Credit Scoring Vs Personalised Lending

In India, all banks have internal credit scoring models and it has not helped them in lending to SMEs.

Two key reasons why banks (formal lending institutions) do not lend to SMEs in India are
a.) Lack of information on actual profitability/cash flows. No official documented evidence of income can be found. This is primarily in keeping with practice of dealing in cash, belief in oral contracts and mostly absence of contracts (sale/purchase) altogether. In addition, the myopic tendency to avoid taxes leads to minimal documentation or under-reporting of incomes. If no concrete data is found, what do the bank feed into their credit scoring models?

b.) Small ticket size and hence high operating expense per loan. Ideally a credit scoring model reduces the high opex of small loans by taking an automated call on whether to do a loan or not without having a credit person go through the case in detail as he is expected to do in larger loan ticket sizes. But, then, for these kind of small loans with no concrete data, what does one feed into the credit scoring model? Subjective evaluations of the credit appraising officer?

It is undisputed that the effectiveness of a credit scoring model is dependent upon the quality of data being fed. However, since the quality/reliability of data that is available to be fed into the credit scoring model is poor and subjective, especially in case of SMEs in India, how does one use a credit scoring model? In fact, due to high level of subjectivity, the data being fed into the credit scoring model can jeopardise the credit scoring techniques.

Credit scoring models can speed up process but they can not replace personalized diligence based lending till the time good data is available. There is barely any electronic footprint left by SMEs that can be dug up for credit analysis. The bank account (if available) details wouldn’t show enough balance, their transactions would be fairly thin. Understood that visiting the customers for a small ticket size loan results in high opex but in the case of SMEs where transactions are primarily cash based, expecting to lend to customers in the SME segment without meeting the customers, suppliers, buyers of the SME and without visiting the location is a recipe for disaster.

A few new age lenders are depending upon use of surrogates/proxies for assessment of actual cash flows, followed by close monitoring of loans. They depend exceedingly on customer visits. Their portfolios have performed well but yes, it is too early. While it is not free of subjectivity, this approach seems to be better than that of large banks who use an inflexible credit scoring model based on documented data. I agree that the rate of growth in such kind of specialized lending may not be as fast as mainstream financial institutions till the time sufficient electronic footprint is generated by the target SMEs. Meanwhile, using some form of credit scoring models in parallel can add a layer of check over the existing rigorous personalized appraisal procedure. This helps in reducing the impact of subjectivity in the personalized lending processes.

Credit scoring models are needed. The critical question that we need to answer today is, how do we improve the quality of data available to be fed into credit scoring models? If not immediately, how do we build the right data backend that provides high quality data in the future?

According to me, this kind of data backend will have two components, one that deals with general data points which can be used for bench marking and two that deals with individual specific data points that further become a part of the general database:

a.) Benchmarking: A good data backend can actually be a like a platform where location specific details on various businesses and margins are fed by staff of lenders. Over a period of time and volume, these numbers will give adequate guidance on the claims of margins/profitability made by the potential borrowers. Once the coverage of data collection efforts improve with time credit scoring models can play a better role.

b.) For individual evaluation: Individual credit/liability histories need to be pushed into this data back-end. Electricity bills, mobile phone bills, credit bureau details, need to be automatically fed or fed based on requests. The question is will the respective companies share data? Will a mobile company share prepaid recharge data of a customer?

Once this is done over a period of time, I believe a credit scoring model will start making more sense for SME lending in India. However, ditching personalized lending altogether, would continue being a distant dream for a fairly long time, if not for ever.

The approach can not be Credit Scoring VS personalized lending. The approach instead has to be Credit Scoring AND personalized lending.

Impact Measurement

In the recent times, there has been a lot of discussion on social performance measurement. From CSR initiatives to charity foundations and from investors to social enterprises, everybody has either adopted or has been talking about adopting social performance measurements.

At the same time there is a group of people who think it is all a fad with complicated measurement systems trying to “measure” qualitative factors which are extremely difficult to quantify and hence extremely subjective. How do you measure “well-being” for instance?

The answer lies in the fact that we have to find proxies that indicate well-being. For instance- number of times the person has fallen sick in the last 6 months. This is just a simplified indication of what measuring is about. The job of finding the right proxies is critical and often learnt from experience. We should not land up with a wrong proxy and try to push results in that direction doing much disservice to the actual intent of the social programme or enterprise.

We need to identify a simple verifiable metric and we have to track it in regular intervals beginning with the baseline.

The metrics must be simple to track but verifiable and the tracking methodologies should not be so expensive that it doesn’t justify the the measurement & verification process altogether.

My career has revolved around the issue of “Income Generation” either through providing technology support, training to small entrepreneurs or through providing access to finance. I keep thinking how I can measure the impact of the work that we do on small entrepreneurs.

What could be that one metric that I could measure to keep understand the impact?

I think the primary indicator to keep track of is “Asset” build up. Assets could be land, building, an additional room in the house, a cow or a a vehicle bought with own money. It is easy to verify and track. In cases where it is part funded by loans, we can find out if his last few repayments were made on time.

What do you think?