Direct and Indirect Impacts of Credit Scoring for Small and Medium Enterprises

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AbstractProposal Title: Direct and Indirect Impacts of Credit Scoring for Small and Medium EnterprisesProposal Number: SES - 1326433Principal Investigator: Dean KarlanLack of access to finance remains one of the core challenges to small firm growth in low- and middle-income countries. Many small and medium enterprises (SMEs) have high returns to capital but if banks cannot identify these borrowers, they may restrict lending or misallocate funds, limiting production and employment growth. Many low- and middle-income countries do not have credit bureaus or other effective public systems that aggregate information valuable for screening, further exacerbating the challenge of identifying high return borrowers. While a lack of adequate financing may constrain the expansion of individual firms, the provision of credit to a single business is likely to have spillover effects on other firms and on consumers. Firms operate in a web of competitors and suppliers, and these businesses will also be affected by credit that is provided to a single loan recipient. For example, standard economic theory suggests that competitor firms will see decreased demand when competitors gain access to credit. At the same time, increased demand for supplier inputs can lead to increased upstream profitability. Classic theories of economic development stress the importance of these linkages in the takeoff to development.This study uses a randomized controlled trial methodology to evaluate the impact of providing credit to SMEs, examining both the direct effects on recipient firms and the indirect spillover effects on competitors and firms linked to treated businesses through supply chains. A large development bank in the Philippines is implementing a new credit scoring system at 45 branches across the country. The new system will process all SME loans and assign a credit score to each loan applicant. Credit scores falling in a certain range below the cut-off for automatic loan approval will be randomly approved or denied. The randomized design generates exogenous variation in access to credit among SME loan applicants, enabling us to measure the impact of credit on firms. An important and innovative aspect of this evaluation is its focus on spillovers across firms. The project will measure vertical spillovers by surveying firms in the supply chains of loan applicants, and exploit variation in the number of firms receiving credit in different industries and markets to measure horizontal spillovers on firms competing directly with treatment and control businesses. Identifying competitor and supply chain markets and the horizontal and vertical interactions of sample firms constitutes a new approach to the study of firms in low- and middle-income countries. The findings are highly policy relevant. Evidence that providing credit to one firm has positive market spillovers, perhaps though increasing competition or allowing suppliers to invest more, would provide a strong justification for increasing access to credit. On the other hand, if gains to the firm receiving credit come entirely at the expense of losses to its competitors, then subsidized credit would accomplish little, suggesting that the gains from microcredit may be overestimated.