Entrepreneurial Finance Lab at Harvard University | Egypt
$438,000 | Stage 2: Testing at Scale | Economic Growth and Trage
The problem: Banks are hesitant to loan money to entrepreneurs without formal financial histories
An estimated 50 percent of the 2 billion people who live on $2 a day or less run small businesses, but these entrepreneurs face a key roadblock when trying to access finance to expand their businesses. Most banks screen loan applications using traditional financial statements, collateral and past borrowing history; many small and medium enterprises in developing countries, however, simply do not have this kind of formalized financial track record.
Studies show that access to small lines of business credit, particularly for women, improves household consumption and the probability of children attending school— 1.86 percent and 2.4 percent improvement for girls and boys, respectively. But because most lending institutions cannot assess the informal financial activities in which these entrepreneurs are engaged for loan-worthiness, the entrepreneurs are unable to access credit and its associated benefits with the same facility as their wealthier counterparts despite their equal business acumen.
The solution: A new way of assessing credit risk
Unlocking entrepreneurial potential in developing countries requires a new way for banks to screen clients and evaluate risk. Harvard’s Entrepreneurial Finance Lab Research Initiative (EFLRI) does just that with a psychometric assessment tool—a mashup of the SAT, a Myers-Briggs style personality test and a quiz on small business know-how.
In tests over four years in seven countries in Latin America and Africa, the tool was able to predict default as well as or better than traditional credit scoring models. In Africa, the initial research and adaptation of the tool has already started to catalyze private-sector scale-up. Financial institutions on the continent are now lending out over $1.5 million per week based on these tools to small-scale entrepreneurs that would have previously been rejected.
With Stage 2 support from DIV, EFLRI is extending its work to the Muslim areas of the Middle East and Asia, starting in Cairo, Egypt, in partnership with the National Bank of Egypt. It is using the funds to test and adapt the assessment tool to the local contexts, including ensuring Shariah-compliance.
The potential: Cost effectiveness, impacts, and implications
The low transaction cost and reliability of psychometric-based credit scoring should make it a highly attractive approach for banks in developing countries. With banks better able to measure risk for individuals without formal financial histories—cutting default rates by between 25 and 40 percent—they will be more likely to make loans to SME entrepreneurs they previously would have turned away, opening the door for the creation of new businesses, more jobs and economic security.
Check out the EFL-RI website for the latest news and updates
Meet Dr. Asim Khwaja, Priniciple Investigator for EFL-RI
Watch this CNBC video about EFL Global Limited, the independent and private organization that EFLRI researchers helped to create
Last updated: August 31, 2015