SME Lending: A Test to Identify Entrepreneurs

Friday, July 16, 2010

1. Do you like taking things apart to see how they work?

2. Do you enjoy going to parties?

3. Given five seconds, how long a sequence of numbers can you memorize?

If your answers to these and about 150 other questions add up, you could run a small business in Nairobi. Or Lima. Or Bogotá. All because a new test identifies the traits that make for successful entrepreneurs in developing economies.

The Entrepreneurial Finance Lab (EFL), a branch of the Harvard Kennedy School’s Center for International Development, has devised a psychometric test to help banks in emerging markets easily screen loan applicants. The goal is to spur lending to small and midsize companies, a vital sector often underfunded in the developing world. These companies are too big to rely on microfinance, yet not big enough to be served efficiently by the banks. “There are millions of businesses in developing countries that could earn significant returns on additional capital that aren’t financed,” says Bailey Klinger, EFL’s director. “And it’s not that banks aren’t interested in them. Quite the opposite. They just don’t have the right tools.”

The 40-minute computer-based test assesses traits like honesty, ethics, intelligence, and motivation. The EFL says three years of pilots in South Africa, Kenya, Rwanda, Colombia, and Peru have shown that the test achieves the same-or better-results than traditional ways of assessing a borrower’s future success and ability to repay a loan. With the test, local banks can cut default rates by 25 percent to 40 percent, says D.J. DiDonna, EFL’s director of business development. They will also be able to extend loans to clients whose credit histories are sparse or nonexistent.

Source: Bloomberg BusinessWeek (link opens in a new window)