In the U.S. one of the primary measures a lender uses to determine the likelihood of a small business owner making timely payments on a loan is their credit history. Of course, there are reasons and situations where an otherwise responsible small business owner might fall behind and have a less-than-stellar credit rating. The last few years of the economy are a prime example.
However, surfing the news this morning, I came across a piece from Sarah Wheaton published last month in the New York Times that caught my eye. “No credit? No problem—take a test,” she writes.
In developing countries without a well-established credit rating system like we have in the United States, you can imagine how challenging it might be for lenders to evaluate the creditworthiness of a potential small business owner. “Banks in 16 countries are using a psychometric test to predict future behavior—specificially, whether someone will pay back a loan,” she writes. “Originally a Harvard doctoral project, the Entrepreneurial Finance Lab’s test has increasingly won the confidence of risk-averse bankers in places where, many economists believe, credit bottlenecks are severely stunting growth.”
The lab’s test asks questions that might not have a “right” answer, but the algorithm they use to score the test seems to be a pretty good predictor of whether or not the entrepreneur will make good on the loan.
- I believe in the power of fate
- I plan for every evenuality
- I’m in between
- Planning takes the fun out of life
There are a couple of lessons learned that were particularly interesting. “Optimism and self-confidence are good signs among seasoned entrepreneurs, but high levels in younger business owners do not bode well, statistically,” she reports.
Additionally, those who took the test were able to get interest rates at about half the percentage as those who didn’t. And, Standard Bank, Africa’s largest bank, has used the test to lend more than $200 million since they adopted the test in 2008.
It’s still too early to tell if this is a viable measure of credit worthiness in the long term, but MasterCard is jumping on board this month with a pilot program at BHD Bank in the Dominican Republic. “Edward Glassman, MasterCard’s group executive for global commercial products, said he had been looking for alternative underwriting models after hearing from banks that they would like to do more with small business, but didn’t have the right tools to do it,” writes Wheaton.
I wonder if we’ll ever see something like this in the U.S.? Would you prefer the bank to look at your credit score or give you a test to measure the likelihood of whether or not you’ll repay your small business loan?