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1
Small Business Credit Scoring
An Empirical Analysis of the Viability of Pooled Data SME
Scoring Models in Latin America
Presented at the Conference on Small and Medium Enterprises, Washington, D.C., Oct. 15, 2004
Margaret Miller
2
Project Objective
To determine if pooled data SME credit scoring tools, which have proved very successful in the U.S. and in a few other select markets, could be developed for large emerging markets in Latin America
3
Relevant Literature on Credit Reporting
Credit reporting can facilitate access to credit Positive relationship between private credit /
GDP and credit reporting (Doing Business) Credit reporting reduces credit constraints on
firms (Galindo & Miller 2001, Love & Mylenko 2003)
Credit reporting reduces the impact of bank concentration on access to finance (Beck, Demirguc-Kunt & Maksimovic 2004)
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Relationship Lending in the Small Business Credit Market
Old paradigm – SME loan market focuses on relationship lending (Petersen & Rajan 1994, Berger & Udell 1995, Miller 1995)
New paradigm – SME loan market segmented with local lenders employing relationship lending technologies and national lenders using automated scoring (Petersen & Rajan 2002, Dell’Ariccia & Marquez 2003, Hauswald & Marquez 2002, Brevoort & Hannan 2004)
Newest paradigm? Many lenders using both technologies?
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Literature on Small Business Credit Scoring (SBCS)
Large banks in the U.S. were more likely to adopt SBCS first (Akhavein, Frame & White 2001)
U.S. banks that adopted SBCS increased their SME lending by 8.4% on average – about $4 billion in increased lending per institution (Frame, Srinivasan & Woosley 2001)
Increased lending volumes from SBCS served to increase access to marginal or riskier borrowers (Berger, Frame & Miller 2002)
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Significant Increase in Number of SME Loans Extended in U.S. Since Introduction of SBCS
U.S. Commercial Lending, Dollars in billions, numbers in millions
2003 2002 2001 1999 1997 1995Value of Loans < 100k 125.7 128.9 126.8 113.9 108.2 100.4Number of Loans 14.1 15.7 10.8 7.7 6.7 4.9
Value of Loans < 250k 224 225 218.4 195 178.8 163.9Number of Loans 14.9 16.5 11.6 8.4 7.4 5.4
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Small Business Scoring Still Limited in Developing Countries
Only largest financial institutions have adopted SBCS Have funds to invest in expert or custom models View SBCS and their SME portfolio data as key
elements of their competitive edge Lenders are reluctant to share data, especially
on the SME market segment; not used to working in common for a pooled model
Difficult for external technology providers to create consortiums
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Deficiencies in the small business lending
Identify improvements in the banking and lending industry to allow small businesses growth and development Manage overall portfolio risk Streamline operations for increased cost efficiencies Increase number of profitable relationships Identify predictive data elements to analyze the credit risk
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How scoring technology can help the lenders?
Reduces cost by increasing efficiency and speed Make consistent ranking of risk and objective
decisions Accurate risk prediction
Majority of risk identified at origination!
Competitive edge Faster response times Better risk assessment
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Small business definition- United States
Annual Sales of up to $5 million Credit of up to $250,000 Types of Small Businesses:
Sole Proprietors Partnerships Corporations
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Small Business Scoring Service (SBSS) in the United States
Fair Isaac partners with Robert Morris Associates (RMA) 17 banks each contribute 100 goods, 100 bads, 100
declines Precoding sheets filled out by hand Paper credit bureau reports
Fair Isaac data entry staff creates electronic database 1995 - Fair Isaac SBSS releases the first empirically
derived commercial scorecards
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Small Business Pooled Models Improvements
Over 250,000 small businesses contributed by 25 banks Data extracted electronically from application processing and
master billing file systems 100% availability of consumer bureau information
Business data provides increase in predictive power Application, Business reports, Financial statements
2001 - Fair Isaac releases second generation of commercial scorecards
Currently building the New Small Business Pooled Models
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Small business scoring pooled models in Asia
Pooled Models in Japan Over 3,500 small businesses contributed by 13 banks Data transferred from application processing and master
billing file systems and availability of consumer bureau information
Business data provides increase in predictive powerApplicationFinancial statementsDemographic information
Currently building pooled models in Hong Kong
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Definition of Small Business in Latin America
COLOMBIA Number of Employees up to
200 Annual Sales of up to $1
million Credit of up to $200,000 Types of Small Businesses:
Sole Proprietors Partnerships Corporations
MEXICO Number of Employees up to
100 Annual Sales of up to
$500,000 Credit of up to $200,000 Types of Small Businesses:
Sole Proprietors Partnerships Corporations
There is no consistent definition between lenders in Latin America.
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Distribution by business activity
30%
16%
7%
8%
11%
8%
2%
18%
COLOMBIA MEXICO
48%
9%
4%
15%
1%
12%
3%
8%
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Acceptance and booked rates
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
Colombia Mexico
Acceptance Rate
Booked Rate
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Distribution of delinquencies
0.0%
0.5%
1.0%
1.5%
2.0%
2.5%
3.0%
Colombia Mexico
One Cycle
Two Cycles
Written Off
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Pooled data development sampling
A random representative portion of accounts with known payment behavior plus declined accounts
Data provided by all institutions participating in the pool
Predictive information and performance information
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Data sources - Personal information about principals
Application Financial information Consumer credit reports
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Value of dataHighHigh
BusinessBusinessPersonalPersonal
Size of CompanySize of Company
LowLow
Small Large
Valu
eVa
lue