Is There an Accurate Test to Weed Out the Good Entrepreneurs?

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

Since the beginning of banking, lenders have toed the line on “creditworthy” businesses to lend to. There is inherent risk in every loan deal, but deciphering good risk from potentially catastrophic risk is the daily problem for every loan officer. But could psychometric evaluation be applied to the borrower vetting process? Two public policy researchers at Harvard have been studying this question since 2008; administering evaluations and following the success rate of test-takers. In their model for testing how likely an entrepreneur is to make good on a loan, questions included “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.”

Their results yielded an unusually high correlation in answers submitted by successful entrepreneurs who were also good borrowers. Teaming with a bank in South Africa, the researchers found when an entrepreneur qualified for a loan using the bank’s traditional credit scoring methods and the researcher’s questionnaire, delinquency rates were 2.8 percent. Applicants who qualified only on the bank’s methods had a delinquency rate of 14.5 percent. In 677 of 913 applications, where the bank said no by psychometrics said yes, the delinquency rate was 9.7 percent. Though psychometrics aren’t perfect (“Everyone who does well on the SAT doesn’t end up with a 4.0 in college”), they are a cost-effective predictor. But given the rate at which banks and alternative lenders are adopting tools and new platforms to reach small business owners, could psychometric evaluations be the next big thing?

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