Joint use of poverty scoring and credit scoring: advantages and limitations of a new technique for socially oriented and sustainability-minded microfinance institutions

Financial institutions face adverse selection, in which risky borrowers are more likely to seek and take up loans. When interest rates increase, adverse selection rises, often disproportionately. Microfinance Institutions (MFIs), which generally operate with higher interest rates, are more exposed to adverse selection. Thorough credit analysis, collateral, credit reporting, and the imminence of legal or social pressure reduce adverse selection. When interest rates drop due to subsidies or operational efficiencies, non-poor individuals seek microloans, particularly when banks deny or cap their credits. This demand for larger loans can tempt MFIs, especially when they are pressured to increase loan volumes while controlling costs. When MFIs seek to accommodate those who should not need microloans, they face a different form of adverse selection specific to microfinance. The significant presence of wealthier borrowers can damage an MFI’s reputation. If such borrowers pose a greater-than-expected credit risk, because lenders might equate wealth with creditworthiness, wealthier borrowers can undermine the financial sustainability of the MFI. Financial institutions, including MFIs, can use credit scoring to mitigate the first type of adverse selection. Credit scoring helps identify risky borrowers, allowing institutions to reject high-risk applications, price loans based on credit risk, and adjust the required guarantees. To address the second type of adverse selection, MFIs can use poverty scoring. Similar to credit scoring, poverty scoring identifies loan applicants with a high probability of experiencing poverty. This technique allows MFIs to remain focused on their mission of serving the poor. This thesis is the first to examine the joint use of credit scoring and poverty scoring in microfinance. It reveals the non-linear relationship between poverty and credit risk, showing that double bottom-line MFIs experiencing both types of adverse selection must use the joint technique to remain sustainable and focussed on financially excluded clients.

Grantor dc:publisher

Oxford Brookes University

Author dc:creator

• Bumacov, Vitalie

Contributors dc:contributor

• Ashta, Arvind
• Singh, Pritam

Statement dc:rights

• All rights reserved

Language dc:language

en

DOI dc:identifier

https://doi.org/10.24384/cqqc-1607

OAI identifier oai:identifier

tle:13d68dad-1f51-4ca4-b572-1821be23c631:d6bd9758-527a-46cd-bfe2-c433766e8fca:1