Upgrading and Incentivising Staff Dr Ekkehard Esser Bankakademie

Upgrading and Incentivising Staff Dr. Ekkehard Esser Bankakademie International Lahore, 10 May 2005

Why are Banks reluctant to venture into SME Lending? SME lending is often perceived as risky SME lending is often perceived as costly But. . . 9/17/2020 . 2

Summary of Lessons Learned Various ways to make it work profitably and with acceptable risk profile § Separate SME Lending Unit as independent department § Decentralized decision-making at branch level § SME loan officer fully responsible and accountable for the entire loan cycle § Performance-based remuneration system for SME loan officers § Strong MIS and loan tracking system to ensure close monitoring and speedy follow-up of overdue loans § Strong internal audit specialized on SME loans 9/17/2020 . 3

Importance of Human Factor q Interaction with clients requires direct human involvement for tasks like assessing potential clients‘ ability and willingness to repay loan (credit risks). q The quality and motivation of staff members has impact on FI‘s ability to provide best possible service to as many customers as possible. q Staff members are the most important „factor of production“!! 9/17/2020 . 4

Best Practise SME Lending Quality - Motivation of Staff Members Quality (and Quantity) Selection of Staff Training Experience Motivation Provide staff with incentive to perform well 9/17/2020 . 5

Lessons Learned v. What staff qualities are we looking for? Young Well educated No banking experience Communicative Committed Interested in how SMEs do business Interested in economic development Strong performance orientation 9/17/2020 . 6

Lessons Learned v. How do we train? Training on the job Class room training Practical and theoretical Results oriented People skills Training is an investment 9/17/2020 . 7

How do we motivate staff? Money is a motivating factor for most humans v Higher compensation will influence individual behaviour. v Money is only one motive for employees to do their job well. v Prestige, power, status are other motivating factors. v Type of motivation comes from “within”. 9/17/2020 . 8

International Experience Monetary incentive schemes often have a significant impact on organisational performance: ü reducing loan delinquency ü boosting loan officer productivity and increasing institutional outreach ü improving efficiency and productivity ü retaining excellent staff 9/17/2020 . 9

International Experience If Incentive Schemes are to be effective, they must be accepted by those they target Ø Fairness – attainable goals Ø Transparency – simple enough to be understood measurable, objective indicators known as “rules of the game” 9/17/2020 . 10

Typology and Form of Incenticves Schemes Typology of Staff Incentive Schemes ü Individual and Group Form of Incentives Schemes ü ü ü Bonus schemes Profit-sharing plans Gainsharing plans Merit pay plans Employee Stock Ownership Plans (ESOP) Pension plans (deferred income) 9/17/2020 . 11

Design Issues Fundamental question: How much weight should the incentive component have in total employee renumeration? Incentives • need to be large enough to influence the behaviour • must be in line with both local and institutional cultures Guideline for Loan Officers 20 -50 % variable, performance related of total compensation 9/17/2020 . 12

Design Issues Fundamental question What kind of behaviour do we want to encourage? § Reduce and/or control client delinquency Short-term incentives § Boost staff productivity Short-term and long-term incentives § Increase staff loyalty Long-term incentives 9/17/2020 . 13

Design Issues Payout frequency? § Short-term payment intervals provide direct feedback to employee, stronger positive effect on productivity § Frequent - regular incentive payments may develop a „entitlementality“ Avoid „entitlementality“ by incentive awards that are very reactive to changes in performance. Split between short-term and medium-term payout 9/17/2020 . 14

Design Issues Performance Measurement § Supervisor Evaluation versus Indicator System that is Transparent – Objective Example: Loan (Credit) Officer § Produce and control as many loans as possible Monthly output (numbers § § of loans approved or disbursed and volume approved or disbursed). Build up a large portfolio Outstanding loan portfolio, both in terms of the number of outstanding loans (caseload) and the volume of the outstanding loan portfolio. Maintain excellent portfolio quality Quality of loan portfolio. This could be measured by various indicators such as the repayment rate or non-performing loans (NPL) Client retention – New clients/acquisition Repeat borrower rate Client‘s business activity etc Outreach to target groups, such as traders. 9/17/2020 . 15

Design Issues Bonus Schemes § Tiered Schemes versus Linear Schemes § Maximum Performance Levels and Bonus Caps versus Reference Performance Levels (= reasonable output of experienced loan officer) v reflect the reality of FI operations v positive incentive for everyone v easily to adjust upwards with „learning curve“ 9/17/2020 . 16

Example of Bad Incentive Schemes § No base salary, only a commission based on ability to lend and loan recovery. High turnover rate among loan officers, left typically after 2 years, „burn out“. § Heavy use of incentive pay, fat monthly bonuses. Loan officers earned more than branch managers. Refused to apply for senior jobs. § To combat arrears problems very strong disincentives for allowing client delinquencies were introduced. Loan officers manipulated statistics or concentrated on recovering funds, almost stopped granting of new loans. § Heavy focus on loan officer productivity with minimum numbers of credits per month to be eligible for bonus. Loan portfolio quality suffered, some engaged in fraudulent behaviour, „fictitious clients“. § Strong emphasis of portfolio quality. Loan officers might become risk averse and shy away from new customers. 9/17/2020 . 17

International Experience Step by Step Approach to the Design of Staff Incentive Schemes: Step 1: Step 2: Step 3: Step 4: Define and Clarify Strategic Goals Analyse the Culture, Clientele, Products, and Processes Define the Incentive Scheme’s Objectives Decide How Much the FI is Willing to Spend – Conduct a Proper Cost. Benefit Analysis Step 5: Determine Which Staff Members and Occupational Levels to Target Step 6: Select the Incentive Mechanism(s) Step 7: Conduct the Technical Design Work Step 8: Run a Pilot Test Step 9: Sell the Scheme to the Staff Step 10: Monitor the Scheme’s Performance and Adjust it as Necessary 9/17/2020 . 18

Performance-based renumeration • A well-designed system will compensate initially increased cost by the improved staff productivity and output quality • There is no single incentive scheme that can serve as a „one size fits all“ solution. Incentive schemes are an integrated and indispensable factor for success in SME lending 9/17/2020 . 19

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