The Inter-American Development Bank (IDB), a multilateral institution financing development efforts in Latin America, recently released an article arguing that psychometric testing can be used by financial institutions to reduce defaults on loans by 20 to 40 percent, increase profits by 15 to 30 percent and reduce operational costs associated with traditional credit evaluation and due diligence by approximately 60 percent.
These numbers are based on a study of a form of psychometric testing developed by the Entrepreneurial Finance Lab Research Initiative, a program developed at US-based Harvard University that is dedicated to evaluating “the impact of psychometric screening tools and alternative financial contracts on access to finance and entrepreneurial growth” in developing countries. The test consists of 150 questions measuring potential borrowers’ “intelligence, business skills, personality, ethics, character, and beliefs.” This information is used to generate a score that is meant to indicate potential borrowers’ willingness and ability to repay a loan. The testing “costs little” and has been implemented by financial institutions in 11 African countries and two countries in Latin America.
Various pilot projects implementing psychometric testing have compared the scores of tested borrowers and their actual business performance and repayment rates. According to IDB, these projects have found that the test is an accurate and cost-effective predictor of creditworthiness.
Some of the pilot projects have been conducted under an IDB facility funded with $25 million as part of beyondBanking, an IDB program intended to promote sustainable banking principles and practices in the Caribbean and Latin America.
By Makai McClintock, Research Associate
Sources and Additional Resources
Entrepreneurial Finance Lab Research Initiative Website:
http://www.hks.harvard.edu/centers/cid/programs/entrepreneurial-finance-lab-research-initiative
Inter-American Development Bank, “Providing Credit to Latin America’s ‘Missing Middle’,” http://www.iadb.org/en/news/webstories/2013-04-30/pychometric-testing-to-assess-sme-creditworthiness,10437.html
Inter-American Development Bank, “New IDB Facility to Allow Latin American Banks to Boost Lending to Small Companies,” http://www.iadb.org/en/news/news-releases/2012-11-08/latin-american-banks-downscaling-facility,10199.html
MicroCapital Story, February 26, 2013, “MICROCAPITAL EVENT: Making Cents International to Host Global Youth Economic Opportunities Conference, September 10-12, 2013, Washington, DC, US,”
https://www.microcapital.org/microfinance-event-making-cents-international-to-host-global-youth-economic-opportunities-conference-september-10-12-2013-washington-dc-us/
MicroCapital Story, December 18, 2012, “MICROCAPITAL BRIEF: Inter-American Development Bank to Allow Public to Select Programs Seeking to Improve Financial Inclusion for People with Disabilities in Latin America and the Caribbean,”
https://www.microcapital.org/microcapital-brief-inter-american-development-bank-to-allow-public-to-select-programs-seeking-to-improve-financial-inclusion-for-people-with-disabilities-in-latin-america-and-the-caribbean/
MicroCapital Story, October 25, 2011, “MICROCAPITAL BRIEF: Inter-American Development Bank (IDB) Group’s Multilateral Investment Fund (MIF) to Loan $7m to Root Capital and Microfinance Institutions FIDERPAC of Costa Rica, ASDIR of Guatemala; Announces $7m Equity Investment in CoreCo Central America I Fund; Rolls Out Psychometric Risk Assessment Tool,”
https://www.microcapital.org/microcapital-brief-inter-american-development-bank-idb-group%E2%80%99s-multilateral-investment-fund-mif-to-loan-7m-to-root-capital-and-microfinance-institutions-fiderpac-of-costa-rica-asdir-of/
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