The small business segment - betwixt and between

The small business segment aka the SME/business banking segment is an important part of a bank’s business and is sandwiched between the consumer and the large corporate segment. It’s relatively easy to define the segments situated at the opposite ends of the spectrum- being individuals we recognize that we fall in the consumer segment for banks, as individual borrowers and depositors. When we think of a large corporate, the likes of GE, Microsoft, BP etc are top of the mind.

What exactly is the SME segment-are they ‘mom and pop’ shops or businesses churning out annual revenues of up to X million dollars? How does one define the SME segment?

The banking industry across the world does not have a single well laid out definition for the SME segment. Typically annual sales/revenue or loan size is used as the criterion.

How would a corporate customer, in a midsized city, a well known entity in its own backyard, view the classification by its banker as a ‘small business’? Not too well, one can presume!

Banks would like to make different product offerings for the three distinct business segments-consumer, small business, and corporate. Again it’s easy to make the distinction between the consumer and the corporate banking segment. A vehicle loan or a home mortgage would suit a consumer and not a corporate. Project finance, syndicated lending or a FX swap line would be appropriate for a corporate. But such a ready distinction in product offerings is not easily available for the small business segment. Moreover, in certain geographies, lending to an individual for a commercial purpose, qualifies for being classified as ‘commercial lending’. One exception for a product offering exclusive to the small business segment, is the Small Business Administration loans in the United States. Generic products for this segment are loans, leasing, cash management facilities, trade finance and commercial real estate financing.

Banks choose to have the SME intermediate segment for a number of reasons. The way risk is assessed and managed for this segment differs from the consumer or corporate segment. While the risk for consumer segment could be credit score driven, assessing large corporate risk takes significant due diligence akin to an investment banking deal. The consumer segment could be managed on a portfolio basis, while large corporates are assessed and monitored on an individual basis. The SME segment could have its own underwriting group, with tailor made risk grading parameters. Requirements for security/collateral could be more stringent than that of the corporate segment, though cash flow based lending is common as well.

Relationships are managed by account/relationship managers as in the corporate segment, albeit with one manager handling significantly higher number of customers. Some banks manage the consumer and small business segment as one business unit, while others have this as separate segments, with a third set of banks, managing small businesses as part of the corporate banking business segment. And another set of banks manage their private and small business customers together!

Usage of banking systems for the SME segment varies from bank to bank. Some banks have different systems to originate loans for each of the three segments-consumer, small business and large corporate. Others originate SME loans either thru the consumer loan origination system or through the corporate loan origination system. Such a dilemma exists in the loan servicing systems as well. Some banks service small business loans through their consumer loan servicing module/system, while others use the corporate lending module/system. A single loan servicing system for both the consumer and corporate segments makes it the easiest choice for banks, when it comes to choosing the appropriate system for the small business segment!

-The views expressed are personal