Benefits and Pitfalls of Statistical Credit Scoring for Microfinance

Publication Date: 23 Dec 2004
Published by: Microfinance.com
Document Type: Paper

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What is statistical credit scoring and how effective is it?

This paper discusses the benefits and pitfalls of statistical credit scoring applied to microfinance. It discusses what scoring can and cannot do, describes the data that micro lenders, who plan to use scoring, should start to collect from all loan applicants, and outlines the basic steps in a scoring project.

The paper finds that statistical scoring quantifies risk and lists the potential advantages that statistical scoring enjoys over implicit or subjective scoring:

• Quantifies risk as a probability;
• Employs an explicit process that can be communicated;
• Enables more refined risk evaluation and management by accounting for a wide range of risk factors;
• Can be tested before use;
• Discloses trade-offs;
• Reveals the links between risk and the characteristics of the borrower, the loan, and the lender.

• Requiring high-quality data on a large portfolio of loans;
• Requiring an experienced consultant;
• Depending on integration with the management information system (MIS);
• Needing an additional step to the traditional evaluation process;
• Working on limiting assumptions like linking risks with quantified characteristics in the database;
• Being susceptible to abuse such as neglects and over-rides.