For certain lenders, social impact is just as important as payback
October 25, 2011
The traditional measure of a borrower’s creditworthiness has been simple: they repay their loans. But things are more complicated for today’s socially responsible lending institutions – such entities as ethical banks, microfinance institutions and credit unions – which need a fair and appropriate way to determine the creditworthiness of their socially-responsible borrowers. In the paper ‘A credit score system for socially responsible lending’, three researchers from the University of Zaragoza’s Department of Accounting and Finance (SP), offer a new credit scoring model that evaluates the social impact, as well as the financial aspects, of a borrower.
Assessing financial and social impacts
Researchers Begoña Gutiérrez-Nieto, Carlos Serrano-Cinca, and Juan Camón-Cala propose that loan applications presented to socially responsible lending institutions should be subject to different credit scoring criteria than that used by a mainstream bank, where only repayment matters. Assessment of both financial and social impacts should take place. “Socially-responsible credit scoring systems,” they continue, “should incorporate both the social commitment of the applicant and the social impact of the project to be financed.” This is in addition to the analysis of the applicant’s past behavior – their repayment history – and their current financial health.
But the most complex part of designing a ‘social credit score’ is how to perform a Social Impact Assessment (SIA) – in part because there is no clear consensus or commonly-accepted definition of SIA. One useful (and general) definition is that such assessment should identify “future consequences of a current or proposed action, which are related to individuals, organizations and social macro-systems.”
Social Return on Investment
In looking at the social impacts they wanted to assess – such as impact on employment, education, diversity and equal opportunity, health, environment and community outreach – the researchers adopted the Social Return on Investment (SROI) approach to SIA.
SROI is particularly appropriate for credit scoring, as it transforms social aims into (quantifiable) financial measures by using proxies (for example, if a social project is focused on employing the homeless, one proxy would assess annual savings in homeless benefits).
Lender’s know-how and mission
One further, and crucial, aspect of designing an appropriate credit scoring model for socially responsible lenders is to incorporate what the researchers describe as the lender’s ‘know how’ – its aggregated knowledge, understanding, and history – and its mission. ‘Know how’, for example, may reflect the lender’s prior experience with a potential borrower, an important part of the decision support system in granting (or refusing) a loan; while a lender’s ‘mission’ speaks for itself in terms of prioritizing loans (a lending institution with a mission to improve women’s financial status will have different lending priorities from an institution with a mission to mitigate climate change). A mathematical algorithm based on AHP (Analytical Hierarchy Process) aggregates lender’s preferences to partial scores assigned to the applicant. Then, a balanced scorecard showing strengths and weaknesses is displayed and a final score is obtained.“
The social credit score model should incorporate the lender’s know-how and should be coherent with its mission,” say the researchers in their abstract of the paper. “For social banks, good borrowers are those that perform activities with social impact; they do good in the ethical sense of the word.”
Reference and citing
A credit score system for socially responsible lending. Begoña Gutiérrez-Nieto, Carlos Serrano-Cinca & Juan Camón-Cala, 2011. Working Papers CEB 11-028, Universite Libre de Bruxelles.