Big Help for Small Business: One Foreign Bank’s SME Loan Experience

If Russia’s economy is going to develop more diversity, one of the most important factors will be the ability to create a strong sector of small and medium-sized enterprises that play a much more significant role in developed economies. In Germany, for example, SMEs, the so-called “Mittelstand,” account for some 90 percent of industry and trade in the country and thus form the backbone of the economy – despite the strength of well-known international giants as DaimlerChrysler, Siemens, BMW and Volkswagen.

Ian Pryde spoke to Stefan Martiniak, senior advisor to KMB-Bank, Moscow about the bank’s experiences in the Russian market.

R.P. KMB-Bank is probably the largest provider of financing and loans to the Russian SME sector. How long have you been established on the Russian market?

S.M. KMB-Bank was originally set up in the early 1990s at the initiative of the European Bank for Reconstruction and Development (EBRD) within the framework of its Russian Small Business Fund, whose aim was to provide loans to SMEs. This was of course part of a broader EBRD program in Central and Eastern Europe, including the CIS countries. KMB-Bank acquired its present name and form in 1999.

R.P. Who owns KMB-Bank now?

S.M. Thirty-five percent of KMB-Bank’s shares are held by the EBRD, with another 35 percent held by the Soros Economic Development Fund, 22 percent by the Deutsche Investitions-und Entwicklungsgesellschaft m.b.H (German Investment and Development Fund) and 8 percent by the Dutch bank Stichting Triodos-Doen.

R.P. Could you provide us with some more background on the role of SMEs in Germany?

S.M. The dominance of SMEs in Germany means that they make a major contribution to the federal and state budgets. But SMEs also account for much of the innovation in Germany and are heavily involved in providing first-class industrial training for graduating students – one of the reasons why Germany has remained a leading industrial power despite the shift of production to lower-cost countries in Eastern Europe and Asia.
Russia is, of course, utterly different, and the Russian Government is obviously mainly concerned with the likes of Gazprom, LUKoil and the other major Russian companies.

R.P. But a presidential program exists to promote the SME sector. Is this helping the development of small business in Russia or is it ineffective?

S.M. Under the presidential program, the regional governors are supposed to provide assistance to this program and help implement it. But, in fact, the level of enthusiasm is rather low. We have yet to encounter a governor or administration that has welcomed us with open arms – people are still very reserved. In Chelyabinsk, for example, the governor and the administration weren’t even interested in entering into discussions with us. Other regions, however, are slightly more positive, such as Yekaterinburg. Moscow is a bit more positive, but, of course, Moscow is always different from the rest of Russia – not least because all the major Russian companies have their headquarters in the capital. So theory and practice diverge greatly.

R.P. How do you explain these reservations, this reluctance?

S.M. I’ve asked myself this question many times. I think it largely stems from skepticism about foreign firms in general and by extension foreign participation in business, a reluctance to let foreigners get involved. Another problem seems to be that the middle bureaucracy acts almost like a sponge, virtually absorbing or even filtering out all the directives from above. And, of course, the same thing happens in reverse to information going from the regions back to Moscow.  The result is that the presidential program and its directives get rather diluted.

R.P. Where does KMB-Bank operate?

S.M. KMB is the only foreign bank with a regional network in Russia, with eight branches from Kaliningrad and Smolensk in the west to Vladivostok in the east. We plan to open a further branch in Yekaterinburg in 2004 and are just waiting for the final go-ahead from the Central Bank. KMB also has 47 sub-branches.

R.P. What is the size and structure of your portfolio?

S.M. In December 2003, KMB-Bank was ranked fifth among our peers by volume of loans issued to both individuals and sole proprietors. We currently have some 35,000 outstanding loans, worth around $250 million, and have awarded over 105,000 loans, worth nearly $900 million. KMB’s client base consists of nearly 43,000 individuals and 18,600 legal entities, with the number rising strongly since 2001. Both the volume and the number of outstanding loans have also been increasing sharply since 1999.

R.P. What kind of entities do you lend to?

S.M. We make loans to clients ranging from sole proprietorships such as small shops and bakeries to industrial production facilities. The loan amounts vary from just a few hundred dollars to $500,000 and are for extra working capital for a business or for further investment in the business.

R.P. What is the loan approval procedure?

S.M. To qualify for a loan, a company must have been working successfully for at least three months and supply full information about its operations. Obviously in Russia many companies have no credit histories, so the bank’s loan officers physically inspect the firm’s premises to make sure it actually exists and isn’t just a front, as is often the case in Russia. With larger loans of several hundred thousand dollars, we demand a detailed and realistic business plan, but with micro loans of less than $5,000 our conditions are less strict. Our loan officers also obviously check up on the collateral offered to secure the loan. This level of due diligence has allowed us to keep the default rate on KMB’s loans down to about 1 percent.

R.P. That’s remarkable!

S.M. Yes, if you consider that German banks have default rates of between 10 and 12 percent, it really is quite astonishing. But it shows not only that our loan officers are doing their work properly, but also that the borrowers do their best to pay back principal and interest on time. In fact, the default rate has remained stable at this low level for quite a number of years.

R.P. But the low default rate also depends on the structure of the loan portfolio. If a large customer defaults on a big loan…

S.M. Exactly, you have major problems immediately. But our experience shows that you can still make money by lending to small clients, and these are often the ones that the larger banks ignore because it is too labor-intensive.

R.P. Do you also make loans to non-Russian SMEs?

S.M. The situation is a bit more complicated here. The German companies are often in need of various kinds of loans, but we can only provide them as long as there is a majority Russian stake in the company, since we are not allowed to grant credit to purely German companies. There are also German companies that ask us to provide loans to their Russian partners and customers. And this is almost like due diligence because KMB-Bank then carries out its usual analysis of the Russian company’s business. So if we then award a loan, the German company feels confident that the Russian company is solid.

We also get German companies making guarantees to us on behalf of Russian companies, which in turn allow us to make loans to the Russians.
This can take a variety of forms. Sometimes the German companies want the Russians to know that they have made a guarantee, and we can make a loan to them. But there are other cases where German companies prefer to keep the guarantee secret. In other words, the German company has confidence in the Russian firm, but believes it will make a greater effort it if thinks it is relying on itself – this obviously reduces the “moral hazard!” If the Russian company fails, it thinks that’s it! And it also encourages us at the bank to be more careful and thorough in our analysis of its business.

R.P. How secure is your position on the Russian market? Other banks look set to move into the SME sector in search of yield and profit.

S.M. We’re now advertising our fifth year on the Russian market and during that period we’ve been able to carve out a very successful niche for ourselves. The Russian banks obviously quickly became aware that a bank was targeting SMEs and making loans to the sector, but initially they were very skeptical about this line of business. Before the financial crash in August 1998, banks were earning easy money on the government debt market, but now they have to become normal banks, so in the meantime, the larger Russian banks in particular are also looking at the sector.

Sberbank, the Russian savings bank, has a similar program, and remains the only Russian bank where in principle all the deposits are insured, while a few months ago, Vneshtorgbank, the foreign trade bank, announced it had earmarked $1 billion for a similar program to grant loans to SMEs. If this can be implemented efficiently throughout the country, it would represent a great success for the Russian economy.

R.P. What kind of returns are you generating here?

S.M. We are very pleased with our returns. We achieved a return on assets of 1 percent in 2002 and of 2 percent in 2003, while return on equity increased from 15 percent in 2002 to 30 percent last year. As of the end of May this year, annualized return on equity was 21 percent. So our shareholders are happy!

R.P. How have the recent bank runs and the liquidity “crisis” affected KMB? Most of the foreign banks here seem to have benefited at the expense of the Russian institutions.

S.M. Yes, the foreign banks have gained, but so have the state banks Sberbank and Vneshtorgbank, which ended up acquiring Guta Bank for the nominal sum of one million rubles. It’s the Russian private banks, such as Alfa, that have suffered more. KMB-Bank has certainly had an increase in the number of people coming to make deposits since the crisis began. We have also had German firms switching their accounts from Russian banks to us because they are in effect getting additional guarantees due to our foreign shareholders.

Special to Russia Profile, an online and monthly print magazine dedicated to Russia and published jointly by RIA-Novosti and Independent Media, Moscow.

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