Bridging MSME financing gaps with customised digital credit scoring

Micro, Small, and Medium Enterprises (MSMEs) are known as the lifeblood of the world economy. The presence of MSMEs in every economic channel develops forward and backward linkages for large businesses as well. According to World Bank data, SMEs contribute 40 per cent to the Gross Domestic Product (GDP) globally. In Bangladesh, MSMEs contribute 25 per cent to the GDP, whereas in comparable economies like Indonesia, Sri Lanka, Pakistan, and Vietnam, MSMEs contribute 40 per cent or more. The International Finance Corporation (IFC) has estimated that about 40 per cent of formal MSMEs in developing countries have unmet financing needs of $5.2 trillion each year. They also concluded that 70 per cent of MSMEs in emerging markets are not receiving adequate funding, with most of these concentrated in Asia and Sub-Saharan Africa. By addressing their unmet financing needs, banks and mobile financial services (MFS) can become effective market players to enhance MSMEs' contributions to emerging economies like Bangladesh.
Although medium enterprises within MSMEs are generally able to place themselves under the umbrella of the banking system, micro and small enterprises struggle significantly. For certain period, most MSME financiers preferred collateral-based financing over cash flow-based financing, believing that security would act as a safeguard for recovery in case of loan default. Financiers also tended to provide generic loan facilities to all types of customers. Market research on product diversity for MSMEs was minimal. However, MSME research has now extended its scope. It is known that many MSMEs, especially those in rural areas, prefer to transact their revenues in cash rather than through the banking system, which hinders their participation in the formal sector.
At the end of the day, although the profits they generate correspond to their income, the lack of prepared documentation prevents them from accessing external sources of financing, particularly from banks and non-bank financial institutions (NBFIs), which leaves the economy distant from the concept of financial inclusion. In the digital era, the financing needs of MSMEs can be met if accurate and reliable data is readily available. To ensure data availability and alignment with international best practices, Bangladesh Bank recently issued guidelines on the licensing, operation, and regulation of credit bureaus. Financiers can easily obtain the necessary data from licensed credit bureaus for credit assessments before making financing decisions.
MSME financing has improved due to the global implementation of credit scoring, which enables financiers to reduce the time required for financing decisions. According to CGAP research, the main disadvantage of traditional credit-scoring methods is that low-income individuals and informal businesses often lack financial data (such as transaction records, tax receipts, and bank statements), resulting in marginal users having marginalised credit scores. This type of credit profile is referred to as a "thin file." In contrast, inclusive credit-scoring models combine traditional financial transaction data with alternative data (such as e-commerce transactions, personal purchases, mobile wallet data, geolocation, bill payment histories, and social media usage), which can help reduce the financing gap. Credit-scoring systems minimise the high operational, financing, and monitoring costs of banks and financial institutions by using digital means. Data is the primary resource processed to assess the creditworthiness of borrowers through credit scoring.
Credit scoring can be an effective tool to streamline a financial institution's MSME financing process, especially with the influx of digital banking in Bangladesh. Broadly, MSMEs are segmented into three categories - manufacturing, service, and trade - each of which includes various sectors of the economy. The credit scoring components used to assess borrowers and their financing requirements should be customised based on business nature, model, and performance. For example, although both logistics businesses and restaurants fall under the service sector, their business models are entirely different. Therefore, the numerical weightage of credit-scoring components should differ for each. Additionally, while logistics businesses are capital-intensive, restaurant businesses are manpower-intensive. Investment in logistics is significant and vehicle-oriented, whereas investment in restaurants is relatively lower and primarily directed toward infrastructure development. As a result, the scoring weightage on gross profit margin and net profit margin should not be the same for both. Similarly, the parameters for account turnover, tied-up period, and debt-equity ratio will differ for each business. Credit scoring parameters for MSMEs must be business-specific and logically linked to the nature of the business.
It is now essential to refine the financing strategy. To eliminate frictions and distortions in credit assessment and reduce the financing gap, financial institutions should design customised credit-scoring methods for MSME assessment. Furthermore, a risk-minimisation-centric credit-scoring policy should be established by the central bank of Bangladesh, similar to the initiative for credit bureaus. With customised credit scoring for MSME customer analysis and financing assessment, bankers will be better equipped to access the unserved or underserved MSME market in Bangladesh.

The writer is a Banker and Financial Modeling & Valuation Analyst (FMVA®) certified from Corporate Finance Institute, Canada.
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