EFL uses psychometrics to give entrepreneurs access to bank loans

One of the greatest challenges for almost every entrepreneur worldwide is access to financing.

There’s a very logical reason for why this is the case: loans — at least those from traditional institutions such as banks — are given out based on a number of metrics such as credit rating, financial records, proof of income, collateral — basically historical evidence as to whether someone has the ability to pay back a loan.

But entrepreneurship, by its very nature — building a new venture, means that many entrepreneurs around the world, specifically those in developing markets, do not have such records.

This leaves those entrepreneurs, especially those whose business is done in the informal sector (or at least started there), at a dead-end in terms of accessing finance.

This is the gap that the Entrepreneurial Finance Lab (EFL) finds itself filling — that of financial inclusion for the previously excluded.

EFL’s mission is to “unlock the entrepreneurial potential of the developing world by equipping banks with better tools to measure risk.”

In short, the company provides entrepreneurs and SMEs access to working capital loans from formal financial institutions (i.e. banks) thanks to a proprietary credit application that uses psychometrics to measure risk. It sounds like a mouthful, but psychometrics is the same technique used in pre-employment screening, and in EFL’s case it measures entrepreneurs’ willingness and ability to a repay a loan.

The video below might make it clearer:

EFL began as research conducted by co-founders Bailey Klinger (a then PhD student at Harvard’s Center for International Development) and Asim Khwaja, a professor at the Harvard Kennedy School, while they were participating in the CID South Africa Growth Initiative back in 2006. The research caught the eye of co-founder DJ DiDonna, who came over from the the Harvard Business School to help launch the company.

After an initial pilot in Kenya, where the partner bank was able to increase lending by 174% while maintaining its target default rate, EFL broke off as an independent business in 2010 and began to work with more partner banks across Africa, Asia and South America.

On the ground

The applications are issued out in the field by EFL-trained bank members, and evaluates an entrepreneur’s business skills, ethics and honesty, intellect as well as attitudes and beliefs.

The EFL application takes roughly 45 minutes, and can be taken offline, on a PC or on a tablet. The answers from the application are used to build a three-digit credit score that the bank can use to inform its loaning-decision.

Interestingly, EFL’s algorithms are created from its global database of (currently) around 100 000 applications and are self-learning. This means that with every application, new data is put back into the EFL system, theoretically making it smarter and more predictive. Of the 100 000-odd applications, about 45 000 have come from Africa.

Colin Casey, EFL Account Manager Africa, tells Ventureburn that an EFL application is taken somewhere in the world every 10 minutes.

The applications are roughly the same worldwide, but are calibrated, says Casey, according to “market specific models using local data”.

So while questions might be the same in different parts of the world, the weighting and distribution is adjusted regionally, as well as the way in which the data is interpreted.

Casey states that since inception, EFL has helped partner banks disburse more than 50 000 loans worldwide, totaling US$265-million in working capital to date. Furthermore, partner banks have lowered default rates by up to 40% while increasing their lending to SMEs three-fold.

Financial Inclusion

In practice partner banks are not using EFL as a replacement for traditional credit scoring, but rather as an aid that can help them make smarter loaning decisions. This expands partner banks’ Micro, Small and Medium Enterprises (MSME) portfolios while helping improve control over risk.

EFL’s value-add is seen both for corporate-focused banks looking to move downwards into the SME space as well as smaller micro-lending banks who are looking to move up into the SME space, as Casey states, “from both sides we provide value.”

Casey adds that EFL is most often used to “graduate micro borrowers up the ladder to bigger loans they couldn’t access otherwise.”

EFL’s numbers are impressive so far, but even more so is its mission-statement: to provide financial inclusion to the un- or underbanked. If entrepreneurship is the tool to help fuel economic growth in developing markets, then EFL is the grindstone.