At noon on a Sunday in Lima, more than 170 bankers from the Latin American and Caribbean region were in a conference room to attend a panel discussion on a new risk analysis tool for small and medium enterprises (SMEs), resisting the temptation to go out and enjoy fine Peruvian cuisine. It was encouraging.
The panel discussion, titled “Revolutionizing the financing of small and medium sized enterprises: The decision of banks to base their risk analysis on psychometric parameters,” was organized by the Multilateral Investment Fund (MIF) and the Financial Markets Division of the Structured and Corporate Finance Department of the IDB Group, as a part of the XLVI Annual Assembly of the Federation of Latin American Banks (FELABAN), held November 17-20, Lima.
The panel featured an innovative risk analysis tool developed by the Harvard University Entrepreneurial Finance Lab (EFL), which we believe is a breakthrough approach to helping financial intermediaries expand their loan portfolio among SMEs. Many SMEs, especially small but growing ones, in the region don’t have audited financial statements, sufficient collateral and longstanding credit history; and therefore are not eligible for traditional bank loans despite their potential for growth.
Based on its academic research, EFL identified a significantly high correlation between the loan repayment rates and the personal traits of entrepreneurs. To filter-in such entrepreneurs who otherwise would not be qualified for loans due to the reasons described above, but consistently demonstrate personal traits that are predictors of becoming successful business owners, EFL created an innovative risk analysis tool based on psychometrics.
The tool evaluates the business loan applicant’s personality, intelligence, business skill and ethics, to predict his/her future repayment capacity. With this tool, EFL was awarded as one of the winners of the G-20 SME Finance Challenge. EFL rolled out and scaled up the implementation of the tool in Africa, partnering with Standard Bank. The MIF is now providing technical assistant grants to financial institutions in Latin America and the Caribbean that wish to be pioneers in implementing this tool for SME risk analysis. So far, institutions from six countries (Brazil, Costa Rica, Guatemala, Haiti, Mexico and Peru) have confirmed their interest in participating in the MIF grant facility.
The high interest among the participants of the FELABAN Annual Assembly in learning about the EFL tool is consistent with the findings of the 5th regional survey in the LAC region on current status and trends in bank lending to SMEs, which integrates the views of more than 100 banks in 20 countries in the region. The survey was commissioned by the MIF, SCF, the Inter-American Investment Corporation and FELABAN, and conducted by D’Alessio, an Argentina-based consulting firm.
The survey reveals that 96% of banks consider SMEs as a strategic area for their business. The importance of the sector is also reflected in the fact that the vast majority have a specialized area or management line exclusively dedicated to the SME segment. And, 77% of financial institutions expect to see their SME loan portfolio grow relative to their total portfolio for 2012.
Why such a high interest in SME finance?
Higher profitability vis-à-vis the other lines of business. In spite of the precarious situation of the global economy, 62% of banks foresee a more prosperous future for SMEs for the next two years. But, a striking finding is that banks are interested in providing financial products and services to SMEs because of the role the segment plays in the national economy and community development, rather than the expected higher profitability.
Despite the increased importance placed on the SME segment, the same poll shows that nearly half of the banks surveyed respond that the participation of SMEs in their portfolios represents only 20% or less. The results of the survey show that the low penetration of banks in the SME segment is partly due to the difficulty of analyzing credit risk with traditional tools which are based on the collateral and credit histories that SMEs often lack.
Now it’s clear why the panel discussion attracted such a big number of participants.
It should also be noted that this year’s survey incorporated, for the first time, questions about the participation of women-led SMEs in the portfolios of the banks interviewed. Recognizing the segment of women entrepreneurs as an untapped market niche, in April 2012 the MIF and SCF launched a new initiative called "women entrepreneurshipBanking (weB)", which aims to help financial institutions implement funding models that support the growth of women-owned businesses, with combination of instruments such as lines of credit, partial credit guarantees, risk sharing mechanisms and technical assistance.
We will soon start structuring the questionnaire for the next round of our annual banking survey on SME finance. Any comments and suggestions for improving the questionnaire, especially regarding new and innovative lending methodologies and women-owned businesses’ access to finance, are welcomed.