Do the belief, attitudes, and personality of business owners or managers matter in determining the probability of business success and the creditworthiness of the enterprise? And if so, could this “psychological capital” be leveraged as a predictive tool not only for credit appraisal decisions, but also to provide broader support to small businesses? Pioneering work done in Jamaica suggests that it could.
The use of psychometric tools in pre-employment screening is now an established practice among human resource professionals. Applying a similar logic to the identification of entrepreneurs with the capacity and willingness to successfully manage a credit relationship with financial institutions has been gaining traction. This is particularly the case in developing economies, where many small and micro entrepreneurs have limited amounts of capital, and thus are unable to meet the collateral requirements for accessing finance from commercial banks.
The Entrepreneurial Finance Lab (EFL) has tested various psychometric instruments on more than 2,000 entrepreneurs across Africa and Latin America. EFL’s psychometric credit-scoring tool focuses on a psychological profile—the entrepreneur’s attitudes and beliefs, performance, and integrity. This has established the fundamentals for the emergence of the concept of “psychological collateral”—the psychological dispositions that affect business success and probability of loan repayment. EFL has pilot tested this concept in Peru and Haiti with the support of the Multilateral Investment Fund (MIF) of the Inter-American Development Bank Group.
Combining psychometrics with business and credit risk rating
A recent project in Jamaica, by Scotiabank Jamaica and the MIF, has taken the psychometric approach a step further. The Scotiabank Enterprise-Wide Risk Management & Financing (SERMAF) project combined psychometric analysis with a methodology for business and credit-risk rating originally developed for micro and small businesses in a previous project done by Scotiabank Jamaica and the MIF. This was the first attempt to introduce a specially designed risk-rating measure for micro, small, and medium-sized enterprises as an assessment tool for lending to this sector in Jamaica, and by extension, the Caribbean.
Using this broader combined approach, SERMAF collected data from 1,008 businesses in a random sample, which as it turns out provided a window into the overall strengths and weaknesses of these businesses. In addition to being significant in helping to define their creditworthiness for Scotiabank financing, and the probability of loan repayment, the data was also useful in determining the efficiency and competitiveness of each business relative to the mean of the normal distribution calculated from the data.
The analysis conducted in Jamaica revealed the following findings:
The psychometric indicators proved particularly important in predicting the possibility of negative earnings, and therefore business risk.
From the sample, more than 600 businesses were rated for creditworthiness, and of these, 100 were rated as the most efficient.
The survey results showed that only a third of top-performing businesses were women-owned. The psychometric data suggests that there are gender differences in the attitudes and beliefs of female and male business owners, and that these differences matter in determining the competitive efficiency and creditworthiness of the business. One example is that female entrepreneurs generally tend to be more risk averse and therefore adopt more elaborate decision-making and internal control protocols.
While this analysis was done on a relatively small scale, mainstreaming this effort to the broader population of small businesses will not only provide useful data on the sector, but also can form the basis for targeted financial and technical support to small businesses to further improve their operational performance and efficiency. Since the analysis facilitates the targeting of dynamic firms, tailor-made programs beyond just financing can be designed to take these businesses to the next level.
Furthermore, this process could be useful in fostering innovation at the business level to drive economic growth. This methodology can be used to determine the extent to which small businesses either use or possess intellectual property assets, such as patents or trademarks, to ultimately support and drive innovation at the sector level. In Jamaica, entrepreneurs are coming up with game-changing innovations and working to bring them to market. For example, Jamaica-based Revofarm has developed a mobile application to connect farmers to markets and the company has teamed up with U.S.-based company aWhere to deliver weather information to small farmers.
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