March 2023 EVENING THE CREDIT SCORE: CAN PSYCHOMETRIC CREDIT-SCORING ADDRESS COLLATERAL ABOUT THIS STUDY CONSTRAINTS FOR WOMEN ENTREPRENEURS? This impact evaluation was conducted by the World Bank’s Africa Authors: Salman Alibhai, Rachel Cassidy, Menaal Ebrahim, Markus Goldstein, Yemsrach Kinfe Edey, and Sreelakshmi Papineni Region Gender Innovation Lab, under the Innovations in Financing Women Entrepreneurs (IFWE) initiative. KEY MESSAGES The Africa Gender Innovation Lab • Psychometric credit scoring measures traits linked to a borrower’s conducts impact evaluations and ability and willingness to repay a loan. Psychometric credit scoring rigorous research to figure out what can enable lenders to reach borrowers who lack formal credit histories, works and what does not work or large, fixed assets to secure loans. An experiment in Ethiopia sought to improve gender equality, and uses this evidence to shape policy. to understand whether unsecured, psychometric-appraised loans could Funded by Global Affairs Canada, improve access to finance and unlock business growth for women IFWE works in partnership with World entrepreneurs. Bank Group operations to pilot, scale • Psychometric-appraised, uncollateralized loans were found to up, and evaluate new approaches to empowering Ethiopia’s female alleviate credit constraints for women entrepreneurs. Women entrepreneurs. IFWE works across entrepreneurs in a randomly assigned treatment group were offered an three components: business skills uncollateralized loan based on a psychometric credit score. After three and services, access to finance, and years, these women were more than twice as likely to have accessed a policy evidence. loan for their business, compared to similar women entrepreneurs in a control group who were not yet offered the uncollateralized loan. The project was a partnership with the World Bank’s Finance, • Access to psychometric-appraised loans increased the likelihood Competitiveness and Innovation of firm survival through the COVID-19 pandemic and other shocks. Global Practice; the Government of The firm closure rate within three years halved: from 33% of firms closing in Ethiopia’s Women Entrepreneurship the control group, to 17% of firms closing in the treatment group. Impacts Development Project (WEDP); the of the psychometric-appraised loans on firm sales and profit growth were Ethiopian microfinance institution Wasasa; and the Gender Innovation less conclusive. Policy Initiative for Ethiopia. • Psychometric-appraised lending can be a viable and impactful The full working paper from this solution for entrepreneurs who lack collateral. The benefits of impact evaluation can be found here. psychometric-appraised lending may naturally extend to poorer borrowers in general—and thus to broader reduction of inequality in credit markets. https://www.worldbank.org/en/programs/africa-gender-innovation-lab CONTEXT FIGURE 1: EXAMPLES OF PSYCHOMETRIC TEST QUESTIONS Despite gender parity in access to microfinance, and many group-based microfinance schemes favoring women, women face more difficulty than men in getting loans of larger size, longer duration, individual liability, and more flexible terms that may promote firm growth.1 In Ethiopia, as in many contexts where credit information systems are in their infancy, financial institutions typically impose stringent collateral requirements for larger loans. Women are less likely than men to own large, collateralizable assets such as housing, land, or vehicles due to inheritance practices, unequal land ownership laws, and social customs. Innovative solutions to replace The psychometric credit-scoring technology takes variables from the test and its meta-data. The scoring model is calibrated against a or reduce the reliance on fixed-asset collateral may help base model from the region, trained on data from similar countries. to expand access to capital for growth-oriented women- The model is then trained over time on local borrower data as the product is rolled out, to improve its predictive power further. owned firms. interventions including business training and access to A PROMISING INNOVATION? loans through MFIs. The uncollateralized loan product was advertised to women entrepreneurs via flyers at Psychometric credit scoring is an innovative technology “WEDP One Stop Shop” offices, in the cities of Adama designed to predict credit risk. Psychometrics—literally and Asela in the Oromia region. Women entrepreneurs “measurement of the mind”—uses questions designed who wanted a loan, but lacked collateral, were invited to measure traits linked to a borrower’s ability to repay to come to their local MFI branch to complete the a loan (e.g., business aptitude) and their willingness to psychometric assessment. The assessment was an repay a loan (e.g., honesty). Psychometric credit scoring interactive, tablet-based test consisting of games, has been shown to enhance screening of micro, small, puzzles, and questions. The psychometric test score and medium enterprises in low- and middle-income was automatically calculated, using a model trained on countries, including those that do not have other forms the test answers and the repayment data from a large of credit history.2 However, to date there is little evidence number of other borrowers from pilots in Ethiopia and on the impact on firms, and particularly women-owned in neighboring countries.4 Borrowers with a high credit firms, of using psychometric credit scoring as a substitute score were deemed potentially eligible to borrow without for collateral. To generate such evidence, the World collateral. Between April 2018 and March 2020, a total of Bank’s Africa Gender Innovation Lab partnered with 357 women took a psychometric test, and 259 scored the microfinance institution (MFI) Wasasa on an impact above the cut-off. To determine their final eligibility, these evaluation.3 The psychometric credit scoring technology women then had to undertake the MFI’s standard due was provided by a US company. diligence screening that includes a documentation check and a business appraisal. Of the 259 women, 131 passed these final stages and fully qualified for the loan. Hence, WHAT WE DID the standard due diligence was still a binding step of the The MFI used the psychometric credit scoring technology screening procedure. to offer large, uncollateralized loans of up to 250,000 Ethiopian birr (US$7,500) to women entrepreneurs. The To evaluate the impact of using psychometric credit new loan product was targeted via the Government of appraisal to substitute for collateral when granting larger Ethiopia’s Women Entrepreneurship Development Project loans, we conducted a randomized controlled trial. The (WEDP), which connects women-owned enterprises with 131 applicants who fully qualified were randomized 1 Agier and Szafarz (2013). “Microfinance and gender: Is there a glass ceiling on loan size?” World Development, 42(6):165–181 2 Klinger, B., Khwaja, A. and LaMonte., J, “Improving credit risk analysis with psychometrics in Peru”. Inter-American Development Bank. Technical Note No. IDB-TN-587 (2013). Klinger, B., Khwaja, A., and Del Carpio, C.. “Enterprising psychometrics and poverty reduction.” Vol. 860. New York, NY: Springer, 2013. Arráiz, I., Bruhn, M. and Stucchi., R, “Psychometrics as a tool to improve credit information.” The World Bank Economic Review 30. Supplement_1 (2017): S67-S76. 3 Alibhai, S., Cassidy, R., Goldstein, M. and Papineni, S., 2022. “Evening the Credit Score? Impact of Psychometric Loan Appraisal for Women Entrepreneurs”. World Bank Policy Research Working Papers, WPS 10230. 4 Alibhai, S., Buehren, N., Coleman, R., Goldstein, M., and Strobbe, F. (2018). “Disruptive Finance: Using psychometrics to overcome collateral constraints in Ethiopia”. World Bank Working Paper Series, 30(1): S67–S76. with 50-50 probability to receive an uncollateralized borrow formally (from 42 percent to 89 percent) and 12 loan or not. All women were informed of their random percent less likely to borrow informally (from family and assignment. The treatment group received their loan friends). Treated women were also more likely to borrow approximately one month later, while the control group larger amounts in total, relative to the control group. were not offered a loan. Comparing the treatment group and the control group allows us to identify the Access to psychometric-appraised loans halved causal impact of being offered an uncollateralized loan firm closure during the COVID-19 pandemic and appraised via psychometrics, compared to women who other aggregate shocks were equally eligible but were randomly not offered an Access to uncollateralized loans increased firms’ three- uncollateralized loan. year survival rate by 17 percent through the COVID-19 From September to October 2021, the research team pandemic and other shocks, from 67 percent to 83 followed up to conduct an endline survey with all 357 percent. We find no significant impact on women exiting female entrepreneurs who had originally taken the test. entrepreneurship altogether, since many who closed their Businesses were facing a challenging macroeconomic original firm reopened a new firm, typically in a different climate at the time of the endline survey, as the survey sector. took place just after national elections and a late peak of Surviving firms were profitable (not “zombie” firms), COVID-19 in Ethiopia, as well as during ongoing conflict but impact on profits were inconclusive in the country. Treated firms earned higher average yearly profits WHAT WE FOUND than control firms, but this effect was not statistically significant. Almost all firms who stayed open report Access to psychometric-appraised loans increased positive profits in the last year. Thus, there is no evidence access to formal finance for previously unbanked that access to psychometric-appraised loans kept borrowers unprofitable or “zombie” firms alive during the challenging Women entrepreneurs who were treated with the offer macroeconomic circumstances. However, treated firms of an uncollateralized loan were 30 percent more likely reported significantly lower profits in the last 30 days to borrow for business purposes from any source in the before September-October 2021, compared to control last three years. Treated women were twice as likely to firms. FIGURE 2: IMPACTS ON CREDIT CONSTRAINTS FIGURE 3: IMPACTS ON FIRM SURVIVAL Treatment Control Treatment Control 100 100 90% 89% 83% 80 80 67% 61% Percentage Percentage 60 60 42% 40 40 32% 20% 20% 20% 20 20 11% 8% 0 0 Total Formal Informal Operating original Started a new Exited business business entrepreneurship Repayment rates of psychometric-appraised loans were comparable to (collateralized) loans prior to 2020 but were hit by the consequences of the COVID-19 pandemic. For uncollateralized loans disbursed prior to 2020, default rates were very low, and comparable to collateralized loan products of a similar size. For loans disbursed in 2020 just prior to the onset of the COVID-19 pandemic, default rates were higher. Despite some rescheduling to take into account the impacts of COVID-19 lockdowns, a small number of borrowers partially defaulted. POLICY IMPLICATIONS AND NEXT STEPS Following this experiment, the majority of Ethiopia’s leading MFIs have requested support in integrating psychometric appraisal technology for lending to women entrepreneurs. The World Bank is now helping to scale up psychometric-based lending, both in Ethiopia and beyond. In Ethiopia, this work to scale-up innovative solutions to empower female entrepreneurs and improve their access to finance is being supported by Global Affairs Canada, through its Innovations in Financing Women Entrepreneurs (IFWE) initiative. This study’s findings are a “proof of concept” that psychometric-appraised lending can be a viable and impactful solution for women who lack collateral, especially in contexts where lending is highly collateral-constrained. The psychometric credit scoring technology helped address the collateral constraint faced by women entrepreneurs in accessing larger, individual-liability loans. The benefits of psychometric-appraised lending also extend naturally to other populations who lack access to collateral—including other marginalized groups, and poorer borrowers in general—and thus to broader reduction of inequality in credit markets. Psychometrics are one among many new digital technologies that might help resolve information asymmetries and overcome constraints in credit markets. With support from the World Bank’s IFWE initiative, financial institutions in Ethiopia are now also exploring other fintech and digital innovation tools to reduce or circumvent the need for traditional fixed asset collateral, such as Point-of-Sale cashflow monitoring, and revenue-based financing. For more information on this study, see the following paper: HERE FOR MORE INFORMATION, Alibhai, Salman, Cassidy, Rachel, Goldstein, Markus, and Papineni, PLEASE CONTACT Sreelakshmi. 2022. “Evening the Credit Score? Impact of Psychometric Rachel Cassidy Loan Appraisal for Women Entrepreneurs.” World Bank, Washington, DC. rcassidy@worldbank.org Africa Gender Innovation Lab afrgenderlab@worldbank.org Photo credit: Impala Communication / World Bank 1818 H St NW Washington, DC 20433 USA This work has been supported through generous contributions from Global Affairs Canada, in partnership with the Umbrella Facility for Gender Equality (UFGE), which is a multi-donor trust fund administered by the World Bank to www.worldbank.org/africa/gil advance gender equality and women’s empowerment through experimentation and knowledge creation to help governments and the private sector focus policy and programs on scalable solutions with sustainable outcomes. The UFGE is supported with generous contributions from Australia, Canada, Denmark, Finland, Germany, Iceland, Ireland, Latvia, the Netherlands, Norway, Spain, Sweden, Switzerland, United Kingdom, United States, the Bill and Melinda Gates Foundation, and the Wellspring Philanthropic Fund.