A post surfaced across my Facebook feed today highlighting the 2012 results of an organization started by another classmate and friend of mine. It is a very interesting organization doing cutting edge work in behavioral finance and microfinance and well worth examining here. In fact Entrepreneurial Finance Lab (EFL) which has built a psychometric testing methodology to measure the credit worthiness of the unbanked has been so innovative last year it won the G-20 SME Finance Challenge, has also been featured in global media giants like the Financial Times and partnered with the likes of the IFC and Aspen Network of Entrepreneurs.
WHAT IS THE BUSINESS ABOUT?
Essentially EFL has developed a methodology using in person psychometric testing and bayesian hierarchal statistical model to help lending institutions to identify high potential, credit worthy entrepreneurs to lend to. The psychometric test is essentially as Business Week describes a test to identify high potential entrepreneurs which over 30 minutes asks 150 or so odd questions to the applicant about his or her personality and business acumen, etc. The test generates a score which is used to access the borrowers risk. This system or others similar to it would replace traditional credit screening methodologies and would work in places where financial institutions struggle to assess credit risk e.g. where there are clients without credit history, business plans and there are no credit bureaus to fact check their reliability. This is an exciting area since initial research has shown that such tools can reduce default risk and expand the lending base to an estimated 200 million USD in unbanked M/SME’s globally.
HOW DID IT START?
EFL started as a spinout from the Harvard Centre for International Development. Where a Professor and PhD student first began building psychometric testing tools as a potential low-cost tool to help screen entrepreneurs after a trip to South Africa in 2006. Then after receiving funding from Google.org and SNV Latin America to build the idea they officially became an independent private organization in 2010. Since they have expanded massively and are now working in 25 countries and have a global staff of more than a dozen people.
WHAT IS THE SOCIAL NEED IT ADDRESSES?
Provide access to finance to the “missing middle” or the SME sector in low-income countries. SME’s only account for 18 percent of employment in low-income countries while they account for more than 50 percent in developed economies. These informal SME’s have a huge potential to be job creators and innovators but lack the capacity to grow largely due to limited access to financial resources. Further as outlined above financial institutions have difficulty lending to such SME’s because they have no way to assess their riskiness. EFL is a tool designed to expand access to finance for the hundreds of thousands cash starved SME’s around the globe.
WHAT IS THE BUSINESS MODEL?
To be honest I am not sure exactly how EFL makes money at the moment. Or if it is even a for-profit organization rather than a research oriented non-profit. Presumably EFL charges the banks that implement its methodology some sort of fee for the technology e.g. the methodology and training. I assume that they also charge some sort of per user fee. But I also know that since it started out of the CID at Harvard and has a lot of partners that the business must be highly partner financed while all of the kinks get worked out of the system. To be truly sustainable it will need to figure out how to make money without partners.
WHAT ARE SOME CONCERNS I SEE WITH THE MODEL?
- Competition for the “richest” of the poor – Much like many criticisms of microfinance models, this methodology creates a more refined way for lenders to identify and lend to the “best” or most likely to be successful of the poor and ignores the rest of the poor. This ultimately means that banks will be competing more efficiently to lend to the best of the poor but may not actually be expanding access to finance to those who need it.
- Customization – Similarly psychometric tests are built on models created mostly in western universities such as Harvard. Their could be some criticism that the models don’t sufficiently understand the cultures in Africa, Asia and Latin America and could miss out on high potential candidates with different “good” personalities.
- Sustainability – EFL seems to still be highly partner dependent. To be truly sustainable it will need to figure out how to make money without partners.
- Implementation costs – The costs of administering and implementing systems such as EFL’s by banks could be time-consuming and burdensome and could increase the overall cost of lending so much that it could make SME lending unprofitable.
WHAT DO YOU THINK?