term profits?
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LESSON 23
FINANCIAL SERVICES MARKET WITHIN BOP
Microcredit pioneer Muhammad Yunus received the Nobel Peace Prize in 2006, a milestone in public
attention to the financial needs of the BOP. Until recently the main focus has been microcredit, historically
the domain of nonprofits. Now the focus is changing—as new players and new products enters the market
and new technologies transform services. A dynamic financial services sector is emerging—moving toward
financial access for all.
Many microfinance institutions now offer savings as well as microcredit. Commercial banks are becoming
active in the BOP market and bringing a still broader range of services, including insurance. Mobile phone
banking, still at an early stage, promises to dramatically broaden access and lower transaction costs.
Remittances to BOP households from family members overseas have emerged as a significant cross-border
financial flow, bringing new attention and new ways to promote economic growth.
As these changes expand access to financial services for the BOP, the effects can be measured in many
ways, not just in the volume or dollar value of transactions:
• New jobs and income. New types of financial services, provided through mobile phone systems,
are generating new jobs and income for millions of small entrepreneurs who sell over-the-air credit.
• Formal identity. Establishing a banking relationship gives people a formal identity they often
lacked before, contributing to the process of political and social inclusion critical to development.
• Greater personal safety. Cash is a burden for the poor, making them vulnerable to crime. By
doing away with the need to carry a lot of cash, such services as debit cards and mobile phone–
based access to cash and bill-paying facilities enhance personal safety and the quality of life.
• More education for children. In Bangladeshi families that are clients of Grameen Bank, nearly all
girls are in school, compared with only 60% in nonclient families.
• More timely health care. In Uganda the Foundation for Credit and Community Assistance
(FOCCAS) links its microloans to participation in child health education programs and has doubled
the share of its clients using practices to prevent the transmission of HIV. In Bolivia microcredit
clients of Crédito con Educación Rural (Crecer) had higher rates of child immunization in their
families than did nonclients.
• Economic empowerment of women. In Indonesia women who are clients of Bank Rakyat
Indonesia (BRI) are more likely than other women to participate in family financial decisions. In
India borrowers from SEWA Bank have organized unions to lobby for higher wages and more
rights as members of the associated Self- Employed Women’s Association.
Through these effects and many more, financial services play a critical part in reducing poverty and
improving the access of the BOP to goods and services.
How large is the market?
National household surveys capture extensive data on financial matters, but little on actual spending for
financial services. Moreover, the costs of these services are often not fully transparent to BOP customers,
who may not know or understand the actual costs of transferring remittances from sender to recipient, for
example, or the true interest rate paid to an informal village lender.
As a result, robust data on spending for financial services are not available in sufficient detail for meaningful
analysis.
What is known, however, clearly indicates that the financial services sector is changing—and doing so in
ways that are moving it toward broad access for the BOP.
Three factors are powering this transformation:
• The microfinance sector is growing up, attracting new participants and creating new services.
• Rapid changes in technology are reducing the transaction costs in financial services, expanding
markets, and interesting large financial institutions in markets previously ignored.
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• Remittances are approaching an estimated US$350 billion a year, and recipients, businesses, and
national governments are learning how to leverage these “BOP to BOP” financial flows.
The following analysis briefly explores the financial services sector through these three lenses.
The changing banking landscape
Several strategies are at work to bring financial services further into the BOP. One is to expand the
microfinance institutions. A growing number of traditional microcredit banks—such as the Cooperative
Bank of Kenya, Financiera Compartamos in Mexico, and BRI in Indonesia have become profitable on a
fully commercial basis, with sustainable microlending now just a part of their core business. And one
relative newcomer, SKS Microfinance in India, has relied on operational efficiency to power rapid growth in
lending.
By the industry’s own estimate, however, microcredit had reached only 82 million households by the end of
2006. Even the industry’s new target for 2015, 175 million households, would represent only 31.5% of
today’s 556 million BOP households.
Clearly, other strategies are needed to reach scale. Some are already in play. Major financial institutions are
discovering that they can go “down-market” profitably, leveraging their capital, their expertise, and their
back-office systems. In one of many examples, Citi in late 2006 announced plans to expand into lowincome
neighborhoods of India with automated teller machines (ATMs) using thumbprints to identify
customers. Banks also are beginning to view those receiving remittances as potential customers for a range
of financial services.
Nontraditional players are entering the BOP market. Retail giant Wal-Mart has received regulatory approval
in Mexico to create its own bank, Banco Wal-Mart, co-located with its stores. If the venture is successful,
other Wal-Mart banks will follow elsewhere.
Some microfinance institutions and big commercial banks are meeting in the middle. Grameen Foundation
USA and India’s largest private sector bank, ICICI Bank, have formed Grameen Capital India to assist
microfinance institutions in raising funds. The joint venture will help microfinance institutions access
primary and secondary debt markets and sell portfolios of microloans to other banks—and will also supply
guarantees and credit enhancements for these portfolios where appropriate.
ICICI has many similar ventures in the pipeline aimed at reaching the BOP. One is a partnership with
microfinance institutions and technology provider n-Logue to harness thousands of entrepreneur-run
Internet kiosks as the first touch point for savings accounts, mutual fund purchases, insurance, and even
equity loans—and to provide branches, franchise operators, and ATMs throughout rural India. Partnerships
like these are spreading across the financial sector as a way to broaden access to services for the BOP.
Steady growth of savings accounts in the BOP provides compelling evidence of its appetite for more than
microcredit. Savings accounts for low-income customers in developing and transition economies are
estimated to number more than a billion. Indeed, for BRI and Financiera Compartamos, savings accounts
represent a much larger part of their BOP portfolio than do microloans. Savings vehicles are often
hampered by outdated laws and regulations. But where permitted, they can play a powerful new role in
deepening the financial sector for the BOP.
Finance for small and medium-size enterprises is growing. While this development does not bring financial
services to the BOP, it does expand opportunity by creating jobs and services. The financing comes in the
form of loans and equity investment beyond the limits of microfinance but too small for the traditional
lending windows of large banks. The Asian Development Bank is developing a series of investment funds
for small and medium-size enterprises in Asia, and the Japan Bank for International Cooperation has
increased by several million dollars its pledge for private sector investment in Africa, including money for
small and medium enterprises. Shell Foundation has helped launch several investment funds in Africa that
focus on small enterprises, bringing in local financial institutions as co-investors. The most effective new
models combine the provision of capital with mentoring, business education, and skills training.
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Commercial banks are seeking new ways to participate in small and medium-size enterprise finance, driven
by such structural factors as low rates of return on government debt in much of the developed world and
stiff competition among banks at the high end of the market. The global banks usually partner with local
banks, able to provide the risk assessment and community relationships critical to success. Meanwhile, the
availability of capital and the support of big money-center banks are driving local banks to better serve local
small and medium-size enterprises, a market many have long ignored.
Technology as a driver
Technology does two key things that help drive the development of financial services: it cuts costs, and it
bridges physical distance. For BOP customers, technology in financial services can address four important
concerns: convenience, accessibility, safety, and transferability. A mobile phone–based transaction system
offers far more convenience and accessibility than a traditional financial institution, whose use may require
that clients find a bank branch or attend a weekly microfinance group meeting. Electronic forms of money,
less prone to theft, are safer than cash. They also are more easily transferred, especially overseas.
Technology is bringing nontraditional players into the financial services market. Most notably, mobile
phone operators are introducing new products and services over their networks that look and feel like
traditional financial services. Start-ups are finding ways to combine mobile networks and traditional banks.
The resulting hybrids—banks partnered with mobile phone operators, or companies that market both
financial and mobile phone services— pose issues for banking and telecommunications regulators. But the
benefits seem so great as to demand solutions, and Pakistan, for example, has instructed the two sets of
regulators to work out effective solutions.
The emerging technology-driven financial services include bank-centric models, electronic currency, and
mobile commerce systems. The services are being provided through a range of technologies: ATMs, mobile
phones, handheld computers, and credit, debit, and smart cards.
In Kenya, Vodafone is partnering with local mobile operator Safaricom and local microfinance institutions
to roll out a financial transaction system called M-Pesa. The system is based on a new mobile phone card,
developed for the purpose that enables microfinance clients to make deposits, check balances, and fully
manage their accounts. Neighborhood banking agents can turn electronic transactions into cash and take
deposits and payments on behalf of clients, earning commissions along the way. Vodafone has plans to
rapidly add more countries.
Prodem FFP in Bolivia is a sector-leading example in the advanced use of ATMs to provide savings
accounts to low-income, illiterate customers in rural areas. Technology, it understood, would be the key to
providing affordable service. Unable to find the low-cost, high-quality technology it sought, Prodem
partnered with a local firm to create it. The result: an ATM that uses visual and audio prompts in four
languages, including three indigenous ones, and a smart card that captures and stores account information
and biometric identification. ATMs aimed at the BOP are now being taken up by big banks, such as Citi in
its ATM venture in India.
Visa International has partnered with FINCA International, a microfinance institution in Latin America, in a
retail banking program for FINCA’s BOP microfinance clients. The program automatically deposits loans
into a savings account opened by the client at a retail bank and issues the client a Visa debit card and a
personal identification number (PIN) to access the funds. Visa and FINCA have found that the program
makes clients more inclined to save now that their money is in a secure place. The program also increases
security by eliminating the need for a loan check, which could be lost or stolen. And it gives clients a feeling
of prestige associated with carrying a Visa card.
Remittances as a new tool for promoting growth
At the same time that banks are discovering that the BOP want and need full access to financial services,
financial sector analysts are discovering that the funds flowing in and out of the BOP are much greater than
previously thought. The Multilateral Investment Fund of the Inter-American Development Bank took the
lead in tracking remittances to Latin America and the Caribbean, and now others are adding to the data.
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The new understanding of the size of remittances brought policy and commercial attention. Reforms were
launched to bring more of the flows into official channels, and new competition emerged among transfer
services (Orozco 2006). With competition have come better service and lower cost. The results have been
especially noticeable in Latin America, where the reported flows from the United States have risen every
year, reaching US$53.6 billion in 2005.12 Worldwide the total is now thought to approach US$350 billion,
with significant flows to every developing region. Indeed, reported remittances doubled between 1999 and
2004.
This stable flow of funds provides a large share of income for many in the BOP as well as a direct “BOP to
BOP” financing mechanism that helps pay for new houses, new businesses, and children’s educations. But
governments and development agencies are only beginning to understand the national and local effects of
remittance flows—and to find ways to increase the benefits from them.
One benefit: at the national level remittances significantly improve country risk ratings, as recent research by
World Bank economist Dilip Ratha (2005) shows. Higher ratings encourage more private sector investment,
which can help create jobs and fuel growth. Another benefit: several banks in developing countries have
been able to “securitize” remittance flows—that is, use these dependable flows to back a financial
instrument sold in international capital markets—and thereby lower their cost of borrowing. Both these
benefits mean greater national financial capacity for domestic investment, increasing the growth effect of
remittances beyond their impact at the household level.
Recognizing the potential in transferring remittances, businesses are launching new services. At the 3GSM
World Congress in Barcelona in February 2007, a consortium of 19 mobile operators, serving more than
600 million customers in 100 countries, announced a system that will transfer remittances entirely through
their mobile phone systems, radically reducing cost. The consortium predicts global remittances of more
than $1 trillion a year by 2012.
These developments notwithstanding, there is still a serious shortage of infrastructure on the ground to
provide financial services to the BOP. Carefully mapping where remittances are sent in Mexico and where
formal banking institutions exist, the Inter-American Development Bank has identified many locations with
substantial remittances but no banking services.
This lack of presence represents a lost opportunity for traditional financial institutions and a barrier to full
financial citizenship for the BOP. It also creates a significant opening to this unserved market for nontraditional
players and branchless banking enterprises.
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The Pakistan Context …..
The Pakistan Context …..
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Source/Reference:
IFC/World Resources Institute Publication, 2007
Titled, “The Next 4 Billion, Market Size & Business Strategy at the Base of the Pyramid
(BOP)”
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LESSON 24
REFLECTION TIME!
Following is an extract from an article by Prof. Dilworth
Robert L. (Lex) Dilworth is an Associate Professor Emeritus of Virginia Commonwealth University in
Richmond, Virginia, USA. He has a doctorate from Columbia University in Adult and Continuing
Education. His specialties are human resource development (HRD), action learning, and organization
development (OD).
The Nature of Reflection!
If you ask someone to define reflection, you are liable to receive widely varied responses. In the simplest
form, mention may be made of stopping to think, a momentary pause in the activities tied to living (e.g.,
stopping briefly to reflect on what is needed on entering a grocery store). When it comes to reflecting on
your life and critical decisions that need to be made, it becomes much more difficult.
For some, stopping to reflect on their existence can seem too painful. It can bring to mind memories of
failure or life tragedies. I had a student about four years ago who told me that she simply could not do any
deep reflection. She said, "I am afraid of what I may see". Part of her memory was in effect off limits.
Protection of her self-image and self-esteem required that she stay clear of certain sensitive subjects.
While there can be obvious psychological blockages to reflection, the more common reasons for finding it
difficult to reflect are much more basic. First, opportunities to reflect are driven out by the frenzy of life
activity and day in and day out crises. Therefore, the ability to reflect lies undeveloped, and when one
attempts it, reflection can seem extremely awkward--like a right-handed person trying to sign their name
using their left hand. Business executives can be especially resistant to reflection because it can seem a
needless detour from current business activity.
It takes time and practice to unlock the ability to reflect. The art of critical reflection takes even longer, and
some never get there. However, once the impasse is breached and reflection starts to occur naturally and
routinely, the individual can feel empowered and in control of their own life. That can be a liberating
experience. When the reflection pushes to the deeper levels of self, it becomes possible to jettison
dysfunctional assumptions and behaviors. Deep learning can then occur. It can become transformative
learning. The individual is elevated to a new plateau of self-awareness. At this point, it becomes what can be
called emancipatory learning--throwing off the self-imposed, and frequently externally imposed, chains that
have been constraining clear thinking and advance.
Reflection in the end is a dialogue with self. It can lead to a form of self-catharsis, where we find ourselves
listening to our inner feelings. I remember a person in one of my action learning sets in 1996 in England
who reached a point where she could hardly wait to get back to her room at night to reflect on events of the
day and their meaning. She indicated that she found herself good company and had meaningful
conversations with herself as part of the act of reflecting.
Jack Mezirow, who has written on transformative learning and reflection, says this:
Reflective learning involves assessment or reassessment of assumptions. Reflective learning
becomes transformative whenever assumptions or premises are found to be distorting, inauthentic,
or otherwise invalid.
In discussing "reflection and making meaning", Mezirow indicates:
Much of what we learn involves new interpretations that enable us to elaborate, further
differentiate, and reinforce our long established frames of reference to create new meaning
schemes. Perhaps even more central to adult learning than elaborating established meaning
schemes is the process of reflecting back on prior learning to determine whether what we have
learned is justified under current circumstances .What this all leads back to and places in focus is
the Learning Equation of Revans.
Here it is the reflective process (the questioning insight, or Q) that confirms or disaffirms what is currently
in the inventory (the programmed instruction, or "P") from the standpoint of true relevance to what is
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being dealt with first hand. What Mezirow is saying in so many words is that reflection enables you to judge
the relevancy and appropriateness of prior learning to the situation that now confronts you.
Are you a knower or a learner?
Knower Learners
• Someone who obtains his selfesteem
from appearing to be right.
He is not willing to admit, “I don’t
know” and is not willing to be
influenced.
• Knowers believe they know all that
they need to know in order to
address the situations that they are
responsible for.
• Knowing is so central to knowers’
identities that it causes them to
sometimes pretend that they know,
even when they don’t.
• Knowers can easily become
defensive. They hide their lack of
knowledge.
• Learners are players in the game of life
and understand they are there to have an
impact on the game’s outcome.
• The main focus of learners is on
increasing their abilities to respond to the
challenges around them and inside of
them.
• They are willing to be influenced. They
consider what other have to offer.
• They admit their ignorance and then offer
their knowledge. They seek
communication through dialogue, i.e.
balancing advocacy with enquiry.
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BOP Market New Approaches & Design Principles for Success (World Economic Forum
Report)
This Framework is based on an analysis of more than 200 Case Studies.
The BOP often find themselves having to make difficult compromises: their incomes are limited, yet they
desire products and services that are suited to their needs; they require information, yet they have difficulty
accessing it; they live in scattered towns and rural villages, yet they must deliver their wares to distant
markets. Companies first need to invest in developing a comprehensive understanding of the BOP and the
constraints they face. The next step is to create new business models that break these compromises and give
low-income people a sustainable foothold in a market that allows them to thrive.
This chapter addresses what it will take to convert the BOP into the next billions. It presents a set of design
principles for developing new business models that are based on an analysis of more than 200 case studies
and numerous discussions with companies planning on or currently engaging with the next billions as
consumers, producers or entrepreneurs. The design principles are structured along four parts of a typical
business model: product innovation, supply chains, marketing and partnerships. They apply specifically to
the circumstances of the next billions and together present a framework for innovation. The five principles,
seen in Exhibit, are:
1. Create life-enhancing offerings
2. Reconfigure the product supply chain
3. Educate through marketing and communication
4. Collaborate to form non-traditional partnerships
5. Unshackle the organization.
The chapter concludes with a discussion of how companies can help new business models succeed by
unshackling the organization. It should be noted, however, that these principles are given as suggestions
rather than prescriptive solutions. There is no silver bullet in this market. Organizations will need to be
prepared to consider many kinds of innovations on several fronts.
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Create Life-enhancing Offerings
Life-enhancing means offering products and services that improve livelihoods and trigger the economic
multipliers that allow the next billions to overcome their constraints. Rather than offer the same products
they sell in the mass markets of developed economies, companies need to adapt their products and prices to
the specific needs of the next billions.
A farmer in a rural area, for example, may want a rugged mobile handset with a data feed that provides
wholesale prices at nearby markets, whereas a day laborer in a city may care more about how the handset
looks and feels and its ability to take pictures. Therefore, mobile operators and handset manufacturers need
to design products and services that deliver both aspirational and pragmatic value. Research suggests the
following practical guidelines:
Price for the budgets of the next billions
Because the next billions have low incomes and little savings, large up-front purchases are often out of their
reach. For many products, pricing will involve some consideration of credit terms. Producers and retailers
of large-ticket items, such as durable goods, for example, could offer financing tailored to the next billions’
budgets in order to increase sales. Service providers, such as mobile operators, could “fit the pocket” of
consumers by lowering recharge amounts, offering flexible terms, and encouraging free or low-cost trial use.
One of the best ways to make products available is to offer less expensive and smaller packages. For
example, a BOP customer may need a small loan for a one-time purchase of inputs for a business operation
or for an emergency. Yet, many institutionalized credit offerings are expensive and available only for large
amounts. With a minimal investment in restructuring, a financial institution might offer small-size loans
with flexible repayment terms. Since families tend to pool their funds for expensive purchases, certain
products should appeal to all family members. One possibility would be prepaid family plans for mobile
handsets because family members tend to share them.
Tailor products to address local constraints and emphasize quality
Developing low-cost products shouldn’t mean sacrificing quality. In fact, because the BOP can’t afford
products that break down, they will often pay a premium for quality they can trust – even if they have to use
credit or trade down to less expensive products in other categories. Some companies have demonstrated
successful examples of assuring quality for locally tailored products and in turn earning the loyalty of the
consumers. Take the example of International Development Enterprises India (IDE India) which is a social
enterprise that engages actively with small scale farmers by supplying manually operated treadle pumps. As
uninterrupted power supply is rarely available to these small landholders, they could not use electrical
pumps. IDE India designed pumps which required no power supply and enabled farmers to trade up from
manual methods of drawing and transporting water to the treadle pumps. In order to keep retail prices low,
product manufacturing is outsourced to local manufacturers, who follow a stringent quality assurance
program and participate in IDE India’s warranty scheme. The enterprise has also facilitated partnerships in
service hubs that provide processing facilities and allow for intermediary sales of produce. This provided
broad based support to farmers and convinced them to pay money for the product as it’s easy to use and of
high quality. IDE India has successfully helped farmers to increase their productivity and in many cases they
have doubled their income, often within two years of purchase.
Develop environmentally sustainable approaches
Raising the income and consumption level of the BOP will place immense pressure on already-stretched
resources such as land, water, energy and ecosystems. Therefore companies should explore economically
sustainable solutions that have a minimal impact on the environment.
Products and services offered to low-income populations should aim for innovative and eco-friendly
methods of production and consumption. Goods marketed to the next billions should utilize packaging that
minimizes environmentally harmful wastes. Farming techniques and inputs should be developed to address
environmental concerns while also enhancing farmers’ incomes.
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Reconfigure the Product Supply Chain
Of the BOP, 68% reside in rural areas, where physical access – for both distribution and sourcing – is a
challenge. Even in urban areas, distribution requires a network of micro-traders. Companies often wrestle
with tradeoffs between cost, coverage and control. Distribution networks need to reach disparate
neighborhoods and villages, while remaining viable at low volumes and prices.
Manufacturers need to ensure that they have adequate oversight of pricing, stocking, and service throughout
the distribution chain to fulfill quality requirements. The following recommendations could guide the design
of effective distribution networks:
Source from local producers
The potential for increased agricultural production is one of the “hidden assets” that often lies untapped in
BOP communities. Companies can develop this value by working with local producers to improve the
quality and volume of their output for a specific market.
Sourcing locally can reduce the cost that companies incur to reach and serve the next billions, enable
provision of customized products for local preferences, and build trust and credibility for the company’s
brand. Most importantly, it can provide a sustainable source of local income, which is vital to BOP farmers
facing volatile markets. Companies might offer mechanisms such as forward contracting or guaranteed
purchasing to reduce risk and uncertainty for farmer incomes. Local sourcing, however, often requires
companies to expand their traditional role and actively coordinate the full supply chain, often enough by
cooperating with several partners.
One of the most prominent examples of local production is Shokti Doi yoghurt, which was introduced by
Grameen Danone Foods Ltd in Bangladesh. Shokti Doi is sourced from, partly processed by, and
distributed and consumed by the local low-income segment. Once a coordinated supply chain is established,
it will grow into a platform that can facilitate other benefits to producer, consumer and company.
Another successful example in this domain is Fair Winds Trading Inc., who partners with Gahaya Links, a
Rwandan woman owned firm that manages a network of 3,000 Rwandan women who weave baskets sold
through an exclusive agreement with Macy's in the US.
Broaden reach and save costs by leveraging local distribution channels
Service providers can work with local entrepreneurs to leverage existing low-cost distribution channels. In
Brazil, Nestlé outsources the “last mile” of its distribution network to women entrepreneurs in small
villages. They receive the company’s products through the mail and sell them door to door throughout the
neighborhood, thus increasing the company’s reach and brand credibility. Another company in India gives
its salespeople bicycles to reach villages with populations of less than 5,000.
Companies could also cooperate to bundle product distribution in BOP regions, thus reducing costs for all
involved. Small product manufacturers in Brazil partner with international retailers such as Carrefour and
Wal-Mart to supply private-label products, thereby reducing retailers’ supply-chain costs, as well as
manufacturers’ marketing costs. As a result, nearly 33% of the population is now buying private label
products. In South America, S.A.C.I. Falabella started providing financial services to unserved segments as a
way to drive retail sales; the services now generate at least 50% of the company’s bottom line. In another
example from Brazil, banks have offered their products and services through lottery shops and post offices.
As a result, 28% of unserved municipalities and 98% of Brazilian towns now have banking services.
In addition, companies can capture discretionary retail spending by combining distribution efforts.
Agricultural retail centres in Indian rural areas offer a one-stop shopping service, providing small-scale
farmers with a range of products and services.
Find creative ways to overcome infrastructure constraints
A key constraint in sourcing goods from BOP producers is the risk of loss or damage of agricultural
products due to poor storage and transport infrastructure. Companies buying from the poor have been
addressing this by establishing “scaled out” local processing and collection centres.
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Training producers and handlers can also help reduce these losses. Sometimes, it doesn’t take a lot to realize
significant improvements. Metro, a cash and carry outlet in India, suffered losses in its tomato supply as
high as 40%. It turned out that during their breaks, handlers sat or slept on top of bagged tomatoes. By
changing its packaging to crates on which they could sleep, Metro was able to reduce waste to 15%.
Companies can also turn the lack of infrastructure into a business opportunity.
The MPESA service by Safaricom in Kenya, for example, allows individuals to transfer money via mobile
phones. Cash can be deposited or redeemed at local shops that are licensed as agents. By converting smallscale
local retailers into a distribution network for the service, the company is overcoming the lack of more
established service channels.
Source/Reference:
The Next Billions: Unleashing Business Potential in Untapped Markets,
Study/Report prepared by World Economic Forum in collaboration with The Boston
Consulting Group
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LESSON 25
REFLECTION TIME (CONTD…)
This Framework is based on an analysis of more than 200 Case Studies.
Educate through Marketing and Communication
Given low literacy levels and lack of access to mass communication, BOP consumers are often unfamiliar
with new products and their intended benefits. As a result, companies need to create marketing programs
that are as educational as they are persuasive, and they must establish strong credibility and recognition for
their brands.
Educate about product benefits
Once BOP consumers are convinced of the value of a new product, they are often eager to invest in it.
Unilever’s successful hygiene promotion campaigns in India involved product promoters visiting villages to
educate consumers on the health benefits of its soap. In a similar manner, agricultural input companies have
used farmer training programs, agro-dealer certification, and model farms to train farmers on the use and
benefit of specific products.
Companies can create opportunities for new customers to experience their products firsthand through
displays, guided product trials, or explanations by trusted advocates. This approach is especially necessary
for complicated products such as electronic equipment, as well as for products that might be perceived as
potentially harmful, such as fertilizers and other agricultural inputs. In India, Hindustan Unilever’s Project
Shakti – a distribution network of village women – is a good example of explanation by trusted advocates.
The women educate their neighbors about the need for personal hygiene and demonstrate the effectiveness
of the company’s products.
Create word-of-mouth advocacy
Consumers in this market are more likely to trust a friend or family member than a salesperson they don’t
know. Leveraging such informal communication networks can become a powerful sales tool. That insight
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led a Brazilian retailer to hire salespeople from the same neighbourhoods where its customers lived and
thereby increase its sales significantly. One consumer-goods company in India identified key opinion makers
in several communities and developed a partnership with them to market products in the neighbourhood.
The company’s offerings now reach 80,000 villages, which account for about 15% of its rural sales. Intel
Corporation partnered with the Vietnamese government to advocate its low-price Thánh Gióng personal
computers in rural community centres; the company now sells over 3,000 systems a month to small
business owners in Vietnam.
Aim for trust and identity in branding.
Low income consumers are generally more willing to accept an unfamiliar product if it carries a well-known
brand or is endorsed by a trustworthy institution. Companies with strong brand recognition can leverage
that asset by launching additional products and brand extensions.
However, because many companies have yet to access BOP markets, relatively few brands are widely
recognized. New entrants to the market can overcome this obstacle by partnering with established brands in
another industry – for example, a financial services firm could collaborate with a trusted consumer products
brand to promote its services. A number of Latin American companies have successfully used this model –
for example, the arrangement between the Brazilian retailer Magazine Luiza S.A. and Unibanco (União de
Bancos Brasileiros S.A.) to offer consumer credit for shopping.
Once a company has secured customer loyalty, it is important to preserve that trust. Many BOP regions
have few or poorly-enforced consumer-protection regulations for truth in advertising or labeling.
Consumers therefore rely on direct experience or inter-personal communication to form an opinion about a
brand. Building and preserving a strong reputation therefore becomes a key for companies seeking longterm
success in the BOP market. Consumer trust must be secured through consistently delivered quality
and reliability.
Collaborate to form Nontraditional Partnerships
As noted earlier, mass production is often ineffective in the BOP market. Serving this segment requires
companies to go beyond traditional “we-make-it and-you-buy-it” relationships to include the BOP in the
actual production of the offer, as well as its distribution. By engaging with the BOP as a market of
producers as well as consumers, companies can substantially lower the cost to serve, since the local
communities have established networks and deeper reach. This includes collaboration on two levels:
partnering with local communities and collaborating with organizations. Such arrangements are a good way
to reduce production costs. Collaboration also captures “hidden” assets – in the form of untapped
resources and local knowledge – while increasing local incomes. That enhances the BOP’s ability to
purchase more goods and services and generates a virtuous economic cycle for long-term sustainability.
Unlock local potential by engaging with communities
By employing hidden assets in local communities, companies can reduce overall cost to serve, customize
local offerings, improve delivery, and penetrate deeper into markets to fill gaps.
Partner with communities rather than individuals
One of the biggest challenges in using local resources is the cost and complexity of sourcing from smallscale
producers. A potential solution is to involve community aggregators, often village leaders, who can
serve as focal point for a group of producers.
PepsiCo in India uses such an approach in its contract farming program for high quality potatoes. PepsiCo
signs contracts with group of farmers in a village and empowers a village coordinator who enjoys the
confidence of the farming community. The coordinator aggregates supply, disseminates information on
farming practices and technologies, and plays a role in setting mutually agreed and pre-announced prices.
Not only do such aggregation schemes make it easier for companies to source in this market, they also make
sourcing from the BOP easier for the local community. Most families who supply to companies aren’t able
to guarantee a consistent flow of goods because they have other constraints. For instance, women who
weave high-quality carpets also need to take care of their families. Since they work on varied schedules, they
can’t deliver fixed volumes directly to the companies who buy their goods. But when village women work
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together collectively, they can organize their work flow so that the company can receive regular shipments
of goods in required volumes.
Invest in talent and expertise building
Another problem with integrating local producers is that they often don’t have the necessary skills to meet a
company’s quality standards. Most companies are reluctant to invest in workers’ skill base when that may
also benefit its competitors. Furthermore, the investments required are substantial and often entail building
missing infrastructure, so they can be unprofitable for single players. One solution is to set up consortiums
with other companies interested in the market and work collectively towards creating a talent pool. Another
option is to deconstruct the value chain and “de-skill” activities performed in the field or at the point of
service delivery. The Aravind Eye Care model in India and the Pesinet healthcare model in Mali are two
examples of this. In both cases, specialist doctors remain in cities, while field staffs who have received basic
training perform the first level of patient screening and information collection for diagnosis.
Create incentives that encourage self-governance
Most organizations are reluctant to source from the BOP because they believe quality will be poor, and
monitoring for quality control is costly. Yet, it is possible to establish low-cost local checkpoints to ensure
that quality standards are met by aligning the interests of the co-producers.
Coca- Cola innovated along these lines in developing countries in Asia and Africa, where it established
“manual distribution centres” (MDC) staffed by local entrepreneurs. Originally developed in East Africa by
its bottling partner Coca-Cola Sabco (CCS), the distribution system is built around thousands of small,
independent distributors. Coca-Cola bottlers actively manage MDC owners as third parties, supporting
them to establish their operations, secure microfinancing, and design effective delivery operations to keep
customers in stock.
Form deep collaborations with unconventional partners
To succeed in this challenging market, companies need to work with other players to develop the right
products, services, and delivery mechanisms. But serving the next billions will require them to go beyond
traditional forms of partnership, to include civil society organizations and even competitors. In doing so,
they will be able to share costs, as well as capabilities and knowledge. And they can enhance current offers
through bundling and convenient access, and fill the gaps in market infrastructure.
Share products and assets
Companies can partner to bundle several products and services together, often making those products more
affordable. In Brazil, Telefónica S.A.’s partnership with Abril S.A. to offer Internet services over the
television network is one such example. Companies can also share distribution and retail networks, and
leverage common logistics and facilities. Consider the partnership of IFFCO, a fertilizer company in India,
and Airtel, a telecommunications company. Airtel realized that IFFCO had an established and efficient sales
channel to widely disperse rural farmers, so Airtel used it to market and distribute its own products for
farmers.
Channel sharing might also involve a global medical company providing local drug companies in emerging
markets with licenses to produce lifesaving drugs. The local companies bring to the table a deeper reach and
more efficient sales force, while the global company brings superior capacity in research and development
systems. The global company might also be able to receive benefits from the government for such
initiatives.
Share capabilities and knowledge
Organizations can also collaborate in deeper ways to distribute or process information, share knowledge for
product innovation, or improve efficiency. For example, the records that telecommunications operators
have on individual payment histories could be used by a finance company as a proxy to establish their credit
worthiness. Financial service companies are exploring ways to use this information to provide microinsurance
and other financial products. Or an insurance company might enter the low-income market by
having the local postman help to market its products door-to-door and return with feedback on product
satisfaction. Such collaboration practices give companies rapid access to critical knowledge on market
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movements and local consumer behaviour, and they help to eliminate the market inefficiencies of reaching
the BOP.
Make Partnerships Work
The pay-off for nontraditional partnerships is the development of valuable skills in producers, partners, and
consumers that will provide long-term profits. They will also help to build mutually beneficial infrastructure
for all stakeholders, including governments. To make such partnerships work, companies should assess their
capabilities, assets, and knowledge base – then identify other partners who have the additional resources
they need. Next, they should analyse the pros and cons of collaborating, with a long-term view of profits. In
initiating a partnership, they should establish clear governance structures, clearly outline roles, and agree on
how the outcomes will be distributed for mutual benefit. Finally, before work begins, they need to make
sure their systems and performance metrics are aligned.
One of the most important things for companies to keep in mind when partnering in the BOP market is
that some companies have a head start. These leaders can serve as active drivers or facilitators, and not
merely participators. That means orchestrating an arrangement in which it is easy for new players to enter
and old ones to leave in order to maximize adaptability to changing conditions.
Unshackle the Organization to Help New Business Models Succeed
Most organizations – even those well established in emerging markets – focus primarily on serving mass
and affluent markets. As a result their cultures, organization structures, and metrics are likely to be out of
step with the demands of BOP markets.
Companies might consider the following remedies:
Demonstrate senior level commitment
Success in next billions markets requires strong commitment from the leadership team and active advocacy
within the organization. These initiatives should be on senior management’s radar and receive special
recognition, in order to motivate employees to be a part of the effort.
Create focus and accountability
An exclusively top-down approach can limit the innovation required to develop effective ways of serving
this market. Companies also need champions within the organization. Barclays and Citigroup for example,
both have departments focused on micro credit, to develop opportunities for low-income customers.
Provide decision rights and autonomy
The separate departments and champions need to be empowered so that they are not constrained by the
norms and processes that govern corporate activity in developed markets – such as standard cost saving and
revenue goals. These often need to be adapted to allow for the up-front investments or longer pay-back
horizons required for developing BOP business models.
Establish objective metrics
New metrics help to strengthen accountability and track results.
Companies also need to rethink the metrics they use to make go/no-go decisions. Return on capital, for
example, is a better metric than the more traditional “operating margin” when serving high-volume, low
priced markets. A low-priced brand of detergent in India, for example, has an advantage over higher priced
brands due to lower investments in product development and marketing, giving it superior returns on
capital.
Create lean and agile structures
BOP business units need to minimize costs and stay flexible. They should avoid duplication and create
shared assets and services rather than loading on large overheads.
Provide access to capabilities and knowledge
Many organizations create functions that are responsible for transferring best practices across business
divisions. These “success agents” are essentially managers who translate learning from business models into
pointers that other divisions can use for entering a new market. Some companies also acquire local
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companies to accelerate the process of understanding the BOP market and developing appropriate brands
and business models.
A market of 3.7 billion people spending US$ 2.3 trillion per annum remains largely excluded from formal
markets. This is a growing population, living in expanding economies worldwide. While there are numerous
challenges involved in reaching them effectively as consumers or business partners, they provide significant
opportunities for companies that find successful approaches.
The Next Billion Banking Consumers
The Challenges & Proposed Responses/Solutions especially in Pakistan’s Context
1) Who are the “Next Billion”?
2) What do the Next Billion need?
3) Developing Financial Products to Reach the Next Billion
4) Distributing Financial Products to Reach the Next Billion
5) Marketing to Reach the Next Billion
6) Redefining a Bank’s Organization Structure to Reach the Next Billion
7) Collaborating to Reach the Next Billion
The problem of financial exclusion—individuals’ limited access to or use of formal banking services—
looms large around the world. It both reflects and contributes to the stark socioeconomic divide that
pervades many emerging markets. In China and India, for example, only about one-third of the population
participates in the formal banking sector. Among the excluded are a distinct and huge group of
consumers—the next billion—whose potential to become viable banking customers has been greatly
underestimated. Categorized by income, this group sits just above the poorest of the poor and just below
those who are currently targeted by most banks.
Governments and microfinance institutions have made some headway in alleviating financial exclusion, but
banks have lacked a clear commercial impetus to do so, stifling the development of business models that
have the reach required to confront this problem. By embracing innovative business models, however,
banks can upend the economics of reaching consumers long considered impossible or unattractive to serve.
This approach would open up unparalleled opportunities for profitable expansion in some of the world’s
most rapidly growing economies.
Who Are the Next Billion?
The next billion consumers can be found largely in Brazil, China, and India, but the group also spreads
across Africa and other parts of Asia. If the next billion constituted a nation by itself, it would be the tenthlargest
economy in terms of GDP, ranking after Spain but ahead of Brazil, Russia, India, South Korea, and
Mexico. In its development, the next billion “nation” stands today where India stood in the 1990s and
China stood in the 1980s: on the cusp of high growth and voracious consumption.
The next billion consumers have no lack of interest in banking. Their demand is so strong, in fact, that they
routinely en-dure the trying, sometimes oppressive conditions that plague the informal sector, including
limited choice, usurious rates, and exploitative terms. It is not unheard of for loans in the informal sector to
be repaid through lifelong indentured service.
Rather than having opted out of the formal banking sector, most of the next billion have been excluded
from participating by financial institutions unable or unwilling to invest in understanding their needs and in
adapting business models to serve them profitably. Our definition of the next billion consumers also
includes people whom banks are compelled to serve but who cannot be served profitably through
conventional business models—for example, individuals in government-mandated priority sectors (such as
low-income consumers) and employees of corporate clients. Banks believe they have little economic
incentive to serve such consumers. Some even prefer to incur penalties rather than make the investments
necessary to comply with government mandates. As a result, these consumers are chronically underserved.
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In several emerging economies, however, a few financial institutions have recognized the potential of the
next billion and are introducing innovative products and distribution methods in order to carve out broad
avenues for reaching this segment.
What Do the Next Billion Need?
To field an offering that resonates with the next billion consumers, banks must first understand the barriers
to participation in the formal sector.
The leading, if obvious, reason for financial exclusion is a lack of steady, substantial income. It is
compounded by the cumbersome mechanics of cash-based economies, which circumvent financial
institutions, making a relationship with a bank unnecessary and preventing individuals from building a credit
history. This one-two punch minimizes the incentive to maintain a savings account and makes it difficult to
qualify for a formal loan.
Poor proximity to banking services is another reason for exclusion. A study by The Boston Consulting
Group in late 2006 and early 2007 found that in India, the rate of financial inclusion among urban
households was more than double that of rural households—57 percent versus 26 percent—in part because
banking outlets are typically located far from rural areas, and people there often lack the means to make the
trip.
Financial exclusion also stems from a scarcity of suitable products. The next billion consumers would like
flexibility, especially the option to skip or make additional payments on a loan. Because many in this
segment do not have steady incomes, such flexibility is a common feature in products available in the
informal sector. Simplicity is also important. In our work in Brazil and India, we found that the next billion
consumers are generally more concerned about manageable monthly installments than they are about
interest rates.
Many of the next billion also desire easy access to small personal loans, but most banks find the expense of
providing small-ticket financial products prohibitive. In addition, banks won’t lend to individuals lacking
collateral, a verifiable source of stable income, or a documented credit history. Moreover, in some emerging
markets, banks in the formal sector can take up to six months to approve a loan—but a villager can meet
with and secure a loan from a local moneylender virtually anytime.
Financial exclusion is exacerbated by poor relationships between banks and communities. Low-income
people, particularly in rural areas, are often wary of banks and find branches intimidating. A profound lack
of financial literacy only reinforces this sense of alienation.
Overcoming these barriers and altering the economics of serving the next billion require banks to pursue a
variety of innovations—in product development, distribution, marketing, and organization structure.
Innovations in marketing, for example, will play a critical role in engaging this untapped group. New
approaches to distribution will be crucial in serving the segment profitably.
Developing Financial Products to Reach the Next Billion
Banks can address many of the problems that cause financial exclusion by developing products that are
simple, flexible, and accessible. For example, offering a loan with a higher number of installment
payments— and allowing the customer to increase or postpone payments with little or no penalty—would
attract many of the next billion.
Also, linking products directly to individuals’ sources of income could mitigate the risk that banks assume
and thereby help make products more accessible to consumers. Banks in Brazil have adopted this approach,
developing payroll- and pension-backed loans that have opened the credit market to many new consumers.
These products now account for about half of all personal loans in Brazil, according to Banco Central do
Brasil.
Unfortunately, regulations sometimes make it difficult— if not impossible—to offer products that suit the
financial means of the next billion consumers. Our analysis shows, for example, that Indian banks would
need to charge a 32 percent interest rate just to break even on the kind of small, short-term personal loan
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that the next billion consumers would want. Yet national regulations prohibit banks from charging interest
rates to priority sectors that exceed the prime lending rate, which currently stands at about 12 percent. This
problem underscores the need for regulatory reform that complements initiatives to reach the next billion
consumers.
Distributing Financial Products to Reach the Next Billion
Banks that already have extensive physical networks should try to maximize the revenue per square foot of
their branches by offering products in addition to financial services, provided that regulations will allow for
this shift. Banks could, for example, set up local communications centers—public pay phones, fax
machines, and Internet access—at rural branches to help make the outlets economically viable, and
therefore more attractive to open and operate with a fully committed, sales-oriented level of service. They
could also use the rural branches to disseminate commodity information and provide access to commodity
exchanges.
At the same time, when one considers the physical and emotional barriers that prevent the next billion from
using branches, it becomes clear that banks seeking to foster inclusion must also employ alternatives to their
traditional outlets. Some banks in emerging markets have already begun to forgo branches, instead reaching
underserved segments through nonbank channels. In Brazil, banks have added nearly 100,000 point-of-sale
(POS) locations by striking deals with post offices, pharmacies, & supermarkets. These channels, which
have operating costs 12 times, lower than those incurred by branches, are more convenient for consumers
and help engage them in the formal banking sector. They now account for more than half of all billpayment
activity in Brazil.
South Africa’s Mzansi account, launched in 2004, illustrates the appeal of nontraditional channels. This
card-based product, which can be used in branches and ATMs but also in post offices and retail stores’ POS
locations, now has more than 4 million subscribers. Self-help groups represent still another viable channel—
and perhaps even a partner—for banks. In a typical self-help group in India, village women save money to
underwrite loans to one another. Through the groups, money from the community is used in the
community, creating a strong moral obligation for borrowers to repay their loans. By drawing on its
personal connections, a self-help group can verify its borrowers’ creditworthiness. If they also collaborated
with banks by directing individuals to tailored commercial products, self-help groups could offer consumers
a familiar path to the formal sector.
Marketing to Reach the Next Billion
Given the uneasy relationship that many low-income consumers have with banks, it is essential that the
financial establishment foster trust among the next billion. Toward this end, expanding inclusion will
require marketing through community-level partnerships—not just through radio, television, and print
media. Moreover, by becoming a partner in a community’s prosperity, a bank could forge bonds that would
be difficult for new financial players to break or replicate. Beyond promoting products and services,
marketing campaigns will need to enhance financial literacy among the next billion. The most effective
marketing campaigns could wind up being equal parts education and sales pitch. As an illustrative example,
consider a leading public-sector bank in India that is currently promoting its credit-counseling services.
These services include free advice on how consumers outside the formal sector can gain access to the
bank’s financial products.
Redefining a Bank’s Organization Structure to Reach the Next Billion
Although all banks in emerging markets should have the next billion consumers on their radar screen, most
of them are not yet ready to undertake the transformation required to serve this segment. In many larger
institutions, a centralized, top-down approach to decision making discourages the types of initiatives needed
to push the boundaries of product offerings. Their metrics and incentives also threaten to inhibit next
billion initiatives in two major ways. First, performance targets, frequently measured by the volume of loans
or savings and applied the same way to both rural and urban branches, motivate the sales force to court bigticket
customers. Second, many banks lack incentives to attract or retain staff in rural areas—a fact
sometimes reflected in poorer levels of service in those locations and a disdain among workers there for
low-income customers.
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To overcome their own impediments to serving the next billion, banks must develop separate organizations
dedicated to tapping this opportunity. These units’ performance metrics and incentives should be aligned
with the priorities for serving such customers. For example, banks could measure performance by the
number of customers served, rather than the size of their wallets. Similarly, these units could be allowed to
emphasize growth over profitability in the short term. To reinforce the importance of this opportunity,
banks should create an executive-level position that focuses on the initiatives and reports directly to the
CEO. One private sector bank in India is leading the way by entrusting to a board-level executive its efforts
to boost financial inclusion of the next billion.
Collaborating to Reach the Next Billion
The next billion consumers will not be constrained by traditional industry boundaries, and this factor,
among others, will help set the stage for new players to encroach on what has been a stronghold of banks:
basic payment and deposit transactions. When it comes to those services, the next billion won’t necessarily
distinguish between telecom providers and banks, for example, and they’ll opt to use whichever providers
offer the least cumbersome and lowest-cost offerings. Consequently, if regulators in emerging markets allow
telecom operators to straddle industry boundaries, these players could mount a strong challenge to banks.
In some rapidly developing economies, new mobile phone customers are being added more quickly than
new banking customers, and mobile phone services, in general, boast a significant cost advantage over
branch based banking. Yet the relationship between the banking and telecom industries need not be
adversarial. Before telecom players lay claim to traditional banking strongholds, banks should explore
opportunities for collaboration, identifying ways to cross-sell their products by leveraging the ease of use,
low cost to serve, and accessibility offered by mobile phones. Players from both industries can share
elements of their offerings and value chains in ways that provide mutual benefits, including more attractive,
targeted products. Banks in particular stand to benefit from a steep reduction in transaction costs, because
transactions executed by mobile phones could cost as little as 10 percent of those executed at bank
branches.
Mobile phone networks are already being used as effective channels for financial services in emerging
economies. In Kenya, telecom customers can deposit money into an account on their mobile phones and
transfer the funds to other mobile-phone users— even in remote areas. The telecom operator’s local agent
can then convert the money into cash, allowing people to avoid cumbersome and costly dealings with
banks. In Zambia, telecom company Celtel introduced Celpay, a service that allows customers to make
purchases, pay bills, and transfer funds through their mobile phones. Two percent of Zambia’s GDP was
transferred through Celpay in 2006, and even those Zambian communities that have little or no financial
services infrastructure can now participate in the banking system.
Laying the Groundwork
The breadth of actions required to reach the next billion consumers may seem daunting, but banks can take
several immediate steps to begin the process of unlocking this opportunity:
• Understand the needs of the next billion consumers.
Which features do they value? What barriers prevent them from engaging in the formal sector?
• Analyze product and channel economics.
For each element of the value chain, what are the opportunities to reduce the cost of serving the
next billion?
• Develop new marketing campaigns.
How can marketing improve financial literacy among the next billion consumers while promoting
the benefits and simplicity of basic products and services?
• Design a new organization model.
Which organization structure would best foster experimentation, including collaboration with other
industries?
• Create an empowered executive position.
Who will oversee the strategy for tapping the next billion opportunities?
• Begin adapting the value chain.
Can the bank focus on core activities and use low-cost partners for all other activities, especially
distribution?
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Boosting financial inclusion will no doubt create economic opportunities for an overlooked and
underserved segment. Socioeconomic imperatives aside, however, the prospect of reducing financial
exclusion represents a significant business opportunity for banks. Conventional banks that act in
unconventional ways can transform the next billion consumers—the tenth-largest economy—into a source
of profitable growth.
Source/Reference:
1. The Next Billions: Unleashing Business Potential in Untapped Markets, Study/Report
prepared by World Economic Forum in collaboration with The Boston Consulting Group
2. The Next Billion Banking Consumers, An Study by The Boston Consulting Group
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LESSON 26
SBP RISK MANAGEMENT GUIDELINES
A Brief Re-Cap:
1. Defining Risk
2. Risk Management (Strategic/Macro/Micro Levels)
3. Board & Senior Management Oversight
4. Risk Management Framework (RMC, MIS, Review etc.)
5. Integration of Risk
6. Business Line Accountability
7. Risk Evaluation/Measurement
8. Independent Review
9. Contingency Planning
1. Defining Risk:
• For the purpose of these guidelines financial risk in banking organization is possibility that the
outcome of an action or event could bring up adverse impacts
• Such outcomes could either result in a direct loss of earnings/capital or may result in imposition of
constraints on bank’s ability to meet its business objectives
• Such constraints pose a risk as these could hinder a bank's ability to conduct its ongoing business
or to take benefit of opportunities to enhance its business
• Regardless of the sophistication of the measures, banks often distinguish between expected and
unexpected losses
• Expected losses are those that the bank knows with reasonable certainty will occur (e.g., the
expected default rate of corporate loan portfolio or credit card portfolio) and are typically reserved
for in some manner
• Unexpected losses are those associated with unforeseen events (e.g. losses experienced by
banks in the aftermath of nuclear tests, losses due to a sudden down turn in economy or falling
interest rates)
• Banks rely on their capital as a buffer to absorb such losses
• Risks are usually defined by the adverse impact on profitability of several distinct sources of
uncertainty
• While the types and degree of risks an organization may be exposed to depend upon a number of
factors such as its size, complex business activities, volume etc, it is believed that generally the
banks face following “Risks”
􀀹 Credit
􀀹 Market
􀀹 Liquidity
􀀹 Operational
􀀹 Compliance/Legal/Regulatory
􀀹 Reputational
2. Risk Management
Risk Management is a discipline at the core of every financial institution and encompasses all the activities
that affect its risk profile. It involves identification, measurement, monitoring and controlling risks to ensure
that:
i. The individuals who take or manage risks clearly understand them.
ii. The organization’s Risk exposure is within the limits established by Board of Directors.
iii. Risk taking decisions are in line with the business strategy and objectives set by BOD.
iv. The expected payoffs compensate for the risks taken.
v. Risk taking decisions are explicit and clear.
• Sufficient capital as a buffer is available to take risk.
• The acceptance and management of financial risk is inherent to the business of banking and
banks’ roles as financial intermediaries.
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• Risk management as commonly perceived does not mean minimizing risk; rather the goal of
risk management is to optimize risk-reward trade -off.
• Notwithstanding the fact that banks are in the business of taking risk, it should be recognized
that an institution need not engage in business in a manner that unnecessarily imposes risk
upon it: nor it should absorb risk that can be transferred to other participants.
• Rather it should accept those risks that are uniquely part of the array of bank’s services.
In every financial institution, risk management activities broadly take place simultaneously at following
different hierarchy levels.
a. Strategic level: It encompasses risk management functions performed by senior management and
BOD. For instance definition of risks, ascertaining institutions risk appetite, formulating strategy
and policies for managing risks and establish adequate systems and controls to ensure that overall
risk remain within acceptable level and the reward compensate for the risk taken.
b. Macro Level: It encompasses risk management within a business area or across business lines.
Generally the risk management activities performed by middle management or units devoted to risk
reviews fall into this category.
c. Micro Level: It involves ‘On-the-line’ risk management where risks are actually created. This is the
risk management activities performed by individuals who take risk on organization’s behalf such as
front office and loan origination functions. The risk management in those areas is confined to
operational procedures and guidelines set by management.
• Expanding business arenas, deregulation and globalization of financial activities, emergence of
new financial products and increased level of competition has necessitated a need for an
effective and structured risk management in financial institutions.
• A bank’s ability to measure, monitor, and steer risks comprehensively is becoming a decisive
parameter for its strategic positioning.
• The risk management framework and sophistication of the process, and internal controls, used
to manage risks, depends on the nature, size and complexity of institutions activities.
• Nevertheless, there are some basic principles that apply to all financial institutions irrespective
of their size and complexity of business and are reflective of the strength of an individual
bank's risk management practices.
3. Board and Senior Management Oversight
a) To be effective, the concern and tone for risk management must start at the top. While the overall
responsibility of risk management rests with the BOD, it is the duty of senior management to
transform strategic direction set by board in the shape of policies and procedures and to institute an
effective hierarchy to execute and implement those policies. To ensure that the policies are
consistent with the risk tolerances of shareholders the same should be approved from board.
b) The formulation of policies relating to risk management only would not solve the purpose unless
these are clear and communicated down the line. Senior management has to ensure that these
policies are embedded in the culture of organization. Risk tolerances relating to quantifiable risks
are generally communicated as limits or sub-limits to those who accept risks on behalf of
organization. However not all risks are quantifiable. Qualitative risk measures could be
communicated as guidelines and inferred from management business decisions.
c) To ensure that risk taking remains within limits set by senior management/BOD, any material
exception to the risk management policies and tolerances should be reported to the senior
management/board that in turn must trigger appropriate corrective measures.
d) These exceptions also serve as an input to judge the appropriateness of systems and procedures
relating to risk management.
e) To keep these policies in line with significant changes in internal and external environment, BOD is
expected to review these policies and make appropriate changes as and when deemed necessary.
f) While a major change in internal or external factor may require frequent review, in absence of any
uneven circumstances it is expected that BOD re-evaluate these policies every year.
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4. Risk Management Framework:
• A Risk Management Framework encompasses the scope of risks to be managed, the
process/systems and procedures to manage risk and the roles and responsibilities of individuals
involved in risk management.
• The framework should be comprehensive enough to capture all risks a bank is exposed to and have
flexibility to accommodate any change in business activities.
• An effective risk management framework includes:
a. Clearly defined risk management policies and procedures covering risk identification,
acceptance, measurement, monitoring, reporting and control.
b.
􀀹 A well constituted organizational structure defining clearly roles and responsibilities of
individuals involved in risk taking as well as managing it.
􀀹 Banks, in addition to risk management functions for various risk categories may institute a
setup that supervises overall risk management at the bank.
􀀹 Such a setup could be in the form of a separate department or bank’s Risk Management
Committee (RMC) could perform such function.
􀀹 The structure should be such that ensures effective monitoring and control over risks
being taken.
􀀹 The individuals responsible for review function (Risk review, internal audit, compliance
etc) should be independent from risk taking units and report directly to board or senior
management who are also not involved in risk taking.
c. There should be an effective management information system that ensures flow of information
from operational level to top management and a system to address any exceptions observed.
There should be an explicit procedure regarding measures to be taken to address such
deviations.
d. The framework should have a mechanism to ensure an ongoing review of systems, policies and
procedures for risk management and procedure to adopt changes.
5. Integration of Risk Management:
• Risks must not be viewed and assessed in isolation, not only because a single transaction might
have a number of risks but also one type of risk can trigger other risks.
• Since interaction of various risks could result in diminution or increase in risk, the risk management
process should recognize and reflect risk interactions in all business activities as appropriate.
• While assessing and managing risk the management should have an overall view of risks the
institution is exposed to.
• This requires having a structure in place to look at risk interrelationships across the organization.
6. Business Line Accountability:
• In every banking organization there are people who are dedicated to risk management activities,
such as risk review, internal audit etc.
• It must not be construed that risk management is something to be performed by a few individuals
or a department.
• Business lines are equally responsible for the risks they are taking.
• Because line personnel, more than anyone else, understand the risks of the business, such a lack of
accountability can lead to problems.
7. Risk Evaluation/Measurement:
• Until and unless risks are not assessed and measured it will not be possible to control risks.
• Further a true assessment of risk gives management a clear view of institution’s standing and helps
in deciding future action plan.
• To adequately capture institutions risk exposure, risk measurement should represent aggregate
exposure of institution both risk type and business line and encompass short run as well as long run
impact on institution.
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• To the maximum possible extent institutions should establish systems/models that quantify their
risk profile.
• However, in some risk categories such as operational risk, quantification is quite difficult and
complex.
• Wherever it is not possible to quantify risks, qualitative measures should be adopted to capture
those risks.
• Whilst quantitative measurement systems support effective decision-making, better measurement
does not obviate the need for well-informed, qualitative judgment.
• Consequently the importance of staff having relevant knowledge and expertise cannot be
undermined.
• Finally any risk measurement framework, especially those which employ quantitative
techniques/model, is only as good as its underlying assumptions, the rigor and robustness of its
analytical methodologies, the controls surrounding data inputs and its appropriate application.
8. Independent Review:
• One of the most important aspects in risk management philosophy is to make sure that those who
take or accept risk on behalf of the institution are not the ones who measure, monitor and evaluate
the risks.
• Again the managerial structure and hierarchy of risk review function may vary across banks
depending upon their size and nature of the business, the key is independence.
• To be effective the review functions should have sufficient authority, expertise and corporate
stature so that the identification and reporting of their findings could be accomplished without any
hindrance.
• The findings of their reviews should be reported to business units, Senior Management and, where
appropriate, the Board.
9. Contingency Planning:
• Institutions should have a mechanism to identify stress situations ahead of time and plans to deal
with such unusual situations in a timely and effective manner.
• Stress situations to which this principle applies include all risks of all types.
• For instance contingency planning activities include disaster recovery planning, public relations
damage control, litigation strategy, responding to regulatory requirements etc.
• Contingency plans should be reviewed regularly to ensure they encompass reasonably probable
events that could impact the organization.
• Plans should be tested as to the appropriateness of responses, escalation and communication
channels and the impact on other parts of the institution.
Uncertainty Tamed?
The Evolution of Risk Management in the Financial Services Industry
A Global Survey/Study identifies:
• Four Reasons why Risk Management remains primarily focused on meeting regulatory
requirements & only secondarily on protecting and enhancing the value of the franchise.
• Ten attributes that would help companies create a world-class culture of Risk Management.
Four Reasons:
• A culture of risk awareness has yet to emerge.
• Compliance is not being turned into competitive advantage.
• The importance of governance is underestimated.
• Quantifiable risks are still absorbing too much attention.
For financial institutions, risk lies around every corner. With little or no warning businesses can stumble and
even collapse because of unexpected events. Growing risk management departments and sophisticated
technology have helped companies in financial services to combat many of the more quantifiable dangers,
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from credit and market risk to such things as regulatory and IT risks. But what about those areas, like
reputational risk, that are both harder to measure and more sudden and severe in their impact?
As, Sir John Bond, Chairman of HSBC, told a conference recently: ‘It used to take years of dedicated bad
management to destroy a company. Now it can be done almost overnight.’
Two years ago, PricewaterhouseCoopers carried out a survey of financial services institutions Worldwide.
The results showed that, while senior executives were keenly aware of the credit and market risks they faced
and were doing more to address them, they tended to pay comparatively little attention to less visible,
equally menacing dangers. Two years on, a fresh survey of more than 130 senior executives in financial
services institutions, carried out by the Economist Intelligence Unit on behalf of PricewaterhouseCoopers
for this briefing, indicates that risk management in general has climbed higher up the corporate agenda and
that an awareness of unquantifiable risks in particular has grown markedly: reputational risk is now regarded
as the greatest threat to an organization’s market value.
Yet significant concerns remain. Many financial services institutions are still failing to think proactively
about unseen and emerging risks. There is evidence that much of the impetus for change in risk
management priorities is coming not from self-assessment but rather from pressure from regulators, rating
agencies and the like. Some 72% of those questioned in the survey said that regulatory pressures were either
an extremely significant or a major driver for changes in the priority of their organization’s risk management
over the past two years.
The evidence of the survey and our interviews suggests four main reasons why risk management remains
primarily focused on meeting regulatory requirements and only secondarily on protecting and enhancing the
value of the franchise:
A culture of risk awareness has yet to emerge.
Risk management has climbed the boardroom agenda since the previous survey: expenditure on risk
management as a percentage of its overall expenses is on an upward trajectory, and more organizations have
a senior risk management executive and committee at the group level. But spending more on risk
management on its own is no guarantee that a company will become better at it. In only 31% of respondent
companies do all major decisions require interaction with, or some form of approval from, the group risk
management committee (that number rises to a still low 47% for larger institutions with total gross income
of $1bn or more). There is a big difference between talking about steps to integrate risk management and
actually taking them. Too often a company’s head of risk is not at the same table as the chief executive
officer or other executive directors when important decisions are being made. A company needs to
inculcate an appreciation of risk that goes beyond the risk management department and permeates the
whole organization.
Compliance is not being turned to competitive advantage.
Too little emphasis on compliance can, of course, expose an organization to regulatory sanction, litigation
and damage to its reputation. But too much emphasis on box-ticking can also distract a company from
using risk management to create value – by reassessing its investment strategies, making better operational
decisions in areas such as pricing and capital allocation, and by gauging its own appetite for risk. True,
almost 70% of survey respondents assess their performance on some measure of risk-adjusted capital. Yet
many are failing to turn this fully to their advantage, by setting more appropriate product pricing, for
example.
The importance of governance is underestimated.
Robust risk management and sound corporate governance invariably make good bedfellows. Indeed, some
argue that it is impossible to get one without the other. But few survey respondents seem to have acted on
the logic of this argument. When asked in which business processes their organization had a structured
approach to assessing risk, only 43% ticked M&A activity and just 17% pointed to the setting of
compensation policies for directors and recruitment policies as a whole. It is accepted that paying executives
too generously for failing to do their jobs competently or ethically raises questions about governance but it
ought to be a major focus of risk management too.
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Quantifiable risks are still absorbing too much attention.
Asked to rate the effectiveness of their organization’s risk management capabilities, survey respondents had
most confidence in their ability to manage data-rich areas such as credit risk, liquidity risk and market risk.
No one disputes the importance of managing these types of risk effectively – respondents still rate these as
the principal threats to earnings, but they are not necessarily the main threat to the health of the franchise
upon which sustainable earnings depend.
Too many organizations are still concentrating on calculating market and credit risk to a further order of
accuracy and too few on understanding the totality of the risks they face in order to give themselves a
competitive advantage.
The tendency for financial institutions to focus on areas of risk that are most familiar and where data and
techniques are most developed is natural, of course. But in an environment where new and potentially lethal
risks can suddenly emerge, the leading institutions consciously and continually look at the bigger picture.
They seek to anticipate and avoid the submerged risks that can abruptly sink an enterprise. And they have
both the crisis management processes and the underlying standards of behavior that are likely to soften the
impact of such risks when they do come to pass. Such institutions accept that uncertainty cannot be tamed;
only mitigated.
Ten Attributes
1. Pay equal attention to quantifiable and unquantifiable risks.
Institutions are increasingly attuned to the dangers posed by less quantifiable risks, particularly with regard
to their market value. That awareness stretches right to the top of the organization.
In a survey of global CEOs, 28% of financial services bosses felt that reputational risk was a significant
threat and 13% felt that it was one of the biggest threats they face.
2. Identify, report and quantify all possible risks.
Despite a growing awareness of unquantifiable risks, there remains a danger that some organizations will
take no action if they cannot find the numbers with which to measure a risk or set of risks. As one
respondent to survey tellingly replied, ‘for some risks, the data is insufficient to construct a strategy.’
3. Let an awareness of risk pervade the enterprise.
Everything from performance to pricing and pay should be adjusted for risk. Too few institutions currently
obey that imperative. Of the 69% of survey respondents to assess their performance on a measure of riskadjusted
capital, fewer than one in five use this information to pay bonuses or set remuneration for senior
executives.
4. Make risk management everybody’s responsibility.
In the past, financial institutions have tended to look outside their own walls when assessing risks. But
issues of governance, culture and integrity are arguably more critical in protecting firms from unseen
dangers – and should be made the explicit responsibility of all members of staff.
‘All 20,000 employees have the potential to do something to enhance or destroy our reputation,’ says Chief
Risk and Compliance Officer of a global financial services provider.
5. Risk managers should have teeth.
Everybody involved in monitoring risk of all kinds should have a genuine influence over decision- making.
Independent risk assessments of a new product or transaction should be made before the CEO and senior
management have approved it in principle. Is it realistic to go back to the drawing board afterwards?
6. Avoid products and businesses the enterprise does not understand.
If you don’t understand the business, you cannot understand the risks facing it. Encouragingly, 77% of
respondents now include a structured assessment of risk in their product development processes. Less
happily, only 43% said they did so when it came to mergers and acquisitions.
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7. Accept that uncertainty exists.
More than two in five respondents to the survey believe that the greatest risks to the organization’s market
value are ‘unknown’ sources of risk. Workshops, scenario planning and cross-industry reviews are among
the techniques that leading institutions are using to assess the potential impact of, and response to, these
future sources of danger.
8. Monitor your risk managers.
The amount of attention being paid to risk at board level still leaves much to be desired. In less than a third
of surveyed institutions are risks and risk management discussed in detail at all main board meetings. And
although awareness of risk has grown in over 80% of institutions, in fewer than half is responsibility for
enterprise-wide risk management higher up the organization than it was two years ago.
9. Good risk management delivers value.
Loss avoidance remains the staple means of demonstrating the value of risk management, but 50% of
survey respondents also look to risk management to contribute to improved shareholder value.
10. Define and enshrine your company’s risk culture.
The enterprise’s appetite for risk should be clearly and widely understood. ‘We have a very clear risk
appetite for certain events,’ says the MD, Credit Risk Management of an international group. The
institution’s senior leadership should set a tone at the top that creates a behavioral and ethical benchmark
for the entire organization. Given the inherent vagaries of human behavior, however, process controls also
need to be put in place to reinforce cultural norms and compensate for any lapses.
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Source/Reference:
1. SBP Website
2. PWC Survey/Study
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LESSON 27
ERM: DEVELOPMENT & IMPLEMENTATION OF “INTEGRATED APPROACHES” TO
MEASURE AND MANAGE RISKS ACROSS THE ENTERPRISE
Classification of Banking Risks
Banking Characteristics Risk Class Risk Category
Legislative
Economic
Environment Environmental Risks Competitive
Regulatory
Defalcation
Organizational
Human Resource Management Risks Ability
Compensation
Operational
Technological
Financial Services Delivery Risks New Products
Strategic
Credit
Liquidity
Balance Sheet Financials Risks Market
Leverage
Risk management has never been more critical for mortgage companies. The secondary market continues to
tighten, the financial system is under unprecedented duress, and more regulatory requirements are on the
horizon. To succeed in this environment—to effectively price products based on constantly changing
market dynamics, reassure investors and shareholders, and grow strategically while adhering to regulatory
requirements—it is essential to reevaluate and modify the mortgage risk management and measurement
framework to align with today’s new risks and ensure an appropriate control structure.
Establishing a clearly defined enterprise risk management (ERM) framework begins with an understanding
of the corporate ERM program and establishment of a line of business ERM vision that supports that
broader program. This vision defines the operating model for how risks will be managed and is mutually
reinforcing, achieving short-term business goals and long-term corporate strategies. While important in
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driving the macro approach to risk management, the articulation of the ERM vision also drives role clarity,
consistency, and accountability throughout the organization.
ERM success requires linkage between line of business and corporate risk strategies:
For mortgage lenders, which is often a line of business or separate legal entity within a larger financial
institution, achieving a risk management?
Vision requires lining up the line of business risks with the corporate risk management philosophy and
framework.
For each line of business, the specific measurement process may vary, but the standards must be consistent
and critically assessed for how well they conform to the corporate ERM strategy. However, risk
measurement cannot be determined in a silo—the interrelatedness of the risks defines the overall corporate
exposure. An effective ERM framework is able to aggregate business unit risk exposures across all business
units.
Assessing these risks is an ongoing, continually updated process as changes to the business model and
market conditions occur. Developing a flexible program is critical to a successful risk management
strategy— especially in today’s market. Effectively measuring and modeling risks helps companies more
accurately estimate their risk exposure and develop a plan to manage it.
Developing a plan to manage the risk is where many mortgage companies today are struggling. From this
perspective, companies can focus their energies on two main areas today to have an immediate impact.
Specifically, a strong focus on governance and an overhaul of key risk indicators will help companies lay the
groundwork for an enterprise risk management platform that grows the business while managing risk
exposure.
A focus on governance lays the groundwork for a reliable ERM strategy
A focus on governance begins with determining the top-level risk management vision and objectives
consistent with long-term strategic goals and risk tolerances. The entire risk management function needs to
be evaluated, and the importance of business risk managers must be emphasized through their appropriate
placement throughout the organizational structure and governance framework. This reorganization
supports a culture where risk management is institutionalized by all management and staff. These risk
managers, reporting up through the ranks and to the board, are responsible for creating a consistent process
for measuring and reporting risk, documenting compliance with risk management plans, and developing a
risk response.
As risks escalate in one area or line of the business, the governance structure ensures that the risks are
assessed with regard to other risks and other lines of business and a response is developed accordingly.
Because the governance structure is enterprise-wide, risks that fall under one line of business but affect the
whole company are appropriately considered at the corporate level. This linkage is a critical component of a
transparent risk management strategy.
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Accurate key risk indicators allow accurate risk measurement
Developing an effective risk response relies on accurate risk measurement. Key risk indicators (KRIs) are a
baseline for effective risk measurement; yet for many mortgage companies, the KRIs and related
tolerances/triggers are not assessed frequently enough to capture changes in the industry or environment. A
comprehensive, ongoing program to review the relevance of KRIs (including data quality) and tolerances
will help ensure adequate risk measurement.
Across the lines of business, there must be ownership of these risks and accountability for the numbers. For
example, management should be expected to manage the risks identified by monitoring KRIs, not merely
reporting the numbers.
As depicted in the diagram, several concurrent phases of risk management activity overlay business
transactions:
• Lagging indicators, as the name suggests, are indicators that provide data only after the fact. Their
usefulness arises when viewing trends over time, and they are a key input into future modeling and
developing of the escalation criteria
• Escalation triggers drive the notification of increased risk throughout the management team and are
reported to management after a specific trigger— determined by the risk governance oversight
team— has been tripped. Vigilance regarding these criteria facilitates management intervention
prior to a risk manifesting beyond an expected or acceptable tolerance or controls failing to
effectively mitigate a risk
• The leading indicators can be collected at any time, for any period, and identify systemic issues or
causal factors, in a tactical and proactive way. These indicators are reported and reviewed on a
regular basis and can be available as requested to understand risks in a rapidly changing
environment
• The scorecard provides management and any risk oversight structures with insight into current risk
exposure, trends, and actions that need to be taken to remain consistent with the corporate ERM
strategy
• The value metrics encompass both financial and non-financial measures that can help to
demonstrate value creation for the investment community
Effective use of these KRIs requires developing procedures and processes to continually analyze and update
the KRIs as the market or business strategy changes. However, while creating a mortgage risk management
strategy that aligns with corporate ERM expectations is important, it is equally important to confirm KRIs
are consistently tracked and monitored across lines of business.
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For example, if one of the leading KRIs for the mortgage business is customer FICO score, with the score
being refreshed on a quarterly basis to observe trends, the effect of declining FICOs may not be felt solely
within the mortgage unit, but within credit card and auto finance units as well. Similarly, when looking at
KRIs for operational or financial data, similar KRIs should use consistent periods (for instance, quarterly vs.
monthly), calculations (such as actual vs. 30-day-average month) and data sources (such as general ledger vs.
production data for certain measurements).
Successfully monitoring risk at the corporate level will take involvement from corporate to work with the
lines of business and establishment of a consistent process for measuring, reporting, and monitoring KRIs.
In some cases, for example when measuring delinquency rates, there may be different calculations or
accounting policies associated with the KRIs. Continually reviewing the KRIs with regard to internal and
external benchmarks will allow identification of variances in a timely fashion so the risk committee or other
oversight governance structure can mitigate risks with the risk response plan.
A strong ERM platform will help position organizations for success
Focusing on the governance structure and KRIs are actionable steps that companies can take now to start
developing a stronger and more adaptive enterprise risk management platform. A strong enterprise risk
management platform will help mitigate risk, improve transparency of risk profiles across the organization,
and position organizations for success.
The effective risk indicators, analysis, event modeling, and tolerances will help to demonstrate full
comprehension of the risk profile at the line of business and enterprise levels. This will provide corporate
risk managers with confidence that the lines of business are taking risks consistent with corporate policy.
Senior management and the board will also have visibility into the risk management plan to be able to
understand risk management procedures and provide top-level support for risk management decisionmaking.
ERM --- Key Drivers and Trends:
Why are companies adopting an ERM approach?
Currently, there are four key forces driving the growth in, and acceptance of, ERM:
• Wake-up calls from corporate disasters.
More than ever, board members and corporate executives realize the consequences of ineffective
risk management. Notable disasters include companies such as Enron and WorldCom, as well as
industry-wide problems such as market-timing and late-trading in the mutual funds industry and
bid-rigging in the insurance brokerage industry. In the aftermath of these corporate disasters, board
members and executives realize that the only alternative to risk management is crisis management,
which can do much more damage to a company’s financial and reputational assets.
• New stringent regulatory requirements.
In response to these events, regulators such as the SEC and the Federal Reserve have increased
their examination and enforcement standards. The Sarbanes-Oxley Act requires enterprise-wide
documentation and testing of controls over financial reporting. Amendments to the NYSE listing
standards require audit committees to discuss risk monitoring and control activities with internal
and external auditors. Basel II and Solvency II will establish a direct linkage between minimum
regulatory capital and the underlying credit risk, market risk, and operational risk exposures of
banks and insurance companies, respectively. In the new business environment, there are clear
incentives for best-practice risk management, while wrongdoers face financial penalties as well as
potential criminal charges and jail time.
• Global initiatives on corporate governance and risk management.
A number of industry initiatives have been organized around the world to establish frameworks
and standards for corporate governance and risk management. The Treadway Report (United States,
1992) produced the Committee of Sponsoring Organizations (COSO) framework of internal
control, while the Turnbull Report (United Kingdom, 1999) and the Dey Report (Canada, 1994)
developed similar guidelines. In September of 2004, the COSO Enterprise Risk Management –
Integrated Framework and Application Techniques was published. This framework incorporates corporate
governance and internal controls as part of an overall ERM structure. These industry initiatives
have clearly established the role of the board and senior management in risk management.
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• Early ERM adopters are reporting tangible benefits.
Companies have reported significant benefits from their ERM programs, including stock price
improvement, debt-rating upgrades, early warning of risks, loss reduction, and regulatory capital
relief. As well, given the significant costs that companies have incurred to comply with Sarbanes-
Oxley, there is an opportunity to convert this “compliance cost” into a “business benefit” by
implementing an ERM program.
Role of Risk Management & Reporting in ERM
One of the key objectives of ERM is to promote risk transparency, both in terms of internal risk reporting
and external public disclosure. Establishing a robust risk measurement and reporting system is therefore
critical to ERM success. The old adage “what gets measured gets managed” holds true in risk management.
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The above illustration shows how risk measurement and reporting fits into the overall ERM process. The
implementation of ERM as a management process involves four stages:
Stage 1: ERM foundation setting
In the first stage, a company must establish a sound foundation for the overall ERM program. The board
and senior management provide what is often referred to as “tone from the top.” This includes developing
the ERM framework, allocating sufficient resources, and engaging in risk policy discussions. The company’s
risk appetite is also clearly defined in risk policies and limits. Education and learning is another key
component, which includes training programs and organizational processes that share best practices and
lessons learned. To motivate desired behavior, incentive systems should incorporate risk management
effectiveness and risk-adjusted profitability measurement.
Stage 2: Risk identification and assessment
An ERM process should integrate various risk assessments to develop a comprehensive inventory. Top
down risk assessments of strategic and business risks can be gathered from the executive team through oneon-
one interviews and/or facilitated group discussions. Bottom-up risk assessments of financial and
operational risks can be developed through standardized templates or software applications. In addition,
risk assessments from independent sources – auditors and regulators – should be incorporated into the
overall inventory. Note that the information developed in this stage is largely subjective and qualitative in
nature.
Stage 3: Risk measurement and reporting
In this stage, more objective and quantitative information is developed. This information includes key risk
indicators (KRIs) for business risk, credit risk, market risk, and operational risk. To evaluate trends and
levels, these KRIs are tracked against policy limits (e.g., market and credit risk exposure limits) or
performance standards (e.g., tolerance for error rates or system downtime). External data should also be
integrated to provide additional context for internal KRIs. External data can include interest rate trends,
industry credit default rates, or competitive or industry benchmark data. Finally, risk reporting is provided
to management and the board, as well as outside stakeholders through regulatory filings and public
documents.
Stage 4: Risk mitigation and management
The most important stage of ERM is risk mitigation and management. This includes resolution of
outstanding issues. Moreover, to be a value-added function, ERM must impact decisions that increase the
risk-adjusted profitability of the company. ERM applications – including product pricing, customer
management, business development, capital management, and risk transfer – integrate risk management and
the key drivers of corporate performance. The overall objective is to make more informed business
decisions based on risk management. These decisions may include reducing risk limits during stressed
market conditions, implementing an exit strategy to minimize losses on a bad investment, or allocating more
capital to grow a business with attractive risk-adjusted profitability.
These four stages of the ERM process should not be implemented in a sequential manner for the overall
company. A sequential approach, in which a company spends the first year establishing the ERM
foundation, the second year identifying and assessing risks, and so forth, is both unproductive and
cumbersome. For example, some companies spend a year or more in conducting risk assessments before
developing KRIs. In the meantime, the qualitative risk assessments cannot be validated with quantitative
data, and the task of designing KRIs for hundreds of identified risks and processes is daunting.
Management should instead focus on the company’s most critical risks and apply the overall ERM process
to them. Another approach is to start with the end, and first determine the types of management decisions
and actions that the ERM process must support. From there, management can work backwards and
develop the appropriate KRIs and risk reporting, risk assessment processes, and ERM foundation.
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Integration of Key Performance Indicators & Key Risk Indicators
Source/Reference:
1. Rebuilding toward the future: A Consumer Finance view on managing risk PWC
Consumer Finance Group
2. Emerging Best Practices in Developing Key Risk Indicators and ERM Reporting, An
Executive White Paper by James Lam & Associate
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LESSON 28
ERM: DEVELOPMENT & IMPLEMENTATION OF “INTEGRATED APPROACHES” TO
MEASURE AND MANAGE RISKS ACROSS THE ENTERPRISE (CONTD…)
Sources for KRI’s:
The development of effective KRIs is a key challenge for most companies. Financial institutions usually
have an abundance of credit risk and market risk indicators, but they are challenged in aggregating this data
as well as developing operational risk indicators. On the other hand, non-financial institutions may have
significant business and quality information, derived from balanced scorecard and quality initiatives, but
they are challenged to develop KRIs for financial risk or technology risk. All companies face the challenge
of developing leading indicators that can effectively provide early warnings of potential future losses.
While the development of effective KRIs is a significant challenge, there are some readily available sources
from which KRIs can be derived.
These sources include:
• Policies and regulations.
Regulations that govern the business activities of the company, as well as the corporate policies and
limits established by management and the board, provide useful compliance KRIs. These KRIs may
include risk exposures against limits or compliance with regulatory requirements and standards.
• Strategies and objectives.
The corporate and business strategies established by senior management, and their associated
performance metrics, are another good source. Note that performance metrics are designed to
measure expected performance, whereas KRIs should be designed to measure downside risk or
volatility of performance.
• Previous losses and incidents.
Many companies have compiled loss/event databases that capture historical losses and incidents.
These databases, or even anecdotic evidence, can provide useful input on what processes or events
can cause financial or reputational loss. KRIs can then be developed for these processes and events.
• Stakeholder requirements.
Beyond regulators, the expectations and requirements of other stakeholders – customers, rating
agencies, stock analysts, business partners – can help in the development of KRIs based on
variables that are important to these key groups.
• Risk assessments. Risk assessments performed by the company--including audit assessments,
control self assessments, and Sarbanes-Oxley tests--can provide valuable input on the business
entities, processes, or risks where KRIs are needed.
Given the various sources for KRIs, the objective should be to develop a high-quality set of KRIs,
rather than high quantity.
Ten key characteristics of effective KRIs:
1. Based on consistent methodologies and standards.
2. Incorporate risk drivers: exposure, probability, severity, and correlation e.g. VaR, Economic
Capital.
3. Be quantifiable: PKR/$, %, or #.
4. Track in time series against standards or limits.
5. Tie to objectives, risk owners, and standard risk categories.
6. Balance of leading and lagging indicators.
7. Be useful in supporting management decisions and actions.
8. Can be benchmarked internally and externally.
9. Timely and cost effective.
10. Simplify risk, without being simplistic.
ERM Reporting --- Key Questions & Attributes:
Over time, a company may develop hundreds or even thousands of KRIs and risk assessments. Then the
company faces a different challenge – the development of an effective ERM report. When designing the
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format and content of an ERM report, and the functionality of an ERM reporting system, it is important to
start by looking at the five basic questions that an ERM reporting system should address:
1. Are any of our business objectives at risk?
2. Are we in compliance with policies and regulations?
3. What risk incidents have been escalated?
4. What KRIs and trends require immediate attention?
5. What risk assessments need to be reviewed?
For a typical company, it might take days, weeks, or even months to answer these questions on an
enterprise-wide basis. The fundamental problem is that current approaches to risk reporting can be
described as “risk measurement by silos,” in which management is provided with static reports that provide
risk information for different risks separately. Moreover, static reports require significant manual work,
resulting in more data problems and less time for risk analysis and strategies.
With an effective ERM reporting system, management should be able to answer all five of these questions
in fifteen minutes. An ERM reporting system should provide executive reporting of enterprise-wide risks
and drilldown capabilities so that all key risks can be monitored simultaneously.
The key attributes of an ERM reporting system include:
• Provides a single point of access to all critical risk information that may reside in disparate risk
systems and data sources.
• Combines executive reporting of enterprise-wide risks with drill-down capabilities to more detailed
risk data.
• Delivers “just-in-time” risk information, from real-time risk alerts to monthly credit reports to
quarterly risk assessments.
• Integrates quantitative KRIs, qualitative risk assessments, policy documents, and external market
data.
• Allows users to provide commentary or analysis to the risk information presented by the ERM
reporting system.
The following illustration provides a schematic of an ERM reporting system:
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ERM Implementation – Avoiding Common Pitfalls
Early on, the key questions business executives asked about ERM began with what. What is enterprise risk
management? What are emerging best practices? What are specific industry requirements? Today, the key
questions begin with how. How to implement an ERM program? How to develop specific ERM tools? How
to integrate ERM into business processes?
With respect to ERM implementation, there are five common pitfalls that companies should avoid. These
pitfalls, and strategies to overcome them, are as follows:
• Don’t let the regulatory tail wag the dog – ERM is about management, not simply
compliance.
Companies face an influx of regulatory requirements that they must comply with, such as Sarbanes-
Oxley for public traded companies, Basel II for banks, and Solvency II for insurance companies.
However, compliance with these and other regulatory requirements represents a necessary but
insufficient condition for success. Companies should go beyond compliance and leverage their
ERM programs to realize tangible business benefits. For example, Basel II establishes bank
regulatory capital requirements only for credit risk, market risk, and operational risk. In addition to
these risk categories, leading companies also consider strategic risk and business risk in their capital
management frameworks. A more comprehensive capital management framework would enable a
company to improve profitability and shareholder value by making better risk-based product
pricing, resource allocation, and business development decisions.
• Don’t just integrate risks – break down organizational silos.
ERM is not just about integrating the key risks – strategic, business, credit, market, and operational
– into a common framework. It is also about breaking down organizational silos in order to identify
interdependencies and make trade-off decisions. Most companies have established oversight
functions as part of their governance, risk, and compliance activities. These functions generally
include risk management, audit, compliance, legal, treasury, and other oversight groups. Leading
companies have broken down these silos by establishing organizational structures, processes, and
incentives. These initiatives include establishing risk committees at the board and executive levels,
appointing chief risk officers, and aligning the interests of individual oversight functions through
common objectives, performance measurement, and incentives.
• Don’t boil the ocean – focus the ERM process on what is most important.
Given the wide scope of ERM, many companies are overwhelmed with their risk identification,
assessment, documentation, and reporting processes. The objective of ERM should not be to
address all of the risks faced by the company. In fact, it would be impossible to identify all of the
company’s risks because that list is infinite. The objective of ERM should be to support decisions
on the critical risks and opportunities for the board of directors, executive management, and
business and operational units. An effective ERM program should prioritize risk information for
the company’s key decision makers. As such, an indication of ERM success is not to say “We have
identified 720 risks across the company, and fully documented related controls and risk
assessments,” but to say “We have identified the major risks that require the attention of various
management groups, and supported their decisions for these major risks.” As an example, some
companies find it useful to maintain a “top 10 risks” list for the company.
• Don’t just tell me, show me – quantify risks through effective key risk indicators.
Many ERM programs produce large volumes of qualitative information (e.g., risk and control
assessments, process maps, policies and procedures) that are not conducive to board and
management decision making. In order to support policy and business decisions, critical risks must
be quantified and reported in a concise and effective manner. That is not to say that quantitative
information is more valuable than qualitative data, but there should be a balance in ERM reporting.
For the company’s most critical risks, quantitative analysis can be used to show trends, risk-adjusted
metrics, compliance with policy limits, and performance against established standards. For the same
risks, qualitative analysis can be used to provide expert risk assessments, alternative strategies and
actions, management recommendations, and other contextual information.
• Don’t produce volumes of data and reports – develop an ERM dashboard.
An ERM report should not be a 50-page report that takes the risk committee two hours to simply
walk through. A common complaint from board members and senior executives is that they cannot
see “the forest from the trees.” Companies should develop an ERM dashboard that provides role
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based information to key decision makers. During a board or management risk committee meeting,
the ERM dashboard would enable board members and senior executives to first see high-level risk
information. In addition, it would allow them to drilldown to more granular data if they want to see
more details. An exciting possibility is to develop the ERM dashboard so that it not only provides
dynamic access to risk information, but also to risk analytical models. As such, it would also enable
board members and senior executives to perform real-time scenario analysis, such as “How would a
30% increase in cruel oil price impact our quarterly earnings, as well as market risk and credit risk
exposures?”
An example of an ERM dashboard is given below.
Summary
In the past 10 years, technology applications were focused on risk quantification in terms of analytical models,
such as asset/liability models, VaR models, credit default models, and so forth. Over the next 10 years,
technology will focus on risk communication in terms of ERM reporting systems. An ERM reporting system
will provide board members, corporate executives, and risk professionals with a single point of access to all
critical risk information – including objectives-at-risk, early warning indicators, KRIs against policy limits or
performance standards, risk assessments and audit findings, escalations of issues and incidents, and riskadjusted
return performance. The time interval for enterprise-wide risk measurement and reporting will
move from monthly to weekly to daily and ultimately to real-time.
The value of risk information is not in its development, but in its application. As such, to realize the full
potential of ERM, risk professionals must deliver the right information, to the right decision makers, at the
right time.
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Case Studies
The following case studies showcase real-life situations where ERM has provided significant and tangible
benefits.
JP Morgan Chase
In 1994, JP Morgan Chase received an inexpensive lesson in the need to manage aggregate market risk
exposures. Previously, the bank had focused its market risk oversight mainly on its trading businesses. In
1994, the Federal Reserve raised interest rates repeatedly, one result being a significant disruption in the
mortgage markets. While the trading businesses performed well, the bank suffered an unexpected, albeit
small, loss in a small S&L that it owned.
According to Leslie Daniels-Webster, chief market risk officer, the bank realized from this experience that it
needed to manage aggregate market risk exposures across three dimensions – trading portfolios,
asset/liability mismatch, and basis risk. The bank further developed its market risk staff and analytical
resources, including VaR and stress testing models. This experience has served the bank well. In 1998, it
weathered the Russian crisis, and it reported earnings of $4 billion (up 4.4 percent) while its peers suffered
significant earnings declines due to market losses.
CIBC
In December 1994, the Toronto Stock Exchange published the Dey Report, which recommended that the
board of every firm listed on the exchange take direct responsibility for risk management efforts within the
firm, and report on these efforts in its annual report. At about the same time, CIBC was expanding globally
in the capital markets business. So the Canadian bank had both regulatory and business reasons to invest in
ERM. That same year, Bob Mark was hired to build an ERM program, including firm-wide market risk,
operational risk, and counterparty credit risk.
The ERM initiative paid off four years later. In the middle of 1998, CIBC was concerned with three early
warning indicators in the capital markets – widening credit spreads, increasing actual and implied volatility,
and the breakdown of historical price relationships. The bank promptly cut global risk limits by one-third
prior to the Russian crisis and market drop later that year, thus avoiding significant losses.
Heller Financial
On May 1, 1998, Heller Financial returned to the NewYork Stock Exchange as a public company. The
commercial finance company aimed to be “world class” in its industry, and realized that it needed to
establish an ERM program. While Heller was confident in its credit risk and market risk functions, it was
missing a formal operational risk methodology and an overall ERM framework.
In September 1999, Mike Litwin, the company’s chief credit officer (who was later promoted to chief risk
officer) led the development of an operational risk methodology and ERM framework. A critical insight
gained during this initiative was that nearly one-third of what Heller had classified as credit losses were in
fact operational losses (e.g., inadequate loan documentation). The ERM program was well underway, and
then on July 30, 2001, GE Capital announced that it was acquiring Heller for $5.3 billion in a cash
transaction, a 48 percent premium. In its press announcement, GE Capital noted that Heller’s risk
management was one of the company’s key assets.
Duke Energy
In July 2000, Duke Energy’s senior executives gathered for a two-day strategy meeting to discuss the future
of the energy business. They reviewed three possible scenarios:
“Economic Treadmill” in which U.S. economic growth slips to 1% per year, “Market.com” in which the
Internet revolutionalizes the relationships between buyers and sellers, and “Flawed Competition” in which
uneven deregulation will continue in the energy industry, resulting in significant price volatility.
To help manage the company’s business uncertainty, Duke Energy appointed Richard Osborne as its first
CRO earlier that year. As early warning indicators for these three scenarios, management established
specific “signposts,” including macroeconomic indicators, regulatory trends, technology changes,
environmental issues, competitive moves and patterns of consolidation in the energy industry. Today, Duke
Energy has performed well relative to its competitors. As of November 2004, the company achieved yearConsumer
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over-year revenue growth of 41percent, compared to 11percent for the industry. The company’s stock has
increased 45percent in one year, outperforming the S&P 500 by 28 percent.
Rockwell Collins
In July 2001, Rockwell Collins went public. Following the events of 9/11, the supplier of military and
commercial aircraft parts faced hundreds of millions in lost sales and the collapse of its commercial market.
Yet the company responded quickly and put in place a contingency plan within 10 days. Management
credits its ERM program in terms of its preparedness and resiliency.
The company’s ERM program had an interesting start. Several years earlier, project manager John-Paul
Besong applied ERM to support the implementation of a critical SAP system. The project went so smoothly
that he was promoted to chief information officer a short time later. Since that time, ERM has been
integrated into other business processes of the company. The results have been impressive. For the
company’s fiscal year ending September 2004, it reported record sales of $2.9 billion (up 15 percent) and net
income of $301 million (up 17 percent). In January 2004, Forbes called Rockwell Collins the best-managed
aerospace company in America.
Source/Reference:
1. Emerging Best Practices in Developing Key Risk Indicators and ERM Reporting
2. An Executive White Paper by James Lam & Associates
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LESSON 29
RISK APPETITE: HOW HUNGRY ARE YOU?
Regulatory pressures, such as Basel II and a greater focus on corporate governance, have been a stimulus
for many changes in the industry – one of these has been the recognition of the need to articulate risk
appetite more clearly. On the face of it, this may seem easy to do. After all, is it not simply a combination of
an institution’s desired credit rating, regulatory capital structure and the relevant solvency needs which set
the ability of the institution to withstand shocks and therefore represent its risk appetite? For some smaller
firms this approach may well be enough, but for others risk appetite is a more complicated affair at the
heart of risk management strategy and indeed the business strategy.
Defined well, risk appetite translates risk metrics and methods into business decisions, reporting
and day-to-day business discussions. It sets the boundaries which form a dynamic link between
strategy, target setting and risk management.
Risk appetite is of course in the eye of the beholder (if the reader will excuse a mixed metaphor!). Different
parts of the organization and external stakeholders have different perspectives. Equity investors’ appetite
for risk will differ from that of the rating agencies. Equity investors want to see a return; rating agencies
want to minimize risk of default. The regulator’s perspective differs from management’s which differs from
that of customers, employees, bondholders etc. Consequently, articulating risk appetite is a complex task
which requires the balancing of many views. Some elements can be quantified but ultimately it is a question
of judgment. All too often many parties take false comfort from purely quantitative risk measures which, if
they were actually attained, would in practice result in huge reputational damage and job losses for the CEO
and the chief risk officer (CRO).
In a corporate context, what do we mean by risk appetite?
At its simplest, risk appetite can be defined as the amount of risk, on a broad level, that an organization is
willing to take on in pursuit of value. Or, in other words, the total impact of risk an organization is prepared
to accept in the pursuit of its strategic objectives.
Risk appetite therefore goes to the heart of how a company does business. How an organization wishes to
be perceived by key stakeholders such as shareholders, employees, regulators, rating agencies and customers
is a function of that company’s risk appetite.
The amount of risk an organization accepts will vary from organization to organization depending on
circumstances unique to each. Factors such as the external environment, people, business systems and
policies will all influence an organization’s risk appetite.
Just as organizational risk appetites vary, so too can risk appetites vary across business units and risk types.
For example a bank’s appetite for risk in mature lending activities may be quite different from its appetite
for risk in an emerging business.
From another perspective, we have seen that smaller losses incurred as a consequence of fraudulent activity
can have a more adverse impact on a bank’s reputation than much larger lending losses incurred in the
normal course of business. Consequently, financial institutions often set a much lower risk appetite for
fraudulent or unethical activity which could damage reputation.
Organizations use different ways to measure risk, ranging from simple qualitative measures such as defining
risk categories and setting target levels around these, to developing complex quantitative models of
economic capital and earnings volatility.
Whichever approach is adopted, risk appetite, if properly articulated, should provide a cornerstone for the
organization’s risk management framework.
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Benefits to the Organization and the CRO
There are considerable benefits in taking the time to articulate risk appetite properly. If a financial
institution (or indeed any corporate) has arrived at a crisp definition of its risk appetite it will have achieved:
• Clarity over the risks that the organization wishes to assume;
• The basis for consistent communication to different stakeholders; and
• Explicit articulation of the attitudes to risk of the senior management.
As CROs play a fuller role at board level1, initiating a risk appetite discussion can be an ideal way to engage
senior colleagues and the board on risk issues and strategy.
In our experience, a top-down approach is usually the best way to begin to tackle the problem of defining
risk appetite. A top-down approach makes the requirements of the various external stakeholders explicit
and stimulates debate in the executive team. The process can also be used to engage board and nonexecutive
directors on the subject. The result is a robust framework that can be used to articulate appetite
throughout the group and to external stakeholders.
Following figure conveys an overall approach which involves assessing risk appetite from different
stakeholder perspectives and risk types. The top down view of risk appetite leads typically into an
assessment of the desired risk profile and an action plan to achieve it.
PricewaterhouseCoopers has developed a number of tools and concepts to help clients cut through the
complexities of this multi-dimensional problem. For example, we have found it helpful to introduce the
concept of risk capacity. An organization’s risk capacity is the maximum amount of risk that it can assume.
This is an important concept because risk appetite must be set at a level within the capacity limit. Capacity
needs to be considered before appetite. Stakeholder views will differ on the desired safety margin and it is
crucial to understand this in setting and understanding appetite. It is also necessary to assess other factors
such as the potential impact of a risk incident, as well as the ability of the organization to control the activity
and the market’s perception of the ‘fit’ with the institution’s other activities. These qualitative factors, when
combined with risk capacity and risk measures, enable a balanced appetite to be articulated and monitored.
A top-down approach works better than a detailed bottom-up assessment. The reason for this is that it is
really the only way to bring in the views of external stakeholders and to create a proactive statement of what
management believes its risk appetite should be. In our experience, bottom-up approaches tend to endorse
the status quo and the existing risk profile. They do not take the thinking forward. The result is often a
passive description of risk appetite today rather than a proactive view of where management wants to take
the organization. Another benefit of the top-down approach is that it ensures that senior management are
‘on the same page’ on risk appetite. This may require more investment at the start but it pays dividends by
making subsequent roll-out much easier.
At one client the first appointee to the newly created role of CRO has used risk appetite discussions to
engage the business unit heads in defining the links between risk and strategy. This is the first time that risk
has been considered as an integral part of the business agenda. Previously risk was treated primarily as a
compliance issue to be monitored by internal audit.
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Approach to Risk Appetite
What does it look like?
A well-defined risk appetite should have the following characteristics:
􀀹 Reflective of strategy, including organizational objectives, business plans, and stakeholder
expectations.
􀀹 Reflective of all key aspects of the business (B/Model).
􀀹 Acknowledges a willingness and capacity to take on risk.
􀀹 Is documented as a formal risk appetite statement.
􀀹 Considers the skills, resources and technology required to manage and monitor risk exposures in
the context of risk appetite.
􀀹 Is inclusive of a tolerance for loss or negative events that can be reasonably quantified.
􀀹 Is periodically reviewed and reconsidered with reference to evolving industry and market
conditions.
􀀹 Has been approved by the Board.
In order to ensure effective monitoring and governance, the risk appetite will incorporate a balanced mix of
both quantitative and qualitative measures. Quantitative measures may include financial targets (e.g. capital
adequacy, target debt rating, earnings volatility, credit or other external ratings). Qualitative measures may
refer to reputational impact, management effort and regulatory compliance.
These qualitative aspects of risk appetite are more difficult to quantify. However, organizations that choose
to measure risk more precisely are modeling these risks to determine their risk appetite on a quantified basis.
Once an organization’s risk appetite is defined, the challenge is to implement robust governance and
reporting framework that ensures day-to-day decisions are made in line with the organization’s risk appetite.
In analyzing the risk appetite statements of our client organizations, the following measures were found to
be the most commonly used: earnings volatility (80 percent); economic capital requirements (60 percent);
reputation (60 percent); external credit/debt ratings (40 percent) and regulatory standing (40 percent).
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