EFL Solutions

The barriers to finance in the missing middle show that unlocking entrepreneurial potential in developing countries requires technology that:

Has low transaction costs

By definition, financing SMEs requires a larger number of smaller investments than when serving larger firms. Having an experienced analyst review applications means high loan origination or due diligence costs: too high for the size of financing in this segment. Small business lending in the US only boomed after automated credit scoring appeared. Effective screening technology must have low transaction costs and therefore be, at least partially, automated.

Has few information requirements

Developing countries are information-scarce environments. There are few deep credit histories and well-formatted audited accounting records, and even conventionally-formatted business plans are hard to find. Screening technology will not achieve scale unless it does not depend on such information.

Is resistant to gaming and manipulation

Applicants want financing, and they will naturally do their best to get it. They will do all that they can to represent themselves as sound and profitable investees. Effective screening technology must therefore be resistant to gaming.

Focuses on future earnings potential and risk rather than current wealth

Without effective low-cost technology to screen small business borrowers, all that banks can do is evaluate collateral in order to reduce risk and have entrepreneurs self-select. But this in effect is a matching of funds to past wealth, not future earnings potential, which is what really matters for sound investing. It locks everyone out who does not have accumulated wealth, and perpetuates inequalities. Effective screening technology must therefore focus on future profitability and likelihood of repayment, rather than only looking backwards.

Is profitable and scalable

There are many governmental and non-governmental programs that provide potential entrepreneurs with advice and subsidized financing. While effective, any such program that relies on volunteers, public funds, or international donors faces significant limits to scale. On the other hand, there are billions of dollars of private capital in developing countries that is almost dormant, and there are millions of entrepreneurs in need of that capital. To achieve scale, effective screening technology must be sufficiently accurate and combined with appropriate financial instruments to make financing this segment privately profitable for investors and lenders.

The EFL is working on the development of new screening technologies and financial contracts that meet these criteria.

Print print | Email email