Term 1 Academic Year 2011

Course: MGMG694 Consulting Practice: Banking Management Instructor: Dr. Sarayut Nathaphan

BAACs Lending Product Recommendations

1. Kotchakorn N. 2. Phattharachit S. 3. Ekachai K. 4. Chanidapha A. 5. Chaowalit S. 6. Ornsiri T.

ID: 5449064 ID: 5449069 ID: 5449071 ID: 5449075 ID: 5449123 ID: 5449044

Section 1: BAAC SWOT Analysis Strength

The complete value chain of loan products offered by BAAC reflects that BAAC has deep understanding of agriculture and agricultural-related business.

Weakness The interest income has decreased when compared with higher lending amount. The loan this year 2012 has increased by 34% but the interest income increased only 15%. Moreover, when compare the net interest income with other commercial banks, BAAC NII has increased less than the others.

Opportunity With the opening of AEC in 2015, it is expected that the whole economy will be expanded especially the export and import business. This would be a big opportunity for BAAC to support the agricultural-related business in term of facilitating their international trade activities.

Threat BAAC still has to expect the delay of loan payment from customers due to the fact that the agricultural business has uncertainties by its nature.

Section 2: Objective & Rationale for BAACs Lending Products

Objective: To be a strategic partner with agricultural-related SMEs business by offering integrated loan and trade finance products

Rationale for the objective: The two main elements of the objective are the SMEs business target, and the trade finance products. This paper addresses the two elements separately as will be described below.

Why SME? There are mainly 3 reasons why SMEs business is selected as the target segment. 1. SMEs business has been growing over the past few years. It also has the potentials to grow much faster for the coming years, especially after the opening of AEC in year 2015. 2. If the bank could be able to offer the products to serve and support the business of this group of customers, the bank could expect for longterm sustainable income and profits. 3. SMEs in Thailand also face the limited access to the capitals from financial institutions. Therefore, it would be a big opportunity for BAAC to serve this group of customers. Overview of Thailand SMEs SMEs in Thailand have been growing at an increasing rate especially for the import and export business. It is undeniable that SMEs play a crucial entrepreneurial role in Thailand, as almost all registered firms are SMEs. In 2009, SMEs in Thailand has registered more than 2.9 million businesses which accounted more than 99% of the total registered entrepreneurs. Basically, the SMEs business is very important for Thailands economy as a whole. In 2007, according to the record from the office of Thailand SMEs promotion, SMEs business create more than 78% of total employment in Thailand, which turns out to be around 38% of total GDP in that year.

Source: Office of SMEs promotion

Exports of SMEs business in Thailand

In 2011, the value of SMEs export was more than 2 trillion baht, which accounted almost 30% of the total export values. This value is continuously growing after the financial crisis in 2009. Last year in 2011, SMEs Export growth rate is at 27.68%. This number is expected to increase in the same fashion for the coming years. Table below shows the total number of SMEs export values and the growth rate from 2007-1011.

Source: Office of SMEs promotion (www.sme.go.th) Challenges faces SMEs in Thailand Currently, SMEs business in Thailand has to face a lot of business obstacles, which includes both marketing and financial aspects. They are lack of entrepreneurship, outdated technology, insufficient R&D, low standards of production, difficult access to funding, as well as high and increasing competition both in the domestic and global markets. For the SMEs perspectives, the most important challenge that will be given a big emphasis is the limited access to credits or funding since most of the SMEs need funding to start-up the business or supports them as their working capitals. The difficult access of credit stems from lacking of information and advice from financial institution, complexity and inconvenience of borrowing procedure, inadequacy of loan collateral, not enough qualification or high expense fee and interest rate. For financial institution perspectives, the problems with these SMEs are lacking of business experience or proper business plan, no record of income statement, and no loan collaterals. This would be the main reason why commercial banks usually lend out up to the loan collateral values. Basically speaking, the demand for SMEs financing is obviously more than the supply from financial institution. Financing situation of SMEs in Thailand It is very obvious that the demand for SMEs financing has been increasing over the past few years. The loan amount is expected to grow much more in the following years. Table below shows the loan amount given to SMEs in Thailand in 2010-2011. Size of business Loan amount (Million) Y-O-Y growth rate 9.2% 14.6% 12.8%

2553 2554 Medium size 784,108 855,985 Small size 1,559,823 1,787,440 Total 2,343,931 2,643,425 Source: Association of development Financing institution in Asia and the Pacific

Government policy for SMEs promotion As mentioned earlier that most of the commercial banks will lend out to SMEs up to their loan collateral values, therefore the government has recently launched the portfolio guarantee scheme to simply back-up the SMEs loans. This program is under the supervision of Thai Credit Guarantee Corporation (TCG). Last year, the loan amount under this national policy is approximately around 36 billion baht. These loans are given out through the Specialized Financial Institutions. BAAC is also one of the members. SMEs financing segmentation through SFIs The diagram below shows the loan segmentation given through SFIs based on the size of the business.

From the diagram above, it shows that BAAC is now mainly serving the small and micro agricultural enterprises. Therefore, there is still a room for BAAC to approach some medium-size agricultural enterprises. The agricultural-related industrial businesses still need to get access to funding to support the growth of their business. Most of these businesses are also involving in the import and export activities. In the next part, we then will discuss more why we choose trade finance products to support those SMEs business.

Why Trade Finance? Trade finance products are mostly related to the business of import and export. During the past 5 years from 2007 to 2011, Thailand export and import numbers have been increasing almost every year, except for 2009. There was a mass protest in Bangkok during 2009 which affected Thailand economy negatively. Examples of trade finance products include letter of credit (L/C), letter of guarantee (L/G), trust receipt (T/R), packing credit (P/C), aval, and etc.
In THB million Export Export Growth Export - Agro Related Agro Related Growth Import Import Growth Guarantee Guarantee Growth Revenue on L/G @1.00% Letter of Credit L/C Growth Revenue on L/C @0.25% Foreign Exchange Derivatives Interest Rate Derivatives Sum of Plain Vanilla Growth on FxDE (Vanilla) Source: http://www.bot.or.th 1,844 28,089,611 26,859,763 54,949,374 19,953 737,518 1,995,276 4,870,186 849,832 2007 5,302,119 2008 5,851,371 10.36% 1,048,000 23.32% 5,962,482 22.43% 2,148,640 7.69% 21,486 871,382 18.15% 2,178 32,123,10 1 34,925,93 0 67,049,03 1 22.02% http://www2.ops3.moc.go.th/ 2009 5,194,597 -11.22% 943,758 -9.95% 4,601,982 -22.82% 2,117,907 -1.43% 21,179 657,265 -24.57% 1,643 29,335,59 2 37,940,87 2 67,276,46 4 0.34% 2010 6,113,336 17.69% 1,099,037 16.45% 5,856,591 27.26% 2,352,361 11.07% 23,524 732,960 11.52% 1,832 36,389,02 8 45,850,74 1 82,239,76 9 22.24% 2011 6,707,988 9.73% 1,402,411 27.60% 6,982,719 19.23% 2,769,431 17.73% 27,694 934,449 27.49% 2,336 48,568,030 58,059,701 106,627,731 29.65%

Export Composition Agro-Related Industrial Mineral & Fuel Other Total

5-Yr Avg 1,068,607.64 4,426,412.44 324,583.84 14,278.46 5,833,882.40

% 18.32% 75.87% 5.56% 0.24% 100.00%

Source: http://www2.ops3.moc.go.th

From information above; 2 main observations can be identified. o Export and import have been growing aggressively for the past 5 years with over 20% growth each year. More importantly, over 18.32% of export is agro-related products which are the products of our target segment Agrorelated SMEs. o Trade finance products like L/C and L/G have potential of creating over THB 30,000 millions baht of income fee in 2011 THB 27,694 millions from L/G, and THB 2,336 millions from L/C.

Fee Income Gain on Exchanges 2007 2008 2009 2010 2011 2007 2008 2009 2010 2011 B AAC 1,189.00 1,309.00 1,258.00 1,461.00 1,750.00 4.59 4.59 6.23 4.83 5.44 BB L 16,693.00 18,351.00 20,200.00 22,028.00 23,334.00 4,020.00 4,315.00 4,173.00 3,741.00 4,236.00 All Banks 72,893.00 82,346.00 90,190.00103,819.00115,878.0020,441.00 35,131.00 21,540.00 26,252.00 34,907.00 Fee Income to Int. Inc 3.00% 3.17% 35.80% 34.60% 22.31% 25.01% G ain on Exchanges to Int. Inc 0.01% 0.01% 0.01% 0.01% 6.22% 7.40% 5.88% 5.18% 7.34% 5.33% 6.32% 6.53%

B AAC BB L All Banks

2.83% 24.83% 15.00%

3.01% 26.45% 17.20%

3.31% 28.52% 21.68%

0.01% 5.98% 4.21%

The fee income to interest income of BAAC is significantly lower than BBL and the average of all banks. In 2011, BAAC has fee-to-interest income of 3.31% in 2011, while BBL has 21.68% and the average of all banks have 21.68%. So by offering trade finance products to agro-related SMEs, BAAC can increase its non-interest income portion and ultimately boost the net profit of BAAC. In addition to the trade finance products, BAAC should also offer foreign exchange products to provide one-stop service for its SMEs clients since the business of export and import will also have foreign exchange currency transactions. The foreign exchange product can improve the gain on exchange income of BAAC further consequently lead to higher net profit for the bank. Conclusively, BAAC should focus on trade finance because export and import have been growing aggressively for the past 5 years. And the fee income from trade finance products can improve BAAC performance significantly since the bank is not performing as well in terms of noninterest income.

Section 3: Recommended Products for the Objective

There are 3 main groups of products which will be recommended. 1. Working Capital Loan 2. Trade Finance products and services 3. Foreign Exchange & Derivative contracts 1. Working Capital Loan products

Overdraft (O/D)

Nature of Transaction: O/D is a short-term loan where a bank gives permission to a borrower to have a negative bank balance up to a pre-arranged limit. The borrowers are charged interest based on the amount overdrawn and the length of time overdrawn, and are usually charged a regular fee for the use of the facility. They have to repay the principal plus a market rate of interest on any balance. Benefit of O/D: Short-term financing to support working capital requirements, which suitable for customer who only need to borrow at the time. Overdrafts are easy and quick to arrange, providing a good cash flow backup with the minimum of fuss. O/D Transaction Flow:

Promissory Note (P/N)

Nature of Transaction:

Quite simply, a promissory note is a promise to pay. It is a formal commitment (also known as a loan agreement or contract) between two parties that is usually necessary when money is borrowed and lent between them. A promissory note should have several essential elements, including the amount of the loan, the date by which it is to be paid back, the interest rate, and a record of any collateral that is being used to secure the loan.

Benefit of P/N: Short-term financing used to boost up business liquidity As borrowers, a promissory note gives them a specified date to repay. This will give you time to earn and save enough money to repay the sum owed plus interest.

As the lender, promissory notes ensure you will be repaid by a specific date unless the borrower defaults.

P/N Transaction Flow:

Letter of Guarantee (L/G)

Nature of Transaction:

LG is a type of contract issued by a bank on behalf of a customer who has entered a contract and promises to meet any financial obligations to the supplier in the event of default. A Payment Guarantee for example, serves as a security for the supplier should the purchaser not meet his payment obligation on a timely basis.

Benefits of L/G A letter of guarantee often helps firms conduct business with parties they would never normally get the chance to deal with. Bank also gets the fee from issuing LG to the customer.

L/G Transaction Flow:

Aval

Nature of Transaction: Aval is a guarantee added to a debt obligation by a third party who is not the payee or the holder. The debt obligation could be a note, bond, promissory note, bill of exchange or draft. The third party providing the aval is usually a bank or other lending institution.

Benefits of Aval: Increase contract party confidence for receiving money by specific date as in P/N or B/E Help firms to get financial reliable and more chance for doing business. Bank also gets the fee from providing Aval to the customer.

Aval Transaction Flow:

2. Trade Finance products and services For importers: In order to increase liquidity of import business, trade finance service in term of Letter of credit (L/C) and Trust receipt are recommended to importer for guarantee receiving quality goods on time and ensuring exporter in collecting payment under L/C terms and conditions. It makes exporters confident of goods shipment and leads to your import business simply. Furthermore, Trust Receipt under Letter of Credit will increase trade opportunities by selling your goods first and paying later .Then, importers can benefit as they can have the funds from the pending payment to use as working capital in their business. Letter of credit (L/C)

Nature of Transaction: Letter of credit is a service for importer requiring receiving quality goods on time and ensuring exporter in collecting payment under L/C terms and conditions. The service, the Bank undertakes to pay for goods or services per the request of applicant or importer by opening L/C to the exporter via the exporters advising bank overseas. The Bank will pay the exporter if all terms and conditions specified in the L/C are in compliance with the rules and regulations of the International Chamber of Commerce (ICC) such as complete shipping qualified goods and correct present document comply with L/C. Normally, the fee for L/C issuance is 0.25% of the opened amount per 90-day period. The minimum fee is THB 1,000. Benefits of L/C: For exporters: The exporter gets a guarantee of amount and period of payment which is specified in the L/C. Moreover, you may be use the L/C as collateral for loans. For importers: The importers will pay invoice when all the specified conditions in the L / C is comply completely. Furthermore, importer can schedule delivery as well. L/C Transaction Flow:

The process starts from importer contacts the bank to request credit line, i.e., L/C or L/C-T/R. After the Bank checks importers credit limit for approval, the Bank will open L/C to advising bank of exporter in a foreign country. Next, a foreign (nominated) bank will pass L/C to exporter to confirm before shipping goods and send export document such as packing credit to their foreign (nominated) bank. Then, when the Bank receives import documents from a foreign (nominated) bank, the Bank will verify import documents with L/C and transfer document of ownership of goods to importer. Finally, the Bank advises exporters nominated bank of the payment due date, then, bank will pay the nominated bank and collect payment from importer on the due date.

Trust Receipt under Letter of Credit (T/R under L/C)

Nature of Transaction: Trust Receipt under Letter of Credit is provided to the importer to receive goods for production or sale and later pay back to the Bank upon the due date. Short-term credit of not more than 180 days in Baht or foreign currencies for importers to finance raw material and goods imports for production and sale. Customers settle credit on the agreed due date. The ownership rights on the goods produced shall belong to bank until the credit has been fully repaid.

Benefits of T/R: Trust Receipt under L/C helps enhance a liquidity and working capital so the importer can ensure that buying raw materials for production or other import problems will go smoothly. The loan can be granted both in Baht and foreign currencies.

T/R Transaction Flow:

Issuing bank

The process start from the customer must receive L/C T/R approvals from Bank. Then, the customer must open L/C with Bank. Lastly, the customer can receive goods for production or sale and later pay back to the Bank upon the due date.

For exporters: Export Loans is a loan or loan guarantee designed to stimulate a country's exports. Typically this involves a direct loan to a foreign buyer of domestic goods and services, or a guarantee for a private loan to a domestic exporter. The loan essentially guarantees that the domestic exporter will be paid. For SMEs group and the customers who are related to agriculture business can be approached by three categories of the export loans which will be stated in the following pages. Packing Credit

Nature of Transaction:

Packing Credit (P/C) is a short term loan which is the maximum period for which the credit can be granted is not more than 180 days. The loans made available to exporters in order to finance the procuring of goods, purchase, processing, manufacturing or packing of goods prior shipment. For those who deal in shipping goods or machinery overseas, packing credit is a viable loan opportunity since it offers the exporter a more flexible payment plan than typical bank loans. The Packing Credit could be offered the financing to the customer in the form of:

Pre-shipment Credit: is provided as a loan or advance by a bank to an exporter for financing the purchase, processing, manufacturing or packing of goods to help an exporter fulfill an export order prior to shipment to the buyer. o Post-shipment Credit: is the credit offered to an exporter to finance export sales receivables after the date of shipment of goods till the date of realization of export proceeds. Exporters dont wait for the importer to deposit the funds. Packing Credit is subject to the bank policy and the nature of the business. The loan also required assets as collateral. Basically, the credit line is depending on the collateral but not exceed 80% of the assets. o

Benefits of P/C: To support the financial term to the exporters in the operating process. To increases the business liquidity to the exporters and eliminate insufficient of the working capital. To facilitate the payment for raw materials and manufactured goods for exporters. P/C Transaction Flow:

The process of packing credit is started from the exporters who need to expose the business by using packing credit to support the operation process of shipment. They will require seeking for the bank representative in order to sign the L/C agreement regarding packing credit service term. The exporters need to submit all required documents to the bank. After credit approval exporters will shift all products to importers together with the importers bank will ask to collect the bill. Documents against Payment (D/P)

Nature of Transaction: D/P is a terms of payment arrangement in which an exporter hand over the ownership documents of products or assets to the bank representative, which then presents them to an importer only after the bank has received payment for the asset. Essentially, the bank holds hostage the ownership documents, which the importer needs to take possession of the merchandise are paid by the importers. The terms of this agreement are set between the importer and exporter at the time of the sale. D/P Sign: terms of payment that the importers must make a payment of the draft amount as soon as the buyer is presented the draft. Basically, the importers need to pay the draft the amount prior the shipment. D/P Term: terms of payment that the importers will require to make a payment of the draft amount at the specific period. Usually the payment period is subject to

the agreement between exporters and importers. The payment periods naturally are during 30, 60 or 90 days.

Documents against Acceptance (D/A)

Nature of Transaction: D/A is a terms of payment arrangement in which an exporter instructs a bank to hand over shipping to an importer only if the importer accepts the accompanying bill of goods or singed on the documents required to take an ownership of the goods of exchange. In essence, this is a deferred payment or credit arrangement. The buyers assent is referred to as a trade acceptance. D/A terms are usually after sight for instance at 90 days or after a specific date between the exporters and importers, such as at 150 days bill of lading date. D/P and D/A charged by bank is subject to bank policy with a minimum rate at 1,000 THB. Benefits of D/A & D/P: Sources of working capital to the exporters. Facilitates the granting of trade credit to a sellers and buyers. Lower the risk for the exporters that the importer will refuse to pay. Ensure the seller that the buyer will have to pay the bill approved before the product is released. D/A & D/P Transaction Flow:

The exporter ships goods and prepares the export documents. The exporter completes an exporter collection form and sends the export documents to the bank together with a bill of exchange demanding payment from the importer. The exporter's bank sends the export documents together with the bill of exchange to the importer's bank to be released to the importer against their acceptance or against their payment. The importers bank approaches the importer to accept the bill of exchange. Followed by a payment to the exporters bank then right after that transfer to the exporters.

3. Foreign Exchange & Derivative Contracts (FxDE)

Foreign Exchange & Derivative Contracts (FxDE)

Nature of Transaction: For clients with business of export or import FxDE contracts are contracts specifying the future date of transactions for exchanging foreign currencies or interest rates between two parties; which

the exchanging rates are agreed on the agreement date (Trade date) or today. Benefits of FxDE: FxDE contracts can help clients managing their foreign exchange risks. With FxDE contracts, exporters or importers will not be affected by the swing of the foreign currencies as the rates have already been locked in since the Trade date. By offering FxDE contracts, BAAC can generate profit in terms of gain on exchanges by sending FxDE orders from clients to commercial banks at profitable rates without creating any directional or foreign exchange rate risk. FxDE Transaction Flow:

In this case, Company A is an exporter who has future income in USD currency on 31 August 2012. To prevent the risk from the movement of USD/THB exchange rate; Company A requests for a foreign exchange contract with BAAC for USD 10,000 against THB on 18 July 2012 the trade date. BAAC then contacts Bank B who is a swap dealer in the financial market to request for the same transaction that Company A contacted BAAC for. o Bank B quotes the rate to BAAC at USD/THB 34 Baht. BAAC informs Company A that for USD 10,000 on 31 August 2012, Company A will get USD/THB 33 Baht from BAAC. By doing this kind of transaction, BAAC can generate gain on exchange from matching clients FxDE contracts against other banks contracts without having to carry any exchange rate risk.

Section 4: Recommended Strategies for the Objective

Strategy 1: Established Brand Awareness of banking products to the SMEs customers in related to agriculture; and create customer loyalty and develop banking product and service by using customer relationship management (CRM) Rationale for the strategy: 1. Brand Awareness is the primary step to illustrate the features of banking products to the potential customers and how to create the products recognized by the market target. It is the brand recall and the brand recognition of the company or products to the consumers then the customers become the brand royalty. The strategy one is supported by the Market Funnel Concept. Established the brand awareness is an important way of promoting banking products. Market Funnel is the marketing models that how we created the potential customers and how to preserve them to be a brand royalty. The model started by Brand Awareness which is the strategy to make those consumers to familiar with the product. It is the degree to which consumers precisely associate the brand with the specific product. Then move up to Consideration phase which is the beginning step of deciding between the most likely purchases, taking test-drives, going to a product demonstrations and running to the Conversion phase to make the purchase. Regarding the marketing Funnel to establish brand awareness is a crucial part to sustain the potential customers to become a Brand Royalty.

2.

This is because banking products; there are very few factors that differentiate from its competitors. Therefore, the products that maintain the highest brand awareness compared to its competitors will usually get the most sales. Brand Awareness is the first step drive up the buying decision and sustains the customers. It is an essential part of brand development which helps the brand to stand out from the others in the competitive market. Customer relationship management (CRM) is a widely implemented model for managing a banks interactions with customers, clients, and sales prospects. Moreover, it also has a significant impact to the bank to increase their customer loyalty in the banks product. Providing financial products to meet customer needs in order to expand market share. Developing new products and Create a campaign in order to offer the benefits of product to new customers.

Action plan for the strategy: Due to the fact that BAAC already has implied Customer relationship management (CRM), our strategys method recommends developing CRM to provide products to customer base on individual needs as follows.

1. Improving RM (Relationship Management) Normally, RM is an introduction to contribute relationship between bank customers and products. However, RM should improve the responsibility by increasing understand in both financing and personal of customer behavior. It will help the bank can offer the products that support and satisfy customers need and lead to be a customer loyalty in future. 2. Developing the Sufficiency Economy Learning Center of BAAC Now a day, BAAC has over 84 centers all over the country but there are a few effective centers which can take care of themselves. Then, BAAC should to develop the Learning Center by focusing on these 3 principal as follows. Knowledge Benefit: The Bank should to contribute knowledge to support customers growth such as advising customer to create value of customers products in order to expand their business as global basis. Value Benefit: The Bank should to make customers feel that they get benefit and opportunity from the bank. For example, bank provides Trust Receipt under Letter of Credit, a short-term credit, to the customer who is an importer to receive goods for production or sale and later pay back to the Bank upon the due date. The trade finance product will help enhance a liquidity and working capital of clients business. Relationship Benefit: The Bank should to form business networking between customers and their businesses relevant because it is not only help the bank built a long term relationships with customers, but also lead the bank gain more new customer from their trading.

3. Increasing the efficiency and effectiveness of lone process in order to respond the needs of the customer precisely such as: Setting in the duration of the loan approval process Increasing decentralizes the authorization of loans approval to the branch Developing in customer Database Developing and enhancing the service branches

Strategy 2: Providing loan products and trading finance with lower interest rate and fees than other competitors for both retaining old customers and acquiring new customers Rationale for the strategy: 1. Lower interest rate means higher competitive strength of banks Basically the interest rate is one of significant factors of business owners for loaning decision making. Loan Interest rate is the main cost of business production and expansion. High interest rate of loan means high cost of business. Therefore, bank can provide loan with low interest rate can compete with other banks effectively. In other words, low interest is the competitive strength of banks. 2. BAAC can provide lower interest rate and fees because of lower cost of funding of the bank Apart from competitive strength of lower interest rate, BAAC also have less Interest expense per deposit comparing to other commercial banks. Notice that Interest expenses of BAAC last year is less than other top 5 commercial banks about 0.66% which means that BAAC have less cost of funding than other commercial banks. Thus, because of lower cost of funding, BAAC can provide lower interest rate for loan and lower fee for trading finance. Interest expenses/ Deposit in 2007 2011 of BAAC and 5 biggest banks Interest expenses / Deposit BAAC Growth rate Top 5 commercial Banks Growth rate 2.50% 2007 1.93% 2008 1.71% -11.49% 2.05% -17.77% 2009 1.44% -15.84% 1.35% -34.14% 2010 1.41% -1.83% 1.48% 9.66% 2011 1.65% 17.17% 2.31% 55.62%

3. Currently BAAC has already provided lower interest rate Currently BAAC offers lower interest rates to customers. From the table above, MLR of BAAC is lower than top 5 commercial banks around 2% which means that, in situation of 10 million loan, loaning at BAAC, the company can save the money around 200,000 baht per years comparing to other banks. This indicates high amount of money saved with lower interest rate of only 2% which is extraordinarily attractive to customers. Interest rate of BAAC and Top 5 commercial banks

Action plan for the strategy: There are 4 main actions to support this strategy. All actions revolve around communication of new products by emphasizing on the lower interest and service rates. 1. BAAC can identify target customers of trading finance by collecting information of old agricultural related SME customers that have potential to import and export. 2. BAAC can identify target customers of working capital loan by collecting information of agricultural related SME customers that used to be old customers of commercial loan 3. After identify target customers, BAAC should send RM to the target customers offering new product by emphasizes on the lower interest rate and fees than other banks. 4. After sending RM to target customers, BAAC must follow the feed back via product trial and questions from customers to improve the communication to customers in the future.

Strategy 3: Improve credit analysis process to determine appropriate risk-adjusted lending rates to each of the customer group. Rationale for the strategy: There are 3 main reasons to support this strategy. 1. By providing risk-adjusted lending & service rates; BAAC can offer its products and services to agro-related SMEs customer group which normally get denied for loan request from commercial banks due to their high risks.
Example 1 Business Risk Management Situation Impact to company Implication of risk Risk-adjusted lending rate by BAAC Lending rate without risk adjustment By Bank XXX Lending rate without risk adjustment by Bank YYY Company A Corn Grower Locked in future selling price of corn Fluctuation in corn prices No impact to revenue Less risky to bank 10% Rejected 12% Company C Corn Grower No agreement on future selling price Fluctuation in corn prices Impact revenue More risky to bank 14% Rejected 12%

Example 1 shows the situation where risk-adjusted lending rate can help BAAC win customers over Bank XXX and Bank YYY whom do not have risk-adjusted lending system. Both Company A and Company C are corn growers. The only difference between the 2 companies is Company A locked in the future selling price of its corn production through forward agreement; while Company C did not lock in its future selling price. The fact that Company A has locked in the future selling price of its product means Company A will not be affected by the fluctuation in corn selling price in the future. This would allow the company to have stable string of revenue in the future; which translates to less riskiness in terms of potential borrower of the bank. Since Company C did not have any forward agreement on the future selling corn price; Company Cs revenue will fluctuate depending on the corn price in the market. Fluctuation of future revenue represents higher risk for the lenders. With the adoption of risk-adjusted lending rate, BAAC can offer Company A with cheaper lending rate than Company C. In this case, BAAC can offer Company A at the risk-adjusted lending rate of 10%. BAAC can offer Company C at the risk-adjusted lending rate of 14%. The 4% different is justifiable by the different level of riskiness Company A and Company C have.

Operating as a normal commercial bank, Bank XXX might choose to reject both Company A and Company C since both companies operate in the SME agricultural sector Bank XXX deemed the whole sector to be too risky for its business. In the case of Bank YYY, however, without the risk-adjusted lending system; Bank YYY might offer both Company A and Company C at the flat rate of 12%. Without the risk-adjusted system, Bank YYY will not be able to differentiate the appropriate lending rate between Company A and Company C. i. By offering 12% flat rate, Bank YYY will face the problem of adverse selection offering too high of interest rate to less risky company (Co. A), and too low of interest rate to more risky company (Co. C). ii. Consequently both companies will choose to borrow from the cheapest funding cost Company A choosing BAAC, and Company C choosing Bank YYY. However, as Company C has higher risk, the rate of 12% might not represent true lending cost for Bank YYY. This could lead to less Net Interest Margin or higher NPL.

2.

From the 3 cases of BAAC, Bank XXX, and Bank YYY; benefits from risk-adjusted can be identified. First, BAAC can offer lending rates that will not create adverse selection like the case of Bank YYY. Second, BAAC can enjoy the benefit of winning customers (both Company A and Company C) from Bank XXX. The adoption of risk-adjusted lending rates can reduce the asymmetric information problem of adverse selection that is caused by providing same lending rates to all customer groups. As the Example 1 in the case of Bank YYY has illustrated, without risk-adjusted lending rate; Bank YYY will face the problem of adverse selection providing too low of lending rate to more risky customer. Aside from the Example 1; many publications have addressed the issue of adverse selection born from the lack of risk-adjusted lending rates. One of many publications includes Risk Based Pricing by Ifori Layegue of KPMG Nigeria whom has made the following statement in KPMG Nigeria website -http://www.kpmg.com/NG/en/IssuesAndInsights/Documents/Risk %20based%20pricing.pdf.

Without understanding the risks of customers, banks often offer under-priced lending rates to their customers. This offering of underpriced lending rate can lead to lower quality of lending and ultimately lead to higher amount of NPL.

3. BAAC can generate higher net profit by charging risk-adjusted rates to

customers -- higher rates to more risky customer groups, and lower rates to less risky customer groups. As Example 1 has shown earlier, with risk-adjusted lending system, BAAC can charge higher interest rate to Company C. The higher interest rate charged is calculated based on the higher level of risk Company C has. With higher interest rate, BAAC can enjoy higher interest income and can therefore improve the Net Interest Income (NII) of the bank. Year BAAC NII BAAC NII Growth KBANK NII KBANK NII Growth SCB NII SCB NII Growth BBL NII BBL NII Growth 2007 28,134 37,431 39,177 47,013 2008 32,096 14.08% 42,436 13.37% 44,330 13.15% 52,927 12.58% 2009 33,441 4.19% 43,374 2.21% 42,005 -5.24% 49,390 -6.68% 2010 32,686 -2.26% 46,744 7.77% 39,754 -5.36% 45,618 -7.64% 2011 35,790 9.50% 56,491 20.85% 50,526 27.10% 52,696 15.52%

By collecting the financial statements of BAAC, KBANK, SCB, and BBL for 5 years from 2007 to 2011; one observation can be identified from analyzing banks NIIs. For the year 2010 and 2011; BAAC fell behind other banks in terms of NII growth. Especially in the year of 2011 where BAAC only managed to generate 9.5% of NII growth while the other 3 commercial banks can generate over 20% of NII growth. If BAAC adopts risk-adjusted lending system; BAACs bottom line would improve from less amount of NPL, higher interest income for riskier customers, and more lending amount from being able to offer loan facilities to SME businesses that commercial banks denied their loan requests.

Action plan for the strategy: There are 3 main actions to support this strategy. 1. Adopt Risk-based pricing in determining lending rates for customers. Customers with higher risks must be charged with higher interest rates than customers with lower risks. The risk-based pricing can be adopted by applying the customers riskiness into the credit analysis process. More importantly, the risk factor should be considered and included when forming the interest rate pricing model. Ultimately each financial institution has different method and approach to determining the lending interest rate; but for risk-based pricing to take place, the risk element must be included in the pricing model. Below is the risk based pricing methodology proposed by Ifori Layegue of KPMG Nigeria in a publication of Risk Based Pricing under KPMG Nigeria website. (http://www.kpmg.com/NG/en/IssuesAndInsights/Documents/Risk %20based%20pricing.pdf)

In this pricing methodology, there are many elements in the method; but the one that is most critical is the Risk Costs. If BAAC can design a database that collects risk-related data like Probability of Default (PD), Loss Given Default (LGD), and Exposure at Default (EaD), then BAAC can incorporate the risk element in its lending rate models. This would lead to a risk-based pricing or risk-adjusted lending rates.

2. Classify each customer group based on their risk-driven characteristics Each stage of SME life cycle has different level of risks. Starting-up

SME business will have low unstable income, and the business will have hard times identifying lending sources. A medium size SME business will have more stable revenue and have more access to lending facilities. Below is the diagram showing different growth stages of SME business. Each growth stage has different income and difficulty to lending facilities. Source from DG Enterprise published by the European Commission. (http://ec.europa.eu/enterprise/index_en.htm)

i. To appropriately set up lending rate, BAAC must be able to identify which growth stage the SME business is in as level of risk for each growth stage differs significantly. Each of the agro-related business has different risk characteristics or components.

i. Corn growers will have risks in terms of the corn selling price determined by the market. Frozen food producers will have risks in terms of raw material buying price which the movement of price will have different effects between corn growers and frozen food producers. Being able to classify or identify each customer group based on their risk-driven characteristics will form a strong foundation and accuracy for the risk-adjusted pricing methodology of BAAC.

3. Identify appropriate risk factors within each customer group. Export and import business will have foreign exchange rate risks that could impact business revenue. If BAAC failed to identify this risk factor in the export-import customer group; BAAC will not be able to price the lending rate accurately. Rice growers will have risks in terms of the rice selling price as determined by the government. Not being able to identify this factor related to politics will cause inaccurate lending pricing. Being able to identify all relevant risk factors in each customer group will allow BAAC to accurately price the lending rate for each customer group.