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Measuring the Likelihood of Small Business Loan Default: Community Development Financial Institutions (CDFIs) and the use of Credit-Scoring to Minimize Default Risk

Andrea Ruth Coravos Professor Charles Becker, Faculty Advisor Duke University Durham, North Carolina 2010
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Andrea Coravos

on 23 April 2010

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Transcript of Measuring the Likelihood of Small Business Loan Default: Community Development Financial Institutions (CDFIs) and the use of Credit-Scoring to Minimize Default Risk

Measuring the Likelihood of Small Business Loan Default:

Community Development Financial Institutions (CDFIs) and the use of Credit-Scoring to Minimize Default Risk Andrea Ruth Coravos Professor Charles Becker, Faculty Advisor
Economics Research Symposium 2010
April 23, 2010
Agenda for today Introduction to community development financial institutions (CDFIs)

Literature review of small business loan default

Introduction to the data

Theoretical model of loan defaults

Empirical results of all-loans, start-up loans, and micro loan defaults

Application of results for a working-world credit scoring model
Community development financial institutions (CFDIs) provide financial services to underserved markets CDFIs extend more credit to “mission” clientele, which includes women, minorities and low-wealth individuals
Given the recent recession and the pressure to
reduce costs, CDFIs are looking for tools to
manage the risk in their small business loan
(SBL) portfolios
Quantitative credit-scoring can predict loan
repayment and can decrease administrative costs
Can community development financial institutions
(CDFIs) use a credit scoring system to increase
efficiency while maintaining their desired clientele? The profit-maximizing function of X CDFI differs from a traditional bank because it depends on subsidies and grants The financial institution depends on grants and subsidized rented capital, which the institution only receives if it reaches out to enough “mission” clientele
In the CDFI model: The bank makes a profit by charging a higher interest rate on the borrower’s loan than the interest rate it pays on depositors’ accounts or rented capital
In the simpliest banking model: (1) Can underserved small business markets be profitable?
The previous literature on this subject focuses on (1) underserved markets, (2) risky borrowers, and (3) small business credit scoring Yes. This finding is often credited Muhammad Yunus
and the Microfinance world.
The poor are not necessarily bad borrowers, but they
often cannot be measured or served by conventional
methods. (2) What factors are predictive of small business loan default?
Financial assets, employment tenure (Mester 1997), FICO Score (Cowan 2006), Female borrowers (Morduch 1999), time-sensitive (Glennon and Nigro 2005)…
Many default models are are proprietary and confidential

The models can drastically change depending on the population
(3) How can someone quantify the level of risk if the predictive factors are known?
Design a statistical model that outputs a “credit-score” for the business

Expensive and rare in the CDFI community

$35,000-$50,000 to create a customized score card (Overstreet and Rubin 1996)

Extend more credit into the small business community (Cowan 2006)
Full transcript