TITLE:
Does Psychometric Testing in Microfinance Actually Work?—The Case of Sogesol
AUTHORS:
Rocheny Sifrain
KEYWORDS:
Credit Risk, Credit Scoring, Psychometric Testing, Microfinance
JOURNAL NAME:
Journal of Financial Risk Management,
Vol.9 No.3,
September
29,
2020
ABSTRACT: Psychometric testing is claimed to be a powerful innovation in credit scoring. Pioneered by the Entrepreneurial Financial Lab (EFL), this technique would enhance credit decisions by screening out high-risk applicants. This paper aims to evaluate the predictive power of the EFL’s psychometric credit scoring model in microfinance through evidence from Sogesol, a Haitian microfinance institution. This evaluation has been conducted at two different levels: 1) A sample of clients has been selected from Sogesol’s database to carry out a back test of the EFL tool, using performance metrics such as the Kolmogorov-Smirnov (K-S) statistic, the area under the ROC curve (AUC) in comparison with the existing socio-demographic model in use at Sogesol; 2) We conduct an analysis of causality between the quality of the portfolio and the credit decisions made based on the EFL tool and/or the traditional credit scoring model through the estimation of a linear regression model. The results show that the psychometric credit scoring model would present low predictive power in terms of K-S and AUC. However, the EFL tool would outperform the socio-demographic credit scoring model in use at Sogesol. The study further indicates that there would not be any statistically significant relationship between the risk level and the decision of granting a loan or not. The paper concludes that psychometric testing in its original format would not be efficient in the context of Sogesol’s microcredit operations. Thus, the paper develops a new credit scoring model along traditional socio-economic and behavioral lines, using logistic regression. This new model presents a better discriminatory power than the EFL tool, regarding K-S and AUC. In addition, it is well-calibrated, considering the results of Hosmer-Lemeshow (HL) test and the Brier score. If properly maintained and integrated into the client selection process, this new model could significantly improve credit risk management practices at Sogesol.