SME credit scoring : key initiatives, opportunities, and issues

Abstract

Small and medium enterprises (SMEs) comprise a substantial part of the economic activity of both developed and developing countries. In the U.S. SMEs employ about 55 percent of the workforce and contribute over half the Gross Domestic Product (GDP). In developing countries, the role of SMEs is often relatively greater. For example, in Latin America, the vast majority of firms are micro or small enterprises and they employ approximately two-thirds or more of the labor force. Access to finance by small firms is a common problem and tends to be especially acute in developing countries. There are many causes for this including the cost and difficulty of evaluating the credit worthiness of small firms. Credit scoring tools are widely used in consumer credit markets to reduce the time and costs associated with loan evaluations but only recently have begun to be used for small business lending. Given the success of small business credit scoring (SBCS) in the developed world, commercial banks as well as the World Bank and other multi-lateral development agencies have been working to adapt the technology for use in developing country markets. This article evaluates what SBCS is, and is not, and discusses some of the potential benefits from adoption of SBCS tools. In particular, the role of pooled data SBCS models is discussed, as they may provide a cost-effective approach to adoption of this technology in some emerging markets. Actual experiences of banks in both the developed and developing world with SBCS tools are also presented, to highlight the advantages of a SME lending strategy involving SBCS as well as existing constraints and limitations to greater reliance on scoring tools.