The Supply Side of Microenterprise Lending

As part of its efforts to assist microenterprise lenders seeking to achieve greater scale, in 2005 FIELD commissioned a “scan” of trends in the supply of microenterprise loans in the United States, focusing specifically on trends in lending by for-profit financial institutions. FIELD retained a team of three consultants, each of whom had experience with business lending in both the traditional banking and community development finance sectors.

The consultants – Patty Grossman, Ellen Chen, and Paige Chapel – engaged in research consisting of: a review of existing literature and studies on trends in lending to the microenterprise market, and a set of interviews with key players in the financial industry. Based on this work, the consulting team identified six key findings:

• For-profit providers of microcredit have fragmented over the last decade with banks, finance companies, asset-based lenders, factors (companies that purchase accounts receivable, invoices or purchase orders for cash) and credit card companies all combining and sharing market and product sets. Banks are the primary suppliers to the micro market and have increased their presences since deregulation.
• Primary and secondary data sources on market size, industry size and market share use definitions of “small business” that differ from those used by FIELD and the microenterprise industry.
• Credit scoring has become so precise in predicting repayment probability that it is the primary methodology used by for-profit providers to determine who is approved for credit or a small business loan.
• For-profit providers of commercial loans less than $35,000 are aggressively reaching “down market” by using credit cards as the primary product and credit scoring as the decision-making methodology.
• The profile of a successful applicant for microcredit from a for-profit provider is fluid because providers are actively refining credit-scoring algorithms.
• “Gaps” still exist in credit availability for small businesses that nonprofit microlenders can fill, however, borrowers in this niche are increasingly marginal and risky.

The authors also identified a set of conclusions, or implications of these trends for the microlending industry, including: 

• Banks and other for-profit providers of commercial credit will continue their downward market drive using credit scoring to reach increasingly “riskier” borrowers. Only the very riskiest borrowers will be left for nonprofit lenders in a perfect information market. Credit cards appear to be the product of choice for banks and other lenders in targeting “marginal” small business borrowers. Ways the nonprofit microcredit industry could compete include:
  • Building a credit-scoring algorithm that facilitates high-volume lending.
• Expanding market research, marketing efforts and customer-oriented technologies such as on-line applications.
• Providing business packaging services to help borrowers who are not otherwise eligible for bank debt to better access for-profit lenders.
• Providing value-added technical assistance as a mission-driven focus to enhance business performance.
• If microlenders choose to compete through high-volume lending, they will require more equity in their capital structure to support potential losses associated with higher levels of risk. The focus on self-sufficiency needs to be recast.
• Partnerships between nonprofit and for-profit providers of microcredit will become more important and will need to be based on a thorough understanding of the parameters of the credit-scoring model employed by the for-profit sector. Partnerships may be more optimally focused on the front-end of the transaction whereby a nonprofit microlender helps a bank partner penetrate a market segment.

Click here to view a full copy of the supply-side study.