By Lucy Conger


Bankers are seeking out microbusinesses and self-employed entrepreneurs these days for a simple reason: in developing countries, they represent an enormous market crying out for financing, and these businessmen and -women have proved to be solid credit risks. “When we looked around, we became aware that microenterprises were the majority segment,” making up over 70 percent of the work force, says Danilo Chavez, operations and finance manager for Solución, the arm of Banco de Crédito del Perú that serves nonconventional banking customers.

Lending to self-employed businesspeople, whose earnings are often unpredictable, presents a host of challenges for banks such as Solución, which grants loans averaging a modest US$1,300, and Banco del Trabajo del Perú, with 100,000 microentrepreneurs among its client base. Peru had no credit bureau that Solución or Banco del Trabajo could turn to when they began their microfinance operations.

Both banks have focused on developing loan evaluation methods to reduce their risk and shorten the time-consuming credit assessment process of clients with no formal jobs and irregular income who are hard-pressed to offer conventional guarantees. Each of the banks has adapted some of the techniques of credit scoring, a method that reduces administrative costs and has been used in wealthy countries to predict risk based on clients’ performance on past loans.

Solución has adopted a number of tactics to address the difficulties of managing loans made from 27 offices in Lima and scattered across 20 of Peru’s provinces. “We hired as quickly as possible staff from the cajas municipales (municipal savings and loan associations), and we bought their know-how,” says Chavez. That move gave Solución a force of loan officers experienced in microlending.

Several formulas are used to prevent over-indebtedness by borrowers. Solución loans up to the value of one month of sales and controls the repayment schedule so that monthly payments are no more than 30 percent of monthly profits.

The Solución adaptation of credit scoring centers on its database, which contains the track records of good clients during the previous three years. Using these records of loan repayments and arrears, Chavez says, the bank is generating a profile of a good client who repays reliably and a bad client who is a credit risk. The point system also distinguishes self-employed entrepreneurs from workers holding steady jobs.

Solución’s policy is to grant smaller loans without a full credit analysis, deploying loan officers only to verify the existence of the business. For larger loans, the officers inspect the business to make sure cash flow is sufficient to meet the repayment schedule and cover other costs. The credit scoring will reduce the bank’s operating costs by eliminating the need for many of the on-site visits.

Banco del Trabajo del Perú opened its doors in 1994 with the objective of serving people in the lower income brackets. “With an income of US$100, you’re a client,” says Carlos Fernandez, former central sales manager from Banco del Trabajo.

The bank adopted a cautious approach. It initially lended only to workers with steady jobs and made starting clients with small loans that were subsequently raised to higher amounts after timely repayment. Rather than give loans, Banco del Trabajo offers a line of credit so that when the client repays, another “loan” is granted for the same amount, Fernandez says.

The bank adopted a new way of evaluating loans based on the “total separation” of the sales force from the loan officers, says Fernandez. The officers have learned how to evaluate the microenterprises, even though the loan applicants typically keep no records and rarely declare their real income. “We are seeing only a piece of the business,” he says. With training, loan officers have learned how to assess the microentrepreneurs’ real income, cash flow and payment capacity.

With experience, Banco del Trabajo has created its own credit-scoring system, which rates variables such as age, sex, marital status, number of children, occupation and whether the client owns property and a telephone. Scoring has shown that the best credit risks are clients who have been in the same line of work for more than five years and who own property. Women are better payers than men, especially women over 40. And microentrepreneurs who produce or trade basic necessities have better repayment records than those who work with seasonal products. Scoring favors microentrepreneurs who are producers and disfavors vendors and merchants, reducing their eligibility for loans.

These experiences in Peru reflect a trend toward adopting credit scoring, which is expected to be the next important technological innovation in microfinance, says Mark Schreiner, a professor of social work at Washington University in St. Louis, Missouri. However, microfinance institutions must beef up their technical capacity if scoring is to succeed.

Credit scoring requires a computerized database on the characteristics of clients; their loans; and the length and amount of each default, says Schreiner. Microfinance scoring models could predict the risk—and the length—of default; the probability that good clients would not seek more loans; and even the potential profitability of a client to the lender. These models would help the microfinance institution set special interest rates for riskier loans, determine when to visit risky borrowers and create incentives for good clients to borrow again, he says.

The use of scoring has led to some interesting findings. In Bolivia, a borrower with a past record of 15-day arrears is likely to repeat the pattern, and a first-time borrower is a slightly higher risk than a second-time borrower. In Colombia, a loan with a greater number of installments is more likely to fall into default, according to Schreiner’s research. Information such as this can reduce risk and show the lender how to structure loans for the best results.

While the banks have been working to lower their credit risk, lending to microentrepreneurs does just that. “This segment in times of recession performs better than medium and large businesses,” says Chavez. This is because larger companies are saddled with fixed costs which compel them to take on debt that becomes burdensome during downturns.

Microenterprises have no fixed costs; they have the flexibility to reduce costs and can adjust their work force by enlisting family members in times of need; and they can benefit during economic downturns as consumers demand the less expensive products made in rustic workshops. However, the microenterprise sector is vulnerable to inflation and the “monetary illusion” it brings, cautions Chavez. Micro and small businesses sell at one price but tend to forget that they will have to replace their inventory with goods they buy at a higher price.

Beyond the economic reasons that explain why microentrepreneurs make good borrowers, there is a psychological motive that reduces risk to banks. “They show a very good credit performance; they are people who value greatly their credit rating,” says Guillermo Zarak, general manager of Solución.