How does your proposed innovation leverage public intervention in catalyzing private SME finance?
Latent Supply and Demand for SME Lending:
Developing countries have a large number of microenterprises and some large firms, but few SMEs. In developed economies, formal SMEs account for around 57% of total employment, but only 18% of employment in low income countries (Ayyagari Beck & Demirguc-Kunt 2003). These firms are not absent only because of inefficient business environments and the costs of formality: new research shows very robustly that they have returns to capital well beyond bank’s cost of capital (e.g. Banerjee & Duflo 2004, McKenzie & Woodruff 2008). There is supply of and demand for finance; they just can’t be matched.
Blocked by a lack of information:
With little credit history, collateral, and financial statements, banks have few low-cost methods to select among applicants. EFL uses psychometric assessments as a viable low-cost, automated screening tool to identify high-potential entrepreneurs and evaluate risk and future potential.
Unlocked with a small public intervention:
Before EFL, these psychometric assessments have never been adapted for risk analysis in finance, nor has their predictive power been proven to the statistical requirements of risk departments in emerging market banks. In order to perform this adaptation, demonstrate that this solution works, and get banks to take it on in a new country, some public support is necessary, and has spurred the adoption needed for systemic change.
Once banks have a low-cost way to identify the large number of SMEs with high returns to capital, lending expands massively. Understanding risk enables risk-management, and innovations such as quasi-equity contracts and risk-based pricing. A relatively small well-targeted amount of public support will allow this dormant capital and latent entrepreneurial potential to connect in a way that is profitable for those involved, and therefore self-scaling.
EFL’s catalytic effect has already been demonstrated:
Each of our first round testing partners is in some stage of deploying the assessment, (9 institutions spanning 7 countries with a total loan books of approximately $63b,). Moreover, within only 3 months of the first round tests being completed, Standard Bank has signed an agreement with EFL to launch pilot implementations in Kenya, South Africa, Ghana, Nigeria and Uganda over the next twelve months. The bank is opening new branches where every business applicant must take EFL to be accepted, and they will be lending from $1,000 to $10,000 to 20,000 SMEs that, under their existing tools and policies, would have been rejected. This means every dollar of public support invested in spreading the EFL assessment to Africa and Latin America has unlocked $20 of private capital in only its first few months, in this one partner alone.
With public help, the growth can be accelerated and amplified; the EFL tool can be adapted and spread to other countries, and billions of incremental dollars of private capital could be profitably lent to SMEs across the developing world.