SME Lending Channel Strategy: Key Success Factors

Imagine you’re a treasure hunter with a single backpack inside a cave filled with gems and jewels. You have limited time, and to maximise your haul, you need to balance the value and weight of what you can fill. Lenders—Banks, NBFCs, or FinTechs (such as unregulated digital aggregators or co-lenders)—face this classic ‘Knapsack Problem’ while trying to create an optimal distribution structure.

Each channel mix—branches, digital, phygital, own, agents, co-lending—brings its own costs and benefits, with varying considerations of scale, risk appetite, resources, and practicality specific to each lender. Moreover, the challenge is a dynamic one. As the business evolves, the relevance, purpose, and effectiveness of each channel also changes.

While there are no shortcuts, five considerations can help bring clarity to your lending distribution strategy:

1. Customer Preferences

It is obvious that different customers will behave differently. However, there are three key factors that determine your channel choices grounded on the customer preferences.

-Comfort with technology: This is filtered at two levels. First, easy access and lower cost of connectivity makes customers more receptive to digital channels and vice versa. Second, demographics of age, education, and socio-economics play a key role. Although digital channels ostensibly break some barriers, certain customer segments will still prefer or need physical interaction or assisted journeys.

-Comfort with information sharing: While closely correlated with technology usage, the changing dynamics around data privacy is a necessary consideration. This means digital channels must incorporate this into their design. Over time, reliance on physical third-party channels like DSAs to collect sensitive information will come under question too.

-Channel Comprehensiveness: Customers also need confidence in channel’s comprehensiveness. Does the channel provide complete information, and is the information timely and reliable? For example, if applying for a loan on a digital channel, will the customer receive timely updates after the application process is over, or will they need to call someone to follow up? Similarly, when dealing with an executive at a branch, will the fine print be hidden by courtesy? Requirements vary for each channel and product.

Finally, customers preferences don’t remain static. Their behavior and preferences change over time. Your channel strategy should anticipate at least some of these changes. The choices may lead you to critically look at deliberate vs inadvertent channel redundancies. This is also a key factor in evaluating channel effectiveness.

2. Risk Management

Channels should necessarily align with your risk appetite around two key areas.

-Channel Risk: Each channel brings its own set of risks. Branches increase operational risks as well as non-standardized communication, which can sometimes lead to issues like mis-selling. A third-party channel allows rapid expansion but comes with increased risk of misrepresentation and even fraud. Digital channels have challenges with stability, scalability, and cybersecurity. Channel choices are based on the products you are selling but, more importantly, need to factor in how the risk will be mitigated. For example, pre-disbursement or welcome calling are often used as risk mitigants for mis-selling. It is for this reason that RBI has mandated a Key Fact Sheet (KFS) to be shared with customers before disbursement.

-Portfolio Risk Control: This pertains more to the internal channels like branches or remote working teams. To what extent do they participate in risk control, especially at origination? For example, front-end teams can either be lead generators or lead converters or may take on the responsibilities of pre-disbursement field investigations or physical customer verification. Digital sourcing may need to be augmented with personal interactions over video calls. To create portfolio ownership, front end may be required to take collection responsibilities especially to manage early delinquencies versus the choice to have a separate collection team from DPD 1 (days past due). In summary, what your channel does is a function of your plan on risk mitigation.

3. Cost Considerations

All channels have varying cost structures. Digital channels are cheaper at scale but need upfront investment and a security-first architecture. Phygital channels necessitate analysis of what parts can be moved digital without compromising on risk strategy and efficiency at optimal cost.

Branch-led distribution takes time and is expensive—initial investment for fit-outs and branding, plus the ongoing fixed costs of rent, salaries, and administration. The breakeven and returns for each lender vary. For Banks, branches serve as a multi-product point of sale, handling assets, liabilities, and cross-sell. For NBFCs, branches are more of a sales office and risk administration centers, with little walk-in sales impact. However, products like gold loans require over-the-counter engagement, while CV loans rely on dealer implants. In the case of FinTechs, branches are offices with minimal POS benefit.

Third-party channels typically engage with multiple financiers and follow the principle of ‘max benefit’ with ‘least resistance’—how fast the case goes through, with the least possible hassle to them, with maximum incentive. You save on fixed costs, but pay the price with lower channel control.

For all the channels, compliance is another cost factor that needs to be kept in mind.

4. Scale of Business

You own scale of business is a key factor in determining your channel choices to achieve right balance of risk and growth. Channels play a key role in ensuring this balance.

Some lenders falter due to their inability to scale because they are too conservative, while others scale quickly but struggle with portfolio quality. This prioritisation of Risk or Growth is not static and evolves based on the scale and stage of the business. For example, at a small scale, your priority is to become relevant, and in a competitive market the only option is to grow quickly is by acquiring peripheral credit i.e prioritising growth. At later stage when the portfolio has reached a critical mass, the focus shifts towards improving risk controls.

A lender needs to decide a few things:

–What is our current first priority—growth or risk?

-Will the channel provide the flexibility of shifting gears in either direction?

This changing of gears cannot be controlled only through the underwriting policy alone. Any sudden shift from either side—growth to risk or vice versa—high attrition is a possibility, which is again a cost.

Generally, say in the first three years of starting a lending business, the first two focus on growth, including product refinement and experimental adjustments, while the third year focuses on bringing some risk control. However, for a large lender entering new product categories, higher priority for risk in initial stages is better, before pushing the growth accelerator.

In the case of digital channels, if you rely on third-party tech vendors to develop your lending apps, you may face the following challenges:

-A gap between your vision and what is delivered, often resulting in poor UI/UX differentiation

-Extended timelines for delivery and your time to market

-Longer update and change processes. Major customizations, post-first deployment, become more expensive and time-consuming.

While there is no dearth of tech vendors, if you are a new lender, it is better to build the customer-facing part ground up. Established lender already have the ecosystem and vendor control to get this done better, although not necessarily faster.

5. Human Resource Considerations

HR impacts all the above factors, hence it is necessary to evaluate it separately. Your risk and customer considerations will determine the skills required, which in turn impacts your cost. Your stage of business will be a factor in determining how quickly you can attract talent, retain them, and at what cost. Smaller entities find it more difficult to recruit the right resources, while larger ones also need some plan to retain the best.

You can control HR costs by using third-party channels, but this comes at the cost of consistency in performance and behaviour. Most of them will be smaller, and their ability to attract good resources is again limited.

Digital channels require strong technical capabilities at backend but also the readiness of front end. So again, skills and training and consequent costs come into play.

End Note

The balance of “value” and “weight” of each factor is crucial to achieving an efficient and effective distribution channel. Optimisation of channels is key to successful SME lending but it isn’t easy. It will require continued calibration, but with clarity in customer preferences, risk, cost, business stage, and manpower, you have a good starting point to maximise efficiency and effectiveness. Just like choosing the right treasures in a cave, you can maximize the value of what you carry out in your lending strategy.

Disclaimer: The opinions expressed here are those of the author and does not reflect the views of FrankBanker.com