The Global Conference on Profiting from Small Business Lending has reaffirmed a concept of enormous economic potential: that expanding credit to underserved communities and businesses around the world can not only promote development but also provide profitable business opportunities for financial institutions. This concept is not in the least far-fetched thanks to modern technology, the growth of credit bureaus, and the advent of credit scoring, all of which help lenders better evaluate risk. With these tools at their disposal, financial institutions need not regard credit for small business with alarm. As one conference participant put it, “If you can measure the risk, you have the opportunity to manage it.”
Despite its demonstrated impact on economic growth in places such as the United States, however, in most countries credit to small businesses and to entrepreneurs remains very limited. Financial institutions continue to be uneasy about the risks in offering credit to small businesses. They also fail to see the quality in small portfolios and worry about the transaction costs, two very important drivers for lenders. Another concern is that small businesses, like consumer finance, entails high volumes. Thus the fundamental question for financial institutions today is whether these and other obstacles to small business lending can indeed be surmounted, to the benefit of all concerned. The key to managing risk, conference participants agreed, is better information. But arriving at better information is a complex process. It requires an entire infrastructure—actually two infrastructures, one specifically for the individual financial institution and the other for the entire financial market—to produce the right kind of information and to ensure that it is useful. That is to say, credit information has to be consistent, good, and timely.
How can all this be achieved in economies where information does not yet even exist? Clearly, it is of utmost importance to establish the respective infrastructures. These consist of the legal and regulatory framework within the country that allows information to flow, and the arrangements within and between financial institutions. Most importantly, it requires a readiness in the business culture: both the internal culture (within the institution) and external culture (within the country) toward credit. And this requires a major investment, not just in technology but also in people, so that they can learn how to change the credit culture.
But that is just the beginning. The next—and very important—challenge is to collect the data that will enable lenders to assess risk. As mentioned above, the data need to be good, consistent, and up to date. But good data alone will not ward off defaults and losses.
It is essential to know how to analyze the data, and then how to get all this information into decision-making. This is where the credit scoring comes in that makes it possible to move from making decisions to managing decisions on credit, which is a great cultural leap for financial institutions in general.
This conference has brought to light a great deal of information about credit scoring. The central question here is how does one develop a scorecard within a financial institution? Does one buy it off the shelf from somewhere, get an expert to tell the institution how to do it, or develop it in-house? Though every financial institution must find its own way to develop the right system for its clientele, it is impossible to do this all alone. To begin with, the institution will have to buy the expertise from somewhere and then apply the knowledge to its particular situation and build the system from there. At the same time, people within the institution itself who have dealt with risk management must not be omitted from this building process. Unless they are involved, a scorecard simply will not work.
The next step, after the scorecard has been developed, is to test it. This will take quite a while. As numerous conference participants have warned, an institution cannot depend on credit scoring right off the bat. It takes time to implement. Furthermore, it requires constant and consistent monitoring to make sure the system’s predictive values are indeed correct. The goal is to develop a scoring system that allows the financial institution to predict how a certain group will perform. It needs to monitor this and see what the actual performance is. To reiterate, credit scoring will not work without consistent management of the entire process. That is one of the keys to its success.
Another word of caution: credit scoring is not a plug-and-play approach, in the sense that one just puts data in a computer and uses the output as its face value. It takes a major investment in time, technology, training, and human resources. And in organization change: Changing the credit culture within an institution is not an easy task.
Furthermore, it is important to recognize that credit scoring and the resulting credit information do not work for all market segments. That is why it is essential for every financial institution to know what it is going to focus on, what markets it is going to go after, and what products it is going to handle. It is not just everybody, every consumer, every industry. Once all that has been identified, the design of a credit score and a credit system becomes much easier and much more focused.
The next question in the minds of many participants is where does an institution go from there? One step would be to develop the internal credit scoring system mentioned above. Another would be to join up with another institution to share scoring solutions. That works for institutions and countries where either the market is not there yet or no one knows the market or everyone has a small part of the market and needs to share in order to build the volume. Deciding on which way to go is a question best left to the experts. Even then there is no easy answer. Views on this vary across the board, for it depends on the country and on the availability of information. But most important, it depends on the willingness of financial institutions to share information for the benefit of all.
So when people speak about competition in this area, it is not competition regarding information. It is competition regarding the use of information. In other words, the issue is competition versus cooperation. What do institutions cooperate on, and what do they compete on? There are many examples of countries that have already decided how to answer this question. Institutions in Finland, for instance, decided many years ago to cooperate on all aspects of infrastructure, but they compete on the customer relationship side.
These kinds of decisions are made by financial institutions themselves—with out the interference of governments. Indeed, there is no need for governments to be involved in this kind of decision.
Yet another issue raised by conference participants concerns credit bureaus. Which models are preferable: private sector or public sector credit bureaus? Private sector ones seem to have the greatest support, according to studies that have investigated them. Within the credit bureaus, it is important to know whether bank secrecy acts, if there are any, affect their function and whether one can provide both positive and negative information or not. It is also essential to know the limitations of positive information—whether a country has property rights that allow institutions to feel secure in their lending, and whether they use collateral or not. This is a subject worth pursuing, because making sure that individuals and the poor have property rights could unleash a huge amount of wealth that is not moving today. A case in point is Egypt, where more than 80 percent of the country’s entire investments are in unmovable properties lacking clear property rights arrangements. This is a very large figure.
Some have mentioned that educating consumers is a very important component of credit bureaus. Others are skeptical about whether this is worth the invest ment. Skepticism regarding this or any other issue is actually a healthy sign. It keeps us asking and trying to determine whether it is the right thing. In any case, there is a model that works for different organizations in different countries. It just needs to be adopted to the particular circumstances. Perhaps it is not appropriate even to call this a solution; it is an approach. And it is one that has to be properly adapted and properly thought through, both at the institutional and national level.
As mentioned earlier, it will take time to implement whatever credit model is chosen, especially because it represents a change in culture, a change in the traditional way of providing credit. One must be very realistic about that. Furthermore, it is going to require a considerable investment of human resources. Here, the change will require new thinking regarding competition and cooperation, as I hinted earlier. Circumstances of history made it a relatively easy culture change in the United States, whereas the situation might be quite different if it was just starting out today. The fact that banks were not competing directly with one another across the United States together with the mobility of the population made people more willing to share the data voluntarily.
Countries with more concentrated systems or very large lenders may find it more difficult to get things started. In these cases, there will be a need for more active public policy. In the final analysis, however, it is incumbent upon the industry itself or those who represent private credit reporting firms to make sure that an appropriate system develops. Otherwise, someone else will step in to set regulations or create something in the public sector that may not be exactly to the liking of the industry. The answer to problems of this nature is cooperation. In other words, the industry has to be thinking about credit issues proactively.
Although conference participants did not exactly reach a consensus on every issue they discussed, they have come away with a new view of the value of credit information and at least a sense of how this information might be transformed into tools that could improve the decision-making process, risk management, and access to credit. The more this information becomes available, the easier it will be to provide credit to those small businesses that are an excellent risk but about whom credit providers have no clue. It is essential to get that information out to build more vibrant financial markets and businesses, and in the long run, to build more vibrant economies.
Contents
Foreword
- Michael Pomerleano, The World Bank and
Peer Stein, International Finance Corporation
Summary
- Hany Assaad, International Finance Corporation
Making Small Business Finance Profitable
- Peer Stein, International Finance Corporation
The Importance of Credit Information and Credit Scoring for Small Business Lending Decisions
- Andrew Jennings, Vice President, Fair, Isaac & Co. Inc
Introducing Scoring to Micro and Small Business Lending
- John Coffman, Partner, C&T International
Credit Scoring in Microfinance
- Maria Otero, President & CEO, ACCION Internacional and Cesar Lopez, Vice
President, Latin American Operations, ACCION International
Requirements for the Successful Use of Credit Information
- Barry Connelly, President, Associated Credit Bureaus, Inc.
The Value of Comprehensive Credit Reports: Lessons from the U.S. Experience
- Michael Staten, Distinguished Professor and Director, Credit Research Center,
McDonough School of Business,Georgetown University
Requirements for the Successful Use of Credit Information
- Fabrizio Fraboni, Director, Strategic Planning & International Division, CRIF Group
Credit Reporting Systems Around the Globe
- Margaret Miller, The World Bank
Small Business Lending and the New Basel Capital Accord
- Mark Carey, Senior Economist, U.S. Federal Reserve Board
Using Internet to Make Small Business Loans
- Ming Siu, Chairman & Chief Executive Officer, SMEloan Hong Kong Ltd.
Chip Cards in Global Small Business Lending
- Theodore Iacobuzio, Senior Analyst, Consumer Credit, TowerGroup Research
