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September 27, 2016

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Developing win-win strategies for small firms

BY identifying and overcoming financial hurdles in local business cycles, China’s regional banks are playing an increasingly critical role in moving China’s domestic economy forward.

Yilong Xu, in charge of Nanyue Bank’s microfinance operations, is a pioneer in this respect, especially when it comes to identifying loan opportunities that may aid small entrepreneurs often overlooked by more conventional banks.

The key to Yilong Xu’s success is an intense focus on the business cycle. The idea is to identify “pain points” or gaps in financing and liquidity that keep small business owners from functioning effectively. By focusing on the business process itself rather than on the credit history of individual borrowers, Xu has been able to largely automate the lending process, while reducing risk and eliminating the need for experienced loan officers.

An innovative feature of Xu’s approach is to make payments directly to suppliers, rather than to the borrowers, thus eliminating any temptation to divert funding to other purposes.

One sector successfully targeted by Xu and Nanyue Bank is transportation. China has roughly 2.8 million trucks operating on national highways. The usual process for moving goods is to contact a logistics company, which then subcontracts the order to a truck owner, who usually has one or two trucks and may drive the truck himself, or hire someone else as a driver.

The standard business cycle, from receiving an order to actually being paid, is roughly 60 to 90 days. During that time, the owner needs to advance the total cost of purchasing fuel, hiring a driver, wear and tear on the truck and paying for highway tolls. Gasoline or diesel fuel usually accounts for around 20 percent of the total cost. Hiring a driver and paying tolls may account for another 25 percent.

Xu identified highway tolls as the “pain point” which the bank could contribute to resolving. Instead of advancing money to the owner of a truck, the bank makes payments directly to the company managing the highway. The bank is then reimbursed at the end of two months, at an interest rate of around 3 percent. The annual rate, once all the loans are aggregated, is 18 percent.

Almost no risk

So far there have been no defaults. In any case, there is almost no risk since failing to pay back a loan would effectively block the truck owner from the country’s major highways. Even more important, however, is the fact that Nanyue Bank has managed to facilitate the growth of commerce by advancing the credit needed to make the system function.

Another sector that is profiting from Nanyue Bank’s innovative approach is the growing of bananas in Hainan.

Banana growers are required to buy insurance against natural disasters. The government pays 75 percent of the amount, and the grower is responsible for the remaining 25 percent. The cycle usually lasts from five to six months. Bananas are planted in February, and for the first four months, the process is virtually risk free. In the last two months of the growing cycle, however, there is a high risk that a crop will be destroyed by rain, hail or some other unexpected event.

To protect against damage, the growers cover the plants with plastic bags, which cost roughly 0.50 yuan (US$0.076) per bag. Traditionally, each grower needs to purchase around 10,000 bags in advance. That means fronting at least 5,000 yuan until the crop is sold and payments are received.

Nanyue Bank identified the purchase of the bags as the key “pain point” in the business cycle. Again, payment is made directly to the suppliers of the bags. The bank is reimbursed by the grower after payment for the crop is finally received.

While the interest in this case adds up to 3 percent during the period when the bags are needed, the amount is still small enough to be easily affordable. The total interest for a two-month loan is roughly 150 yuan. The large number of loans and the quick turn-around make the plan especially profitable.

The largely automated loan process, combined with the elimination of the need to establish a credit rating for borrowers, means that the entire operation can be run by a small number of bank personnel. In contrast to traditional loan operations which have an over 10 percent default rate, Nanyue Bank’s default rate is only around 0.3 percent.

An interesting footnote is that Xu is able to run Nanyue’s microfinance operations with a skeleton staff of only six people. Three are dedicated to credit modeling based on big data. The other three handle sales and developing new clients. The process is otherwise highly automated. The genius is in the design.

 

Winter Nie is a professor of operations and service management and is Regional Director for IMD Southeast Asia & Oceania. She teaches in Orchestrating Winning Performance (OWP) Singapore, taking place November 28 to December 2, 2016. Shanghai Daily condensed the article.




 

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