Newsletter No. 6
March 11, 2015

Use of Advanced Credit Scoring Techniques by Conventional Lenders

Conventional lenders, including commercial banks, are increasingly incorporating what are called “psychometric” credit scoring techniques into their credit evaluation and underwriting procedures for small business (SME) loans. These loans usually only require that the borrower complete an application. Application only, or “App. Only” loans, based largely on the Fair Isaac Score (“FICO”)® score(s) of the principal owner(s) have been used extensively in the United States for at least 25 years, with mixed results.

Psychometric scoring techniques can include any number of metrics. Psychometric scoring is normally associated with on-line lending platforms such as Lending Club®. However, the metrics themselves are increasingly being incorporated into standard credit procedures found in most commercial banks, worldwide, allowing banks to offer loan products to small businesses that otherwise would not qualify as well as reducing underwriting costs. Psychometric scoring can complement the standard metrics used by banks and other lenders extending SME loans, including bank balances, trade references, as well as business and personal credit reports. Standard metrics focus on confirming a borrower’s cash flow and historic ability to handle and discharge credit obligations, whereas psychometric scoring might focus on the borrower’s personal qualities as support.

One developer of psychometric scoring systems is Entrepreneurial Finance Lab (EFL Global®) - EFL’s system is based on an application, plus a questionnaire completed by the loan applicant. Currently, CfC Stanbic Bank in Kenya is originating $1 million/month in small business loans, incorporating EFL’s system. Stanbic offers 2 loan products to SME borrowers, one with a 6-12 month term and loan amounts between $550 and $22,000, and another with a term up to 36 months and a maximum loan amount of approximately $33,000 (91.75 Shillings = $1.00). Descriptions for these 2 loan products can be found here -

Conventional “app. only” products have been in use in the United States since the 1980’s. As mentioned earlier they make substantial use of FICO scores and other metrics. In the US, app. only products have typically been used to extend credit for up to 60 months, with maximum amount of $100,000. In the late 1990’s, originators packaged app. only loans into syndications that were sold to the Public as securities, with the attractiveness being their high yield. As with sub-prime mortgage securitizations a few years later, these securities often received AA or AAA credit ratings from S&P and Moody’s. Also, as was later the case with sub-prime mortgage securitizations, a number of lease securitizations failed.

Problems with app. only securitizations included the “holdbacks” issuers had to provide, in consideration for high credit ratings that, effectively, increased the yield the issuer had to have on each loan in order for it to make economic sense. This had the effect of reducing the credit quality of the loans backing the security. Other problems often included FICO scores, found on the personal credit report of a business owner, not being an adequate predictor of the ability of the underlying business to pay off a loan.

As one Officer of ELF has said, some banks have had very good results using the ELF System, some have had mixed results, and some have dropped the system altogether. Hopefully banks in emerging markets will use psychometric scoring, alongside conventional credit analysis, in a way that confirms the ability of a potential borrower to repay a loan. However, as was the case with app. only loans, the danger is that there could be major defaults that, in the end, result in a contraction of credit extended to SME’s.

Newsletter No. 5
January 28, 2015

Smallholder Finance
Emphasis on Increasing Supply of Credit

I recently came across a report on smallholder finance, specifically trying to address the gap between demand for, and supply of, financial services to smallholder farms.    You can read the report here - The Report states that financial institutions currently only provide $20 billion, or 4%, of the Global capital needs of smallholder farms.

The Report recommends that one solution to this funding gap is for international donors and development banks to substantially increase supply-side technical assistance to financial institutions that extend credit to smallholder farming operations.     The Report argues that only 3% of such technical assistance is directed at alleviating supply-side constraints, with the rest going to stimulate the demand side, including improving farming practices, addressing value-chain bottlenecks, etc.

Supply-side assistance would include, but not be limited to, the following:

  • Development of credit guarantee schemes to provide support for financial institutions willing to extend credit to smallholders.
  • Development of smallholder lending products on an “end-to-end” basis, including term structure, underwriting, credit procedures, marketing, documentation and monitoring.
  • Advisory work with regulators and supervisors, to ensure that the lending products conform with regulatory an supervisory requirements

As I argued in Newsletter No. 3, a major supply-side constraint is the over-reliance by lenders on collateral as a basis for extending credit, as opposed to establishing that the potential borrower has sufficient cash flow to repay the loan.    In order to reduce reliance on collateral it is necessary for lenders, as well as regulators and supervisors, to understand how to establish that a borrower has adequate cash flow, and learn to rely on cash flow as the primary source of repayment.

While demand-side programs are still critically important, especially outreach to potential borrowers to help them improve record keeping, etc., it is equally important that potential lenders have loan products available that are both attractive to the potential borrower, protect the lender and makes sense in the market in which they are offered.

Newsletter No. 4
November 12, 2014

Agriculture in Ukraine
Access to Finance, or Lack Thereof, Drives the Size of Ukrainian Farms

One feature of Ukrainian Agriculture is the presence of large farming operations, commonly called “Agro-Holdings.”

Agro-holdings in Ukraine comprise at least 50,000 hectares (125,000 acres), and can be as large as 600,00 hectares (1.5 million acres). Agro-holdings make up approximately 25% of the land area of Ukraine under cultivation (approximately 32 million hectares). This newsletter will argue that the sole reason that Agro-holdings being so large is poor access to finance for most Ukrainian farmers. This newsletter will also briefly discuss the default of one of Ukraine’s largest Agro-holding, Mriya (, and its implications for future investment in Ukraine as well as future structure of Agro-Holdings in general.

Agro-holdings can include the following features:

  • All agro-holdings operate on leased farmland, where the operator leases farmland from former collective farm members who received Title when the collectives were privatized in 2000. Lease terms range from 20 to 50 years, require annual payments, and most all lease agreements give the lessee, the agro-holding in this case, the option to purchase.
  • Agro-Holdings can be either strictly farming operations or vertically-integrated, incorporating processing as well as large-scale growing of crops. An example of a vertically integrated Agro-Holding is MHP (, which is one of the 2 largest producers of broilers in Ukraine and, in addition, farms approximately 320,000 hectares (800,000 acres).
  • Unlike smaller farming operations in Ukraine, which grow up to 10 crops largely for risk-management purposes, Agro-Holdings usually grow a relatively small number of crops. According to its web site, MHP grows wheat, corn, sunflowers and rapeseed.
  • Many Agro-Holdings utilize international capital markets for both debt and equity. Shares of MHP are traded on the London Stock Exchange. Securities issued by other Agro-Holdings can be found on the Frankfurt and Warsaw Exchanges, among others. Some agro-holdings are owned by international private equity firms.
  • Agro-holdings experienced substantial growth in acreage between the beginning of the Financial Crisis of 2008, when Ukrainian banks began to experience large volumes of non-performing loans crimping their ability to extend additional credit, and today.

Most agro-holdings, with the exception of Mriya and one or two others, had a good year in 2014. In 2014, grain production in Ukraine was approximately 61 million tons, equaling the record in 2013, and this includes the loss of production in eastern Ukraine due to the on going fighting.

Advantages Enjoyed by Agro-Holdings –

Although larger farms may be able to negotiate discounts for inputs such as fertilizer and chemicals, there are little or no economies of scale in capital costs for large farming operations. Once a farm exceeds a certain size it must buy another tractor, hire an additional manager, etc.

The only reason that I can see that agro-holdings exist today in Ukraine, as defined, is that their mere size improves their access to financing, by allowing them to largely bypass local financial institutions which currently are dealing with non-performing loans and are unable to extend credit to any significant degree and, instead, raise capital on international markets and, in addition, use the futures markets. Agro-holdings also have advantages not enjoyed by most smaller Ukrainian farmers in access to transportation and grain/export terminals. If Ukrainian financial institutions were better able to serve the financing needs of the entire Ukrainian agricultural sector, including smaller farms, my belief is that one would not see farming operations in Ukraine of the size of Agro-holdings.

For example a few years ago a 5,000 hectare farm in eastern Ukriane sought financing from Ukrainian banks. After being turned down for bank financing in Ukraine they did an Initial Public Offering of common stock on a European stock exchange, at a time when there was a very strong apetite for offerings from Ukrainian farming operations. There is no more expensive cost of capital than selling shares, but this farm had no other choice. The transaction costs, legal and accounting fees associated with issuing shares, are substantial, and the issuing companies are giving up a share of their profits. The “cost” of equity can approximate 50% per year, compared to the cost of reasonably priced medium or long-term debt at around 12% (assuming the borrowing is in Dollars or Euros). Thus this farm paid a premium of, perhaps, 38%/year, the approximate difference between the cost of equity and the cost of debt, because their capital needs could not be met through Ukrainian financial institutions.

Mriya –

Mriya Agro Holdings currently farms approximately 300,000 hectares, mostly in western Ukraine, and sales in Fiscal Year 2013 of approximately $500 million. Mriya’s total outstanding debt is approximately $1.2 billion, and they’re currently in default to 4 different classes of creditors: Bond holders; commercial banks; leasing companies; international development banks, including the International Finance Corp. and the European Bank for Reconstruction & Development. From strictly an operational standpoint, there is no reason why Mriya should be in the state that it's in. In Ukraine operating costs, at least those denominated in local currency, are low, and Mriya is able to sell much of their output in hard currencies. Given Ukraine’s current precarious economic and fiscal situation, and its need to attract foreign investment, how the disposition of Mriya’s debts is handled within the Ukrainian legal and regulatory system may have a profound effect on the willingness of international investors to invest in Ukraine in the future.

Once the solvency of Ukrainian financial institutions returns to a point where they can consider extending additional credit to farming operations, I believe the advantage enjoyed by agro-holdings will disappear. The question then becomes what will happen to the large farming operations that currently dominate Ukraine’s agricultural sector, once they lose their advantage over smalling farming operations in Ukraine in access to financing.

Newsletter No. 3
August 6, 2014

Underwriting Loan Transactions in Emerging Markets
Collateral Complements Cash Flow, Not The Other Way Round

Until financial institutions in emerging markets, as well as regulators and supervisors, start using a potential borrower’s ability to repay a loan, as measured by the borrower’s cash flow rather than by the borrower’s available collateral, future growth in commercial lending in emerging markets is going to be limited, and the level of non-performing loans will continue to be elevated. Collateral, whether in the form of cash, personal or real property, or a combination, is a very effective secondary source of repayment on a loan, but it should never replace cash flow as the primary source of repayment. However, in many emerging markets collateral is not just considered the primary source of repayment; often collateral is the only source of repayment considered by a lender.

If cash flow, rather than collateral, can be established as the primary source of loan repayment in emerging markets, the following benefits can be expected:

  • Reduced collateral requirements will increase the number of potential borrowers
  • In return for reducing collateral requirements, lenders can likely increase loan interest rates, leading to increased loan profitability (in this particular country market interest rates, as advertised in the booklet, were quite low)
  • Lenders will be able to offer more innovative loan products to their customers

I was recently working on a commercial lending project in a West African country, where the objective of the project was to increase the volume of commercial lending, especially medium-term lending (terms of 13 – 36 months) to Small & Medium-Sized Enterprises (SME’s), by intervening with local financial institutions, regulators (in this case the country’s central bank), and fostering the formation of non-bank financial institutions focusing on medium-term lending. In virtually every emerging market with which I am familiar, non-bank financial institutions are always the first movers when it comes to offering new lending products. In the US, non-bank financial institutions were the first to introduce SME lending.

During the course of the project I had the occasion to speak at an SME Conference co-sponsored by the Country’s Ministry of Economy. One of the handouts at the Conference was a booklet, in which each major bank in the country was listed. Also listed were their loan terms. In every case the banks required collateral in an amount equal to 125 - 150% of the loan request. If such collateral was available in a form satisfactory to the lender, and the potential borrower met certain additional requirements, they would qualify for the loan. Nowhere in the requirements listed in the booklet was cash flow ever mentioned as a credit criterion, much less the primary source of repayment.

Central bank regulations for this Country emphasize collateral coverage over cash flow coverage. In addition to payment history, if the loan amount is not covered by sufficient collateral the central bank can force a financial institution to provision the loan. Ratios of non-performing loans in this country are very high, and lenders have reported losing a number of cases in Court, where they have brought suits against defaulted borrowers.

Under the auspices of the Central Bank, this Country has recently established a very sophisticated web-based secured asset registry, allowing lenders to file security interests (or ownership interests in the case of financial leases) in collateral used to secure a loan (or personal property in the case of financial leases). Although the secured asset registry will improve a lender’s ability to do what it is already doing, namely extending credit based on collateral, the registry is not a necessary condition to establish a potential borrower’s ability to repay a loan. Short of having to monetize collateral, only cash flow allows a borrower to repay a loan.

Every business has cash flow. In emerging markets it often takes a loan officer more effort to find and establish that there is sufficient cash flow for a borrower to repay a loan, in addition to having sufficient cash to repay existing obligations. It is not easy, but until financial institutions are willing to make this effort, and to satisfy regulators that cash flow, and not collateral, is the necessary requirement to establish that a borrower has the ability to repay a loan, loan growth to SME’s will lag and non-performing loans will continue to be elevated.

Collateral can and should be used as a means to augment a lender’s secured interest, but it should never be used as a primary source of repayment. To do so means that the lender, in order to be repaid, is effectively stating that he would have to liquidate the borrower’s collateral. I believe that this approach to loan underwriting leads directly to a higher level of non-performing loans and, in addition, more Court cases.

Newsletter, No. 2
October 25, 2013

Regulation & Supervision of Chinese Financial Service Providers – Major Developments Ahead

I recently had the pleasure of giving 7 presentations covering all aspects of leasing to a conference in Beijing, Peoples’ Republic of China (PRC) focused on leasing to Small & Medium Enterprises (SME) and agricultural enterprises. The conference was co-sponsored by the International Finance Corp. (IFC) and the China Banking Regulatory Commission (CBRC). There were approximately 140 people in attendance, made up of representatives from Chinese leasing companies as well as regulators from the CRBC. I came away from the Conference very optimistic about the future of commercial finance in the PRC as well as with a number of insights which I will share in this newsletter.

Based on what I learned at the conference, the Government of the PRC appears to want to increase the availability of credit to SME’s. To achieve this goal will require both major changes in how lenders in China underwrite transactions, as well as changes in regulatory and supervisory policies that will serve to support these changes. Overall policies that may support these changes may come as early as November 2013, from the meeting of the 3rd Plenum of the Chinese Politburo. These possible changes in policy have the potential to result in a significant expansion in commercial lending in China, to all types of Chinese commercial enterprises, as well as the number and type of commercial lenders.

The current situation in the PRC can be described as follows:

  • Bank loans make up approximately 80% of the capitalization of Chinese companies, with bonds and equity making up the rest, making China one of the most “banking-reliant” countries in the World
  • 5 State-owned and 12 joint-stock banks account for 70% of all lending in China
  • A large majority of the credit extended by the 17 State-owned and joint stock banks go to State-owned Enterprises (SOE’s)
  • The Peoples’ Bank of China wants the 17 largest Chinese banks to minimize risk, causing these banks to focus primarily on lending to SOE’s
  • Credit officers are very conservative in their underwriting and credit policies
  • Cash flow lending is a relatively new concept in China

In order to broaden access to credit for Chinese SME’s, the Chinese Government may consider the following:

  • Encourage increased loan volume from smaller Chinese banks, including approximately 120 smaller regional banks as well as local banks serving rural areas
  • Encourage the establishment of more non-bank financial institutions (NBFI), including leasing companies, which in China is called “de-banking.”
  • Improving the interest rate environment for savers, by offering higher interest rates for conventional deposits, as well as other “wealth management” products

One of my observations from attending the conference is that the Chinese Government wants to increase the flow of lending to certain types of industries, mostly private companies as opposed to SOE’s, including but not limited to:

  • Hi-tech
  • “Green Industries,” including companies who provide products and services designed to address the chronic are and water pollution problems that are found throughout China.
  • Agricultural enterprises

In fact the purpose of the conference was to make regulators working for CBRC more familiar with issues surrounding increased lending to SME’s and agricultural enterprises. In addition to these three industry groups, companies that provide products and services designed to address the aging of the Chinese population, are also receiving a great deal of attention from private investors as well as the Chinese Government.

To accomplish this goal Chinese financial institutions and regulators will likely have to modify existing practices, including:

  • Increased cash-flow lending to private companies 
  • Different ways of funding NBFI’s, including term loans extended by banks 
  • Increased use of different types of financial products, including leasing, revolving credit, etc. 
  • Changes in regulatory and supervisory policies designed to address changes in changes in credit policies and procedures by banks and NBFI’s.

As new policies are introduced into the marketplace, the next several years promise to be an exciting period for the Commercial Finance Industry in China.

NOTE - If you would like to receive future editions of this newsletter, please send me an email at, and I will immediately include you on the mailing list.

Newsletter, No. 1
June 23, 2013

Regulation & Supervision of Financial Services Providers –
More Isn’t Necessarily Better

When financial services providers consider whether or not to enter new markets, increasingly the existing and future regulatory and supervisory environment has become the major consideration.   Since the Financial Crisis of 2008, the reaction of Governments around the world has often been to tighten regulatory and supervisory regimes for all market participants, not just those whose failure might pose a systemic risk.

I fear that the unintended consequence of increased regulation and supervision may well be to constrain the ability of businesses, especially Small & Medium Enterprises (SME’s) to obtain the credit they need to efficiently operate and expand their businesses.    In order to insure that their countries and markets remain places where both lenders and borrowers, especially SME borrowers, can expand and grow, government agencies charged with regulation and supervision of financial services companies need to balance the future health of the industry they are responsible for regulating and supervising, against the level of systemic risk they are attempting to minimize.

Recently I attended the 31st Annual Euromoney World Leasing Convention in Berlin.    Speaker after speaker talked about increased regulation and supervision being a major reason for decisions not to enter new markets.      Financial leasing is often the means by which SME’s are able to obtain financing for new equipment, allowing them to make lease payments using the benefits of the equipment (increased revenue, cost savings, or both).

Examples of increased regulatory and reporting requirements given at the Convention included new German rules enacted in 2009 and applying to all leasing companies, bank-affiliated and non-bank lessors, operating in Germany.     According to speakers at the Convention, the increased regulatory and reporting (but not necessarily supervisory) requirements have caused smaller lessors to exit the German market.    Also, according to speakers, prospective new entrants to the German market have to comply with increased permitting requirements taking nearly a year to comply with.   In many cases, the result is a new entrant declining to even enter one of the world’s largest financial leasing markets.

Not only can increased regulation and supervision reduce the supply of credit, especially to SME’s, at a time when many SME’s are simply trying to survive, it also potentially reduces the opportunity for innovation.    Innovation in the Financial Services Industry almost always comes from smaller players, often non-bank financial institution.    For example in the United States US Leasing and Colonial Pacific Leasing, pioneers of SME leasing in the United States, were both Founded or Co-Founded by individuals with prior connections to the Forest Products Industry.    Once US Leasing and Colonial Pacific became highly successful in financing SME’s larger lenders, including banks, began to enter the market for SME financing.

Existing laws and regulations must also be consistent across applicable laws, as well as comply with internationally recognized principles applying to each financial product.    For example in Serbia the Law on Leasing states that the equipment supplier is responsible for delivering the equipment to the lessee, whereas the Law on Contracts and Torts states that the lessor is responsible for equipment delivery.    One of the internationally recognized principles of leasing is that of an “arm’s length transaction” which, among other things, stipulates that the equipment supplier is responsible for delivering leased equipment and that the lessee is not obligated to the lease unless and until the equipment is delivered and accepted by the lessee.      On this particular provision these two laws, both applying to financial services companies offering leasing, are diametrically inconsistent with each other.    

One area of commercial finance that increases risk in many markets is laws and regulations applying to foreclosure and/or repossession, most commonly the requirement for first obtaining a court order in order to foreclose or repossess.     In Ukraine, a draft law has recently been submitted to the Parliament that would allow lenders in cases of default, to foreclose and/or repossess assets without a court order.    If passed, this draft law will hopefully serve to allow Ukrainian lenders to reduce the level of non-performing loans and leases on their balance sheets, and thereby free up capital in order to start increasing the volume of new loans.


1. Regulators and supervisors should review all laws, regulations and supervisory protocols to make sure they are consistent with each other and consistently applied.
2. Regulators and supervisors should make efforts to familiarize themselves with the industries they are regulating and supervising, including participation in workshops and training sessions offered by financial service professionals.
3. Regulators and supervisors, along with the industries they regulate and supervise, need to work together to insure that the regulatory and supervisory regime offers both opportunities for financial services companies to efficiently serve the market, especially SME’s, and at the same time limit systemic risk.

NOTE - If you would like to receive future editions of this newsletter, please send me an email at, and I will immediately include you on the mailing list.