Balancing efficiency with inclusivity in microfinance credit scoring
Published Sep 26, 2022 12:05 am
FROM THE MARGINS
Microfinance institutions (MFIs) are strategic partners of the government in achieving financial inclusion. They operate mostly in areas not served by banks, making financial services accessible to the poor, the micro-entrepreneurs, the informal workers and other marginalized sectors. The BSP reported in March that MFIs are present in 84 percent of our local government units (LGUs) while only 69 percent is reached by banks. MFIs, according to Finance Secretary and former BSP Governor Benjamin Diokno, are among the principal drivers of last-mile financial inclusion because they operate in more than half of our unbanked LGUs nationwide.
With worsening poverty, the demand for microfinance services is expected to grow. This presents opportunities and challenges that must be managed well by regulators and industry players alike.
Credit pollution
Microfinance clients are considered risky borrowers, both due to their economic vulnerabilities and the insufficient data on their creditworthiness. With government pushing financial inclusion, more microfinance players and other financial providers are entering the market. This is good, but it also increases the risk of credit pollution. Poor clients could borrow from several MFIs and other financial institutions, like their middle-class counterparts with multiple credit cards. Instead of using loan proceeds for income-generating enterprises, clients may borrow from one MFI only to pay for their loans from another institution. Multiple borrowing could lead to over-indebtedness and high percentage of loan defaults, which is detrimental to both the clients and the MFIs.
Credit pollution became a serious problem in the microfinance industries of India, Cambodia, and other countries. In India, a number of client-borrowers committed suicide, tragic circumstances that negatively affected their microfinance industry.
The Philippines was quick to learn from these experiences, and MFIs bonded together to establish their own credit bureau, called the Microfinance Information Data Sharing Inc. (MiDAS). The MiDAS is the data sharing system that allows Philippine MFIs to submit reports, send inquiries, and retrieve results on borrower information. It addresses adverse selection and moral hazard problems by consolidating and sharing borrowers’ creditworthiness records.
Credit scoring
Credit scoring is a risk management tool used by financial institutions to evaluate clients’ creditworthiness. The MiDAS is part of the credit scoring system handled by the Credit Information Corporation (CIC), the centralized registry of credit data. There are other credit bureaus, like BAPCB, CIBI Information, TransUnion Philippines, and Compuscan Philippines, among others, which are used by commercial banks and other institutions. All MFIs, banks, insurance firms, credit cooperatives, and non-bank financial organizations submit their clients’ credit history to the CIC, for processing into coherent reports for the reference of lenders.
In the past, MFIs relied on the assessment of loan officers who interact with clients on a regular basis. Credit scoring strengthens the process, as it leaves no room for subjectivity and uses quantitative measures of the performance and characteristics of past loans to predict the future performance of similar loans. It quantifies risk as a probability, providing a consistent and explicit means of evaluating loans. It accounts for a wide range of risk factors and gives quantitative evidence on the impact of policy choices, creating efficiency in the evaluation process.
Rehabilitation, not exclusion
MFIs differ from most commercial banks and other financial providers in their treatment of defaulters and analysis of data from their credit bureau. The MiDAS enlists both defaulters and good creditors. Among MFIs, those who miss payments are not called “defaulters” but borrowers-at- risk (BARs). The MFIs do not blacklist them. Instead, corrective or support measures are undertaken to rehabilitate and enable them to repay their loans. By allowing more flexible payment terms, adjusting interest rates, giving technical assistance and other means, BARs are assisted in continuing their businesses and rebounding from financial difficulties.
This approach is consistent with MFIs’ stance that they are not in the business of lending but in the business of poverty eradication. Microfinance credit scoring gives defaulters a chance to bounce back, because if they are not given the chance, the cycle of poverty will just be perpetuated.
Credit bureaus are good, but we need to make sure that they will not lead to financial exclusion. We cannot allow a cut-and-dry situation where everyone with poor credit score will not be given a chance to avail of a loan or be granted another loan (or only given loans at higher interest rates or in too-small amounts hardly enough to start a viable microenterprise). Experience has shown that the poor can save and repay their loans when appropriate credit and savings methodology is applied, i.e., manageable loans, with small weekly repayments spread over six months to one year. In microfinance, the context is as important as the quantitative data.
Financial inclusion is essential to poverty eradication because we need inclusivity for social impact. Credit scoring should complement — not replace or obliterate — current microfinance methodologies. After all, informal and qualitative data from face-to-face visit and client assessment has been a tried-and-tested methodology over three decades of microfinance.
“Scoring cannot displace loan officers and the subjective, one-on-one risk evaluation that has been a chief innovation of microfinance.” - Mark Schreiner
(Dr. Jaime Aristotle B. Alip is a poverty eradication advocate. He is the founder of the Center for Agriculture and Rural Development Mutually-Reinforcing Institutions (CARD MRI), a group of 23 organizations that provide social development services to eight million economically-disadvantaged Filipinos and insure more than 27 million nationwide.)
Microfinance institutions (MFIs) are strategic partners of the government in achieving financial inclusion. They operate mostly in areas not served by banks, making financial services accessible to the poor, the micro-entrepreneurs, the informal workers and other marginalized sectors. The BSP reported in March that MFIs are present in 84 percent of our local government units (LGUs) while only 69 percent is reached by banks. MFIs, according to Finance Secretary and former BSP Governor Benjamin Diokno, are among the principal drivers of last-mile financial inclusion because they operate in more than half of our unbanked LGUs nationwide.
With worsening poverty, the demand for microfinance services is expected to grow. This presents opportunities and challenges that must be managed well by regulators and industry players alike.
Credit pollution
Microfinance clients are considered risky borrowers, both due to their economic vulnerabilities and the insufficient data on their creditworthiness. With government pushing financial inclusion, more microfinance players and other financial providers are entering the market. This is good, but it also increases the risk of credit pollution. Poor clients could borrow from several MFIs and other financial institutions, like their middle-class counterparts with multiple credit cards. Instead of using loan proceeds for income-generating enterprises, clients may borrow from one MFI only to pay for their loans from another institution. Multiple borrowing could lead to over-indebtedness and high percentage of loan defaults, which is detrimental to both the clients and the MFIs.
Credit pollution became a serious problem in the microfinance industries of India, Cambodia, and other countries. In India, a number of client-borrowers committed suicide, tragic circumstances that negatively affected their microfinance industry.
The Philippines was quick to learn from these experiences, and MFIs bonded together to establish their own credit bureau, called the Microfinance Information Data Sharing Inc. (MiDAS). The MiDAS is the data sharing system that allows Philippine MFIs to submit reports, send inquiries, and retrieve results on borrower information. It addresses adverse selection and moral hazard problems by consolidating and sharing borrowers’ creditworthiness records.
Credit scoring
Credit scoring is a risk management tool used by financial institutions to evaluate clients’ creditworthiness. The MiDAS is part of the credit scoring system handled by the Credit Information Corporation (CIC), the centralized registry of credit data. There are other credit bureaus, like BAPCB, CIBI Information, TransUnion Philippines, and Compuscan Philippines, among others, which are used by commercial banks and other institutions. All MFIs, banks, insurance firms, credit cooperatives, and non-bank financial organizations submit their clients’ credit history to the CIC, for processing into coherent reports for the reference of lenders.
In the past, MFIs relied on the assessment of loan officers who interact with clients on a regular basis. Credit scoring strengthens the process, as it leaves no room for subjectivity and uses quantitative measures of the performance and characteristics of past loans to predict the future performance of similar loans. It quantifies risk as a probability, providing a consistent and explicit means of evaluating loans. It accounts for a wide range of risk factors and gives quantitative evidence on the impact of policy choices, creating efficiency in the evaluation process.
Rehabilitation, not exclusion
MFIs differ from most commercial banks and other financial providers in their treatment of defaulters and analysis of data from their credit bureau. The MiDAS enlists both defaulters and good creditors. Among MFIs, those who miss payments are not called “defaulters” but borrowers-at- risk (BARs). The MFIs do not blacklist them. Instead, corrective or support measures are undertaken to rehabilitate and enable them to repay their loans. By allowing more flexible payment terms, adjusting interest rates, giving technical assistance and other means, BARs are assisted in continuing their businesses and rebounding from financial difficulties.
This approach is consistent with MFIs’ stance that they are not in the business of lending but in the business of poverty eradication. Microfinance credit scoring gives defaulters a chance to bounce back, because if they are not given the chance, the cycle of poverty will just be perpetuated.
Credit bureaus are good, but we need to make sure that they will not lead to financial exclusion. We cannot allow a cut-and-dry situation where everyone with poor credit score will not be given a chance to avail of a loan or be granted another loan (or only given loans at higher interest rates or in too-small amounts hardly enough to start a viable microenterprise). Experience has shown that the poor can save and repay their loans when appropriate credit and savings methodology is applied, i.e., manageable loans, with small weekly repayments spread over six months to one year. In microfinance, the context is as important as the quantitative data.
Financial inclusion is essential to poverty eradication because we need inclusivity for social impact. Credit scoring should complement — not replace or obliterate — current microfinance methodologies. After all, informal and qualitative data from face-to-face visit and client assessment has been a tried-and-tested methodology over three decades of microfinance.
“Scoring cannot displace loan officers and the subjective, one-on-one risk evaluation that has been a chief innovation of microfinance.” - Mark Schreiner
(Dr. Jaime Aristotle B. Alip is a poverty eradication advocate. He is the founder of the Center for Agriculture and Rural Development Mutually-Reinforcing Institutions (CARD MRI), a group of 23 organizations that provide social development services to eight million economically-disadvantaged Filipinos and insure more than 27 million nationwide.)