Credit Scoring for Microfinance: Can It Work?

In rich countries, lenders often rely on credit scoring—formulae to predict risk based on the performance of past loans with characteristics similar to current loans—to inform decisions and to control costs. Can credit scoring do the same for microfinance lenders in poor countries? This paper argues that scoring does have a place in microfinance. Although scoring is less powerful in poor countries than in rich countries, and although scoring will not replace the personal knowledge of character of loan officers or of loan groups, scoring can improve estimates of risk and thus cut costs. Thus, scoring complements—but does not replace—current microfinance technologies. Furthermore, the derivation of the scoring formula reveals how characteristics of borrowers, loans, and lenders affect risk, and this knowledge is useful whether or not a lender uses predictions from scoring to inform daily decisions. In the next decade, many of the biggest and most profitable microfinance lenders will likely make credit-scoring models one of their most important decision tools.