In developing countries where cash remains king and credit ratings are rare, lenders are leery to loan to first-timers (i.e., most small businesses), leaving entrepreneurs with few options to grow their microenterprises.
Until now. MasterCard has partnered with the Harvard-spawned Entrepreneurial Finance Lab (EFL) to break through this impediment to global progress with a psychometric loan test designed to weed out the risky borrowers from the worthy.
Back story: In 2006, Harvard doctoral students Bailey Klinger and Asim Khwaja were searching for ways to bridge this lose-lose trust gap when inspiration struck: Why not adapt the personality quiz that companies use to screen job applicants to provide similar reassurance to bankers regarding untested loan applicants?
The Entrepreneurial Finance Lab, partnering with MasterCard, devised test questions to assess the odds someone without a credit history is a good loan risk. Questions, such as the ones below from EFL, have no right or wrong answers, but are intended to probe honesty and ethics, willingness to repay and business skills.
1. What percent of managers steal from their company?
2. How well to you manage inventory?
3. What is the difference between sales and profits?
4. Which is most important for your business: better prices, better quality, personal relationships?
5. How much do you agree or disagree with the following:
- I believe in the power of fate.
- When good things happen to me, it’s usually because of luck.
- I believe the future is in my hands.
Two years later, backed by a grant from Google and SNV Latin America, EFL began applying computer analytics to a 45-60 minute personality survey to create a nontraditional, three-digit creditworthiness rating where none before existed.
“We’re the world’s first thin-file, emerging market credit scoring company, trying to tackle a $1.5 trillion problem that banks face in emerging economies, which is: How do you bank the unbankable?” says Chief Operating Officer Dennis DiDonna.
The past six years, EFL has processed more than 72,000 applications in 24 languages and 20 countries throughout Asia, Africa and Latin America, many submitted offsite via e-tablet. The company hopes to expand its global reach with MasterCard’s help.
By using questions to which there are no right or wrong answers, the loan survey measures two key factors: applicants’ willingness to repay loans and their ability to do so.
The willingness factor breaks down into honesty and ethics. “What the data shows is that someone’s view of the external world around them actually predicts how honest and ethical they are,” says DiDonna. The honesty assessment alone can change a bank’s loan default rate by 8 percent, he says.
The ability to repay is measured by an applicant’s personality (i.e., optimism, drive, personal control over outcomes), business skills and intelligence.
To prevent applicants or loan officers from gaming the quiz, each test is randomized, so no two are ever alike. Biometrics, digital photos, fingerprints and other identifiers are used to ensure that no one can take the same test under different identities. The computer analytics also flag unusual responses that may indicate that a loan officer is coaching an applicant.
“What our tests have shown is that this type of tool, on clients that are traditionally already accepted, can reduce defaults by an additional 25 to 40 percent, on top of what banks can already achieve,” says Klinger.
It also serves our collective good by giving credit where credit is due — and sorely needed.