Menus Subscribe Search

Follow us


rorschach

Can a Test Tell If You’re a Good Entrepreneur?

• December 05, 2012 • 4:00 AM

How psychometrics are helping loan officers weed out the bad risks from the good.

Bankers around the world know there are profits to be reaped by making loans to promising small businesses that fall just short of traditional definitions of “creditworthy.” Ever since Nobel Prize winner Muhammad Yunus’ Grameen Bank pioneered “microfinance” by making tiny loans to single mothers in Bangladesh, development policymakers also have believed that getting credit to small businesses—those too large for Grameen-style microloans but still lacking collateral or credit history—is not only possible, but the key to helping a nation’s economic growth. So how to figure out who’s a good risk for a loan—and who isn’t?

Now, some banks think a simple, 40-minute questionnaire for entrepreneurs can tell them a lot about whether a company is worth the risk. Two public policy researchers at Harvard, Bailey Klinger and Asim Khwaja, first adapted the questionnaire from psychometric evaluations— a tool psychologists, child custody lawyers, executive recruiters, retail employers, and even the NFL have used since the concept  emerged from academia in 1918, when the U.S. Army started mentally testing potential doughboys.

Psychometric evaluations typically include brief, open-ended questions related to ethics, attitudes, skills, and intelligence. In Klinger and Khwaja’s model for testing how likely an entrepreneur is to make good on a loan, that means questions like “Do you like to attend parties?,” “Do you enjoy taking things apart to see how they work?” or “Do you believe that luck is a big part of success?” as well as cognitive problems like “Look at this sequence of numbers for five seconds, then try to recite as many digits as you can.”

The researchers launched pilot programs in South Africa, Kenya, Rwanda, Colombia, and Peru in 2008, and spent two years administering evaluations and following the success rate of test-takers. They discovered an unusually high correlation in the answers submitted by successful entrepreneurs who were also good borrowers.

“[Psychometrics] aren’t perfect; everyone who does very well on [the] SAT [test] doesn’t end up with a 4.0 in college,” says Brian Hoffman, professor of psychology at the University of Georgia. “But it’s a cost-effective predictor.” That is, psychometrics appear to be a cheaper, more accurate way to predict human behavior in many fields that have been using them to evaluate people.

The Harvard team’s innovative application of psychometric tools earned a stream of grants and plaudits, and eventually a prize for innovation in development finance sponsored by the G-20. Boosting growth among small and medium-sized enterprises, from second-hand-clothing sellers to light manufacturers, has long been seen by development experts as crucial for job creation and ultimately poverty alleviation in low-income countries. In countries like Yunus’s home of Bangladesh, the economy is dominated by a few large, established corporations or industries, and innumerable, and informal, micro-enterprises. Meanwhile, mid-sized operations average only 15 percent of low-income countries’ GDP, compared to roughly 50 percent of high-income nations’ GDP. Research finds that neither the really big nor the really small businesses have the growth potential—or unmet credit needs—of those mid-sized operations with 10 to 250 employees. But lenders tend to see this segment, generally lacking collateral or extensive financial records in the developing world, as too risky a bet. They aren’t the charity cases that foundations and policymakers itch to assist, either.

“These business owners might be poor, but not poorest of poor. Not the kinds you can put on a glossy brochure to pull people’s heart strings about helping them make money,” says Klinger.

To expand the use of their questionnaire, Kwhaja and Klinger created a company called the Entrepreneurial Finance Lab (EFL) in 2010, and signed up one of the largest banks in Africa, Standard Bank of South Africa. The next step has been to send loan officers into bazaars, street markets, and main streets with laptops or cell phones loaded with the questionnaire.

The bank found that when an entrepreneur qualified for a loan using both the bank’s traditional credit scoring methods and EFL’s questionnaire, delinquency rates were 2.8 percent. Applicants who qualified for a loan based only on the banks’ traditional credit scoring methods had a delinquency rate of 14.5 percent. And in 677 of 913 applications, where the bank said no but psychometrics said yes (and therefore a loan was granted), the delinquency rate was 9.7 percent. Psychometric evaluations were helping Standard access, albeit on a small scale, a huge new pool of fairly successful borrowers that it otherwise would have turned down. Those 677 businesses now had access to growth capital, enabling them to hire new employees.

“The whole point of the development finance business in the last 15 or 20 years was to get around [the credit] problem,” according to Nicholas Hope, director of Stanford’s Center for International Development and a veteran of World Bank programs in China and Indonesia. He was referring to a problem known as the “missing middle,” in which small and medium-sized enterprises were overlooked by lending institutions and charitable organizations.

Roughly 45,000 applicants have answered some version of EFL’s questions as part of their loan application process. Banks like Standard in South Africa but also others such as Mexico’s BBVA Bancomer and EFL’s newest client in Indonesia, Bank BPTA (pending formal central bank approval, though they’re already using the tool more widely than any other bank), have made $156 million in loans—generally from $800 to $100,000—to entrepreneurs based at least partly on their psychometric responses.

The loans are going out at a pace of roughly $8 million a month, according to Klinger. In early November, the Inter Development Bank in Washington, a sort of World Bank for Latin America, announced $25 million in loan guarantees for Latin American banks that incorporate psychometrics in lending decisions for micro- to medium-sized enterprises. Some banks are even considering using psychometrics to re-evaluate terms on loans they have already made, Klinger said.

This rapid rate of adoption globally could do a lot to spur growth in a huge, long-neglected segment of small businesses. But, with large corporations using sophisticated new tools to engage borrowers with little institutional support or financial savvy, there are potential pitfalls. Critics of psychometrics in hiring have claimed that the tests can reinforce gender and racial stereotypes. Seth Kaplan, professor of psychology at the University of Georgia, described the dynamic this way: “A test is a sample of behavior, and anytime you’re trying to make inferences about future behavior, it’s always kind of a deterministic model.”

Klinger agreed that, in the lending context, it would be ethically dubious to judge creditworthiness based on latent personality traits but argued that this mischaracterizes the method being applied by EFL.

“We walk a very careful line,” he says. “We work with some of the top people in the field, but we are not psychologists. We’re not measuring whether somebody is smart or has a certain level of ambition, but asking some questions from that context, and relating those answers to statistical history of default rates. It may sound like a fine-print legal distinction, but it’s a substantive difference.”

Jared Miller, Latin America director for Klinger’s company, summed it this way: “We don’t measure who [entrepreneurs] are really, we measure who they present themselves to be.”

Critics of micro-finance also contend that the high interest rates that for-profit players like HSBC offered borrowers canceled out the potential to lower poverty rates. Francisco Rojo, project manager for the IDB’s Multilateral Investment Fund, which focuses on smaller-scale, market-based development projects for the IDB and has helped EFL enter the Latin American market, allows, “We are not setting out criteria in terms of interest rates; banks decide that.” In his view, though, that would likely prove unnecessary. “The idea is, if they charge very high interest rates, and they see it successful with profit, then they will begin to lend to that same segment and then they will compete and interest rates will get lower.” EFL executives echoed this point.

Given the rapid rate at which banks are adopting tools from psychometrics to expand the reach of their loan officers, and small businesses’ estimated $2 trillion in unmet credit needs in the developing world, we’ll find out soon whether Rojo’s prediction about interest rates comes to pass.

Michael Fitzgerald
Michael Fitzgerald is an associate editor at Pacific Standard. He has previously worked at The New Republic and Oxford American Magazine.

More From Michael Fitzgerald

A weekly roundup of the best of Pacific Standard and PSmag.com, delivered straight to your inbox.

Recent Posts

November 24 • 4:00 AM

Nudging Drivers, and Pedestrians, Into Better Behavior

Daniel Pink’s new series, Crowd Control, premieres tonight on the National Geographic Channel.


November 21 • 4:00 PM

Why Are America’s Poorest Toddlers Being Over-Prescribed ADHD Drugs?

Against all medical guidelines, children who are two and three years old are getting diagnosed with ADHD and treated with Adderall and other stimulants. It may be shocking, but it’s perfectly legal.



November 21 • 2:00 PM

The Best Moms Let Mess Happen

That’s the message of a Bounty commercial that reminds this sociologist of Sharon Hays’ work on “the ideology of intensive motherhood.”


November 21 • 12:00 PM

Eating Disorders Are Not Just for Women

Men, like women, are affected by our cultural preoccupation with thinness. And refusing to recognize that only makes things worse.


November 21 • 10:00 AM

Queens of the South

Inside Asheville, North Carolina’s 7th annual Miss Gay Latina pageant.


November 21 • 9:12 AM

‘Shirtstorm’ and Sexism in Science

Following the recent T-shirt controversy, it’s clear that sexism in science persists. But the forces driving the gender gap are still being debated.


November 21 • 8:00 AM

What Makes a Film Successful in 2014?

Domestic box office earnings are no longer a reliable metric.



November 21 • 6:00 AM

What Makes a City Unhappy?

According to the National Bureau of Economic Research, Dana McMahan splits time between two of the country’s unhappiest cities. She set out to explore the causes of the happiness deficits.


November 21 • 5:04 AM

Sufferers of Social Anxiety Disorder, Your Friends Like You

The first study of friends’ perceptions suggest they know something’s off with their pals but like them just the same.


November 21 • 4:00 AM

In 2001 Study, Black Celebrities Judged Harshly in Rape Cases

When accused of rape, black celebrities were viewed more negatively than non-celebrities. The opposite was true of whites.


November 20 • 4:00 PM

Women, Kink, and Sex Addiction: It’s Not Like the Movies

The popular view is that if a woman is into BDSM she’s probably a sex addict, and vice versa. In fact, most kinky women are perfectly happy—and possibly healthier than their vanilla counterparts.


November 20 • 2:00 PM

A Majority of Middle-Class Black Children Will Be Poorer as Adults

The disturbing findings of a new study.


November 20 • 12:00 PM

Standing Up for My Group by Kicking Yours

Members of a minority ethnic group are less likely to express support for gay equality if they believe their own group suffers from discrimination.


November 20 • 10:00 AM

For Juvenile Records, It’s ‘Justice by Geography’

A new study finds an inconsistent patchwork of policies across states for how juvenile records are sealed and expunged.


November 20 • 8:00 AM

Surviving the Secret Childhood Trauma of a Parent’s Drug Addiction

As a young girl, Alana Levinson struggled with the shame of her father’s substance abuse. But when she looked more deeply into the research on children of drug-addicted parents, she realized society’s “conspiracy of silence” was keeping her—and possibly millions of others—from adequately dealing with the experience.



November 20 • 6:00 AM

Extreme Weather, Caused by Climate Change, Is Here. Can Nike Prepare You?

Following the approach we often see from companies marketing products before big storms, Nike focuses on climate change science in the promotion of its latest line of base-layer apparel. Is it a sign that more Americans are taking climate change seriously? Don’t get your hopes up.


November 20 • 5:00 AM

How Old Brains Learn New Tricks

A new study shows that the neural plasticity needed for learning doesn’t vanish as we age—it just moves.


November 20 • 4:00 AM

The FBI’s Dangerous Misrepresentation of Encryption Law

The FBI no more deserves a direct line to your data than it deserves to intercept your mail at the post office. But it doesn’t want you to know that.


November 20 • 2:00 AM

Brain Drain Is Economic Development

It may be hard to see unless you shift your focus from places to people, but both destination and source can benefit from “brain drain.”


November 19 • 9:00 PM

Gays Rights Are Great, but Ixnay on the PDAs

New research suggests both heterosexuals and gay men are uncomfortable with public same-sex kissing.


November 19 • 4:00 PM

The Red Cross’ Own Employees Doubt the Charity’s Ethics

Survey results obtained by ProPublica also show a crisis of trust in the charity’s senior leadership.



Follow us


Sufferers of Social Anxiety Disorder, Your Friends Like You

The first study of friends' perceptions suggest they know something's off with their pals but like them just the same.

Standing Up for My Group by Kicking Yours

Members of a minority ethnic group are less likely to express support for gay equality if they believe their own group suffers from discrimination.

How Old Brains Learn New Tricks

A new study shows that the neural plasticity needed for learning doesn't vanish as we age—it just moves.

Ethnic Diversity Deflates Market Bubbles

But it's not in the rainbow and sing-along way you'd hope for. We just don't trust outsiders' judgments.

Online Brain Exercises Are Probably Useless

Even under the guidance of a specialist trainer, computer-based brain exercises have only modest benefits, a new analysis shows.

The Big One

One in two United States senators and two in five House members who left office between 1998 and 2004 became lobbyists. November/December 2014

Copyright © 2014 by Pacific Standard and The Miller-McCune Center for Research, Media, and Public Policy. All Rights Reserved.