Importance of Credit Bureaus in Microfinance – Part 1

Credit Information Bureaus (CIBs) are a somewhat new agenda in microfinance, even though they have been an integral part of traditional finance for decades. Quantitative data (income sources, cash flow repayment rate, number of outstanding loans, etc.) used for credit risk scoring of microfinance clients is vital considering the growth rate of the sector as well as the booming competition within. Obstacles related to credit reporting in this high-touch model must be swiftly overcome in order to leverage the huge benefits credit scoring has to offer in the microfinance context.

Four Benefits of Credit Scoring for Microfinance Clients

Microfinance clients stand to gain a lot through the installation of credit rating systems. Here are four benefits:

1. Quick service

Credit bureaus can efficiently provide access to information needed to sort out high-risk clients from low-risk clients. Automation of the loan approval process significantly reduces the time taken to evaluate loan applications, thereby saving the client’s time, which may be better invested in the actual business. The quicker the loan is approved, the quicker the client may start his/her business project.

2. Better financial discipline

Credit scoring mechanisms penalize microfinance (high-risk) clients with poor repayment histories and reward microfinance clients with good credit discipline. Default-prone clients are subjected to unfavourable loan conditions (smaller size, higher interest rate, frequent repayment schedule, etc.), while low-risk clients are eligible to avail favourable pricing structures and better customer service. In other words, credit scoring helps encourage microfinance clients to adopt prudent financial management practices (such as prompt repayment, avoidance of over-indebtedness, reduce chance of personal bankruptcies, etc.) which improve their credit report.

3. Access to more options

Credit bureaus centrally store information about all microfinance clients in a country and this data can be universally accessed by different microfinance institutions. As a result, clients can easily apply for microcredit in different towns or cities and this ‘frictionless transferability of borrowers’ increases the range of MFIs clients can approach (which also encourages MFIs to be more competitive).

4. Fair selection process

There is always a possibility that loan officers manipulate client information in order to favour certain customers, or that loan officers mistakenly refuse credit to valid applicants. This possibility of nepotism and false negatives is greatly reduced if quantitative, non-subjective data is systematically analysed to arrive at a credit score.

Four Types of Benefits of Credit Scoring for Microfinance Institutions

It goes without saying that microfinance institutions benefit if their clients benefit; however, apart from that indirect advantage, credit bureaus benefit MFIs in four areas.

1. Financial benefits

Credit bureaus impact financial statements in three ways: firstly, owing to the theory of economies of scale, credit bureaus reduce the transaction cost of credit risk assessment; secondly, because of efficient loan processing and universal access to client information, microfinance institutions can advance more loans to clients, thereby increasing sales; and thirdly, the microcredit pricing structure is optimized as per client risk (i.e. interest rates and provisioning for bad debts can easily be varied according to the client’s credit score).

2. Risk Management

Credit scoring systems essentially help microfinance institutions manage credit risk, whether the end result is risk mitigation or avoidance. Keeping in view in-depth knowledge of client’s credit histories, high-risk clients may be accepted and put through certain processes to reduce risk exposure.

For instance, client with high outstanding balances can be asked to submit their repayments more regularly, may be monitored more frequently, or may be accepted for small loan sizes only. Greater analysis of a high-risk profile may reveal certain low-risk characteristics (such as promising business plan, expected bumper crop in the next season) that balance out the overall profile and make the client eligible for favourable terms.

As mentioned earlier, the quantitative analysis of risk reduces the chance of mistakes, and this automated risk assessment is carried out at comparatively lower costs.

…cont.

The next post talks about two other benefits MFIs stand to gain through credit scoring systems, as well as the macro-level advantages of microfinance credit bureaus.

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