How can alternative data help Micro, Small and Medium Enterprises (MSMEs) access credit?

Micro, Small and Medium Enterprises (MSMEs) play a huge role in facilitating economic development due to their flexibility and affinity to innovation. Even more so in emerging economies with a high contribution from the informal sector. Yet, MSMEs face several challenges when trying to expand, especially in accessing adequate funds to finance their operations and growth. MSME Finance Gap (2017) estimates that informal SMEs face a finance gap of $2.9 trillion annually.  

Since MSMEs lack access to traditional credit facilities through banks and other traditional lenders, there is a shortage of credit data on MSME borrowers —also referred to as ‘thin file’ borrowers. This information asymmetry has paved the way for identifying new ways to assess the creditworthiness of MSME and other thin-file borrowers—including the use of alternative data in credit reporting.  The G20 High Level Principles on Digital Financial Inclusion recognizes the importance of exploring alternative data as a legitimate source of credit information. 

Alternative data has had many definitions over the years. The International Committee on Credit Reporting (ICCR) expands on alternative data as ways to collect and analyze data on creditworthiness based on information readily available in digitized form but ‘alternative’ to conventional methods such as documented credit history. It has been broadly categorized as

• Structured data e.g. utilities, mobile phone, rental information and taxes 
• Unstructured data e.g. social media and internet usage, emails, text and messaging files, audio files, digital pictures and images

As more work around this come forward, the definition will continue to evolve. Also, the specifics of this definition to a country or a region can differ, since it depends on the kind of credit information that the Credit Reporting Service Providers (CRSPs) in these jurisdictions collect. As a result, what is alternative in one market can be traditional in another.

What are some of the key policy areas and issues to look at when promoting alternative data?

• Improving the availability and accuracy of the information being collected. Due to the lack of clarity on what constitutes alternative data and how it should be treated, there are many issues countries face while ensuring the availability and accuracy of information collected. This is further exacerbated by the absence of digitized public information and digital footprint of MSME transactions, unavailability of data, or poor data quality. Regulators and policy makers can address this by issuing guidance on how alternative data may be sourced and processed. This could include implementing the use of unique identifiers like passports, identification alternatives such as social security numbers, tax identification numbers etc. Government agencies can also work towards digitizing their records and promoting the development and provision of access to Open Data Systems and Standards for MSMEs. 
• Expanding credit information sharing. Limited coverage and high minimum loan size thresholds for business loan data in CRSPs are another area of concern. This can be addressed by regulators promoting open, fair and competitive credit information sharing by these service providers and reducing or eliminating minimum thresholds for reporting financial commitments to CRSPs. In cases of inefficient markets, the feasibility of establishing a Credit Registry or Databank to promote information sharing can be assessed. 
• Enabling cross-border data exchanges. Identifying MSMEs across jurisdictions has been tough due to inconsistent and non-standardized identification systems. Policy makers and regulators can use a multi-level approach to deal with this. At the international level, they can coordinate and collaborate through standard-setting bodies like the Bank for International Settlements to develop cross-border data sharing standards and information regulations, and at a domestic level, they can encourage the adoption of a harmonized core set of data attributes to be shared domestically and across borders. This can also be complemented by assessing the feasibility of implementing the G20 Global Legal Entity Identifier or its variant for individuals such as ID4D in order to address cross-border usage and sharing of data. 
• Balancing integrity, innovation and competition. As the use of alternative data expands, regulatory authorities are faced with the challenge of balancing the need to encourage innovation while ensuring adequate consumer protection. To keep up with the fast pace of technological change and understand the benefits and risks to consumers, policy makers and regulators should collaborate on the development of principles of responsible innovation and consider the feasibility of implementing/ utilizing regulatory tools for enabling innovation, such as hubs and sandboxes, to promote alternative data centric innovations, including alternative scoring techniques, in their markets.
• Data Privacy, Consumer Protection and Cybersecurity. Among the most prevalent concerns regarding the use of alternative data is the inadequacy of the existing laws - be it data privacy laws, transparency and disclosure regimes, or regulation and laws on consent. The rapid growth of cybersecurity concerns and its potential impact on global financial systems also need to be dealt with. To combat some of these concerns, policy makers should ensure that alternative data is collected and processed lawfully, and consumers have the ability to object to the processing of their information, including the opportunity to transfer their data to any other service provider. Furthermore, cybersecurity risk assessments need to be embedded into the overall risk management procedures of industry participants, and consumers should be made aware of all the relevant information during the data collection.

The adoption of alternative data comes with various challenges and concerns that need to be addressed for it to be effectively leveraged. But overall, access to credit for MSMEs and individuals can be enhanced and expanded by promoting the use of alternative data in credit reporting.  Even more so for individuals and enterprises functioning in the informal sector with ‘no or thin credit files’, where complementing traditional data sources with alternative data sources can assist in the design of more custom-made financial products and services. Read more about the use of alternative data to improve access to credit for MSMEs here.