Can Credit Scoring Help Attract Profit-Minded Investors to Microcredit?

Microcredit is uncollateralised cash lending to the self-employed poor.1 The central challenge of microcredit is to manage the risk that a client will behave “badly”, whether by defaulting, paying late, or not returning for repeat loans. Indeed, microcredit was founded on two innovations that reduce the cost of managing these risks: joint-liability groups and skilled loan officers’ careful evaluations of an individual applicant’s business, chattel, and character. Outside microcredit, wealthy countries developed a third risk-management innovation. Scoring relates the risk of behaving “badly” with indicators associated with the borrower (for example, type of business and debt/equity ratio) and the loan (for example, amount disbursed and number of installments). With sufficient data and care, scoring predicts risk more accurately and less expensively than nonautomated methods. Moreover, scoring explicitly quantifies risk as a probability (for example, a 17 percent risk of reaching 30 days of arrears). Research shows that scoring increases not only profits but also the number of clients and the number of poor people who become clients. In general, scoring improves risk management, leading to a cascade of benefits.