For its first 27 years as a lender, Chicago-based Allies for Community Business (A4CB) used credit scores when deciding which small businesses would receive loans. But starting in 2021, the not-for-profit organization has ditched the input that boils down perceived borrower risk to a single number.
The reason, according to A4CB CEO Brad McConnell, is that the credit score includes factors that his group believes are not relevant when assessing a borrower’s attitude toward debt. For example, he says, a long-past medical emergency or other singular event that caused trouble paying debts does not determine a person’s future ability to repay.
A4CB now evaluates would-be borrowers on the city’s financially underserved West and South Sides “in a much more streamlined, rules-based manner that is based on the habits of the small-business owner,” says McConnell.
Of particular interest to A4CB in its screening process are the answers to three questions:
Have you avoided bankruptcy and charge-offs above $500 over the last two years?
Over the last 12 months, have you repaid on time for all of that you’ve taken out that’s shown in your credit report?
Do you currently have at least 25 percent availability on your outstanding credit lines?
BAI recently spoke to McConnell for an episode of the BAI Banking Strategies podcast. Below are some of the conversation’s key questions and answers, both of which are edited for length and clarity.
BAI: What makes you confident that the answers to those three questions are enough to strike that balance between wanting to get to “yes” on a loan and, at the same time, protecting your lending capital?
McCONNELL: Over the last several years, we were doing exactly what we’re doing now, but we were doing it informally. Our underwriters would look at each individual loan application, and they’d often ask one more question or ask for one more bit of information. But, we found in our analysis that it didn’t really add much to our predictive ability. Now, we’ve taken what we were doing and codified it to make the process much more efficient and electronic. Having good relationships with the small business owners that we’re lending to and providing them good advice on how to use that capital and handling all the other issues that arise over time makes it more likely they’ll pay us back.
What are the early results that you’re seeing on how it might help you fulfill your mission as a community lender?
From the initial anecdotal evidence, I can make a couple of observations. The first is that we’ve seen a huge spike in the number of applications relative to what we would have expected otherwise. The second thing is that we’re seeing a difference in the tenor of the relationship that we’re building from Day 1 with small business owners. I think we’re showing respect for community business owners who have been told “no” over and over again when they have sought capital through traditional channels. That relationship-building really matters.
Over the past year or so, many financial services providers have made public statements about making more money available in underserved communities across the country. What are you seeing in terms of how those commitments are being converted into action?
We’ve seen a significant increase among a number of institutions and the dollars that they’re willing to invest at very low rates in organizations like us. That enables us to go off and do what we do, which also I think creates a higher degree of accountability for us. I welcome this because when people make bigger investments, they have bigger demands for transparency and accountability and for results. That pushes us to do more, and it allows us to do more and to do it better.
Based on your experience, what do you think banks and other lending capital providers need to know to truly be effective in underserved communities?
You need to know in a much more nuanced manner what the demand is and then how best to shape supply for that demand. That’s number one. Number two is, once you’re a financial institution who understands the demand, then you’ve got to deliver. You have to make offerings that suit the needs of a business owner who’s working in a low-income community, but who has a really good idea and hard work they will apply to that. Small business owners want to create wealth and jobs in their community, but they need the assistance to do so.
What can banks learn from groups like A4CB about how to think about credit, lending and even the broader community?
One of the main reasons why large institutions don’t do small-dollar loans is that they’re not economical. We’re trying to prove is that it’s not nearly as uneconomic as everyone thinks it is. We’re trying to drive down the unit costs of doing a small-dollar loan, while at the same time continuing to say “yes” as often as possible and also keeping our price low. All of the lessons that we’re learning, we’re absolutely going to share with bigger financial institutions. On the community side, it requires being with people in their communities, and that’s awfully hard to do at scale in a way that’s cost-efficient. That kind of work is a much tougher thing for a traditional financial institution to get right. But it’s absolutely the right thing to do, and it’s crucial to do for the reputation of each organization that cares about community development.
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