NextBillion - An Initiative of the William Davidson Institute at the University of Michigan

Thursday, December 6, 2012

Bankers around the world know there are profits to be reaped by making loans to promising small businesses that fall just short of traditional definitions of “creditworthy.” Ever since Nobel Prize winner Muhammad Yunus’ Grameen Bank pioneered “microfinance” by making tiny loans to single mothers in Bangladesh, development policymakers also have believed that getting credit to small businesses—those too large for Grameen-style microloans but still lacking collateral or credit history—is not only possible, but the key to helping a nation’s economic growth. So how to figure out who’s a good risk for a loan—and who isn’t?

Now, some banks think a simple, 40-minute questionnaire for entrepreneurs can tell them a lot about whether a company is worth the risk. Two public policy researchers at Harvard, Bailey Klinger and Asim Khwaja, first adapted questions for such a questionnaire from psychometric evaluations— a tool psychologists, child custody lawyers, executive recruiters, retail employers, and even the NFL have used since the concept emerged from academia in 1918, when the U.S. Army started mentally testing potential doughboys.

Psychometric evaluations typically include brief, open-ended questions related to ethics, attitudes, skills, and intelligence. In Klinger and Khwaja’s model for testing how likely an entrepreneur is to make good on a loan, that means questions like “Do you like to attend parties?,” “Do you enjoy taking things apart to see how they work?” or “Do you believe that luck is a big part of success?” as well as cognitive problems like “Look at this sequence of numbers for five seconds, then try to recite as many digits as you can.”