Harvard researchers have a way to help banks screen loan applicants easily. The goal: to spur lending to small and midsized companies in the developing world
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.
In developed countries, psychometric tests are widely used by blue chip companies to evaluate possible hires. Klinger and his colleague Asim Khwaja came up with the idea of applying these tests to evaluate creditworthiness, in part because academic research showed that characteristics like IQ influence the rate of credit returns. The EFL consulted industrial psychologists, studied the literature on entrepreneurs, and extracted elements from existing tests. The resulting evaluation can be customized to reflect an applicant's business, company size, and country, though the core questions remain the same. The EFL says the tool can save banks time and money, since standard screening can take three days or more when banks don't have existing borrowing histories to draw on.
South Africa's Standard Bank, the continent's biggest, has signed on to become EFL's first paying client and roll out the test in South Africa and Kenya this August. "We're hoping a flagship client like Standard Bank, as they scale up quickly, will open the door for other banks," says DiDonna. "As you can imagine, banks are pretty risk-averse." If the test works in Africa, EFL hopes to introduce it to the U.S. and Canada, where many immigrant entrepreneurs also lack credit histories and collateral.
The bottom line: Harvard researchers have devised a simple, inexpensive way to test the business skills of would-be entrepreneurs in emerging markets.