Pakistani-American Prof's Tool Helps SME Financing in Emerging Economies

Pakistani-American Prof. Asim Khwaja and his doctoral student Bailey Klinger at Harvard’s Kennedy School of Government observed that banks have money to lend, but even profitable small businesses in developing nations often cannot access it, choking growth.

Prof Asim Khwaja of Harvard's Kennedy School
Looking into the reasons, they found it was the lack of access to tools like credit agency reports and FICO credit scores which are common in developed economies. This discovery gave birth to Entrepreneurial Finance Lab to develop alternative tools for bankers to assess risks to lend money to small business owners. Their basic tool is a multiple-choice psychometric test. Here's how New York Times describes it:

The lab’s model asks questions that do not necessarily have a right answer; using an algorithm, it aims to predict whether an individual is likely to default based on how the answers relate to one another. For example, to assess their sense of personal control over outcomes — which tends to correlate with loan repayment — respondents might be asked to rate how much they agree or disagree with the statement: “I believe in the power of fate.” Another question on risk tolerance might ask them to choose between opposing responses with equal social desirability, such as: “I plan for every eventuality,” “I’m in between” or “Planning takes the fun out of life.” There are some unexpected findings: Optimism and self-confidence are good signs among seasoned entrepreneurs, but high levels in younger business owners do not bode well, statistically. And the math and reasoning questions meant to measure fluid intelligence can also assess integrity — of the loan officer. Too many correct answers can reveal that an applicant was coached.

Banks in 16 developing countries are now using EFL's psychometric test to lend money to owners small and medium size businesses. Bank financing of small and medium enterprises (SMEs) is good for both the borrowers and the lenders as well as the national economy. It's a great source of revenue and income for the financial institutions. It helps small businesses grow and create jobs. In developed economies like the United States, SMEs create about half of all business activity and almost two-thirds of employment growth. In poor nations, such enterprises, on average, account for only about 17 percent of spending and one-third of new jobs.

Asim Khwaja is Professor of Public Policy at the Harvard Kennedy School of Government. Here's his bio as posted on Harvard's Center For International Development website: "His areas of interest include economic development, finance, education, political economy, institutions, and contract theory/mechanism design. His research combines extensive fieldwork, rigorous empirical analysis, and microeconomic theory to answer questions that are motivated by and engage with policy. It has been published in the leading economics journals, such as the American Economic Review, and the Quarterly Journal of Economics, and has received coverage in numerous media outlets such as the Economist, NY Times, Washington Post, International Herald Tribune, Al-Jazeera, BBC, and CNN. His recent work ranges from understanding market failures in emerging financial markets to examining the private education market in low-income countries. He was selected as a Carnegie Scholar in 2009 to pursue research on how religious institutions impact individual beliefs. Khwaja received BS degrees in economics and in mathematics with computer science from MIT and a PhD in economics from Harvard. A Pakistani, UK, and US citizen, he was born in London, U.K., lived for eight years in Kano, Nigeria, the next eight in Lahore, Pakistan, and the last eighteen years in Cambridge, Massachusetts. He continues to enjoy interacting with people around the globe".

State of Bank of Pakistan's policies  have catapulted Pakistan to the top of the  list for microfinance in Asia. Pakistan ranks first in Asia and third in the world in Economist Intelligence Unit's overall microfinance business environment rankings. Similar support for SME sector loans can help stimulate the national economy, grow tax base and create much needed jobs to lift more people out of poverty. Tools like the EFL's psychometric test can be deployed as part of this effort to grow the SME sector.

Related Links:

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Pakistan's Financial Services Sector

IBA's Entrepreneurship Report

Microfinance in Pakistan

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Pakistani-American Shahid Khan Richest South Asian in America

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US Promoting Venture Capital & Private Equity in Pakistan

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