A successful SME digital lending business depends on fast and accurate risk assessments.
Fast because it’s what your customers expect from a digital lender.
Accurate because if you make a poor lending decision, your business loses money and takes on additional risk. You can’t fund loans based on a hunch that your customers are creditworthy—you have to be certain about it.
Which customers you’ll extend credit to, and what the precise terms of the loan agreement should be, are the most critical decisions for your business. Who will pay on time? Who will default? What businesses make the most profitable customers?
These traditional time-consuming decisions are based on a close examination of creditworthiness, which drives the credit terms and limits, and is typically represented in the form of a credit score.
Business credit scorecards are the answer for today’s lenders looking to expedite this process. Throughout this piece, we will take a deeper look at what business credit scorecards are, how they work, and how they can help SME lenders make better, faster credit decisions.
The What: Business Credit Scorecards as the New Due Diligence
Credit managers no longer have weeks, or even days, to complete the due diligence process. In a matter of minutes, they need to mitigate risk, reduce days sales outstanding (DSO), and comply with today’s changing regulatory requirements.
Traditional bank lending relies more heavily on your credit score to determine creditworthiness, but customizable scorecards allow SME lenders to look at alternative factors. A FICO score is no longer the only determining factor.
A business credit scorecard is a customized formula with multiple variables, designed to dictate the level of risk a lending company will accept. While the development process is typically the same, a business credit scorecard will be unique for each financial institution as information will be applied differently based on the level of risk a lender is willing to tolerate.
The formula’s variables span different categories of payment experience, public record details, financial information, and third-party credit scores. Credit scoring involves between 10 and 20 variables, including:
- Years in business.
- Number of employees.
- Revenue.
- Number of liens.
- Net worth.
- Third-party credit scores.
While consumer credit scores range from 300 to 850, business credit scores are typically between 0 and 100. Major firms like Equifax, Experian, and Dun & Bradstreet all have their own methods for scoring credit.
The Why: Business Credit Scorecards Mean Faster, Better Decisions
While customers expect speed, lenders have to find a way to promptly and efficiently evaluate risk. Here are four broad benefits of using business credit scorecards in your digital lending business:
Reduced Risk
Better information leads to a better evaluation of risk, which means you have fewer customers who contribute to bad debt for your company. A credit scorecard alerts you of any red flags before they become an actual issue.
A recent McKinsey study shows that cutting-edge credit scoring models can lead to a decrease of up to 40% in credit losses in major financial institutions, making it clear just how effective they are at predicting customers’ likelihood to default.
Faster Decisions
By determining your tolerance ahead of time, you won’t waste time on borrowers who won’t be accepted in the long run. By having a predetermined rating for approvals and denials, you’ll spend far less time on the reviewing process, which ultimately translates to more bandwidth for loan servicing and onboarding.
Consistent Decisions and Quality Control
Subjectivity? Prejudice? Not with business credit scorecards.
Using the same formula every time, with a documented, repeatable process, makes it easy to train staff and leaves you far less vulnerable to disputes about creditworthiness. Consistent decisions mean employees are able to spend their time on more difficult accounts or spend time manually reviewing cases that are outside normative values.
More Revenue
Analyzing creditworthiness has traditionally been a highly manual and labor-intensive process. By automating even some of your credit decisions you will be able to process new accounts in greater volume.
Having a repeatable process for accounts that clearly fall within the parameters for either approval or denial means resources are allocated more efficiently. Credit managers can focus on accounts that are statistically in the middle, giving these accounts their focus for extra due diligence or adjusting term limits to adequately control risk.
The How: Business Credit Scorecards in Action
The benefits of automatically qualifying borrower potential are clear, but how do lenders go about designing their own business credit scorecards to benefit their organizations?
Knowing which variables to include in the formula depends on how your lending company defines creditworthiness and what “bad accounts” exist within the portfolio. Each lender’s appetite for risk is different. While some may actively target subprime markets with high-interest loans, others are looking for super-prime markets.
It’s important to define your individual target and define creditworthiness accordingly. Regardless of your market, “bad accounts” will be characterized by late payments or accounts that have gone out of business or gone bankrupt.
By defining your target (who is creditworthy) and analyzing current bad accounts (who should be avoided), we have an understanding of what the formula should predict. Now you can choose the appropriate variables to include within your business credit scorecard.
Then, the lender assigns a point value (up to ten) to each variable. The variables are weighted appropriately based on their importance, and the results are added. The total score determines the credit decision, with lower scores meaning credit is denied and high scores delineating acceptance. Middle-range scores can be assigned conditions for credit approval by adjusting terms or limits.
Developing and implementing business credit scorecards is an ongoing endeavor, which requires continual validation and testing to ensure risk is being adequately addressed, and that variables are still applicable.
Ideally, digital SME lenders should apply different scorecards for different segments of their portfolio.
Safer Credit Decisions Are Here: Demo Onyx IQ Today
Automating your lending processes, including the complexities of risk analysis, can translate to additional profit and efficiency through a shortened sales cycle and a better allocation of resources and time.
Drive efficient and secure credit decisions by combining all your data sources and customizing the process to tailor credit scoring to meet your organization’s needs. With Onyx IQ, you can effectively qualify borrower profiles, and close more deals.
See our business credit scorecards in action by scheduling a demo today or emailing us at info@onyxiq.com.
