# **1. Introduction**

Given the important role that small and medium enterprises (SMEs) play in a healthy and dynamic economy, many studies have attempted to understand the factors that affect their creation and performance.<sup>5</sup> These studies show that SMEs face greater financial constraints than large companies, and that these constraints could be one of the factors that limit their growth (Hall, 1989; Beck et al., 2006; Beck and Demirgüç-Kunt, 2006; Beck, <mark>Demirgüç-Kunt, and Maksimovic,</mark> 2008; Cavallo et al., 2010; Ibarraran, <mark>Maffioli,</mark> an <mark>d Stucchi,</mark> 2010; Canton et al., 2013; Mateev et al., 2013). SMEs face greater financial constraints in part because they are subject to information asymmetries that are less salient for large firms. SMEs often lack audited financial statements and other information about their operations, and as a result, financial institutions have difficulties assessing the risk of lending to them (de la Torre, Martínez <mark>Pería, a</mark> nd <mark>Schmukler</mark> 2009).

This paper studies a novel intervention that aims to enhance the amount and type of information on SMEs useful to potential lenders. A large body of literature has examined the role of information sharing and credit bureaus in reducing information asymmetries and increasing credit to SMEs (see, for example, Brown, Jappelli, and Pagano, 2009; Love and Mylenko, 2003; Martinez Peria and Singh, 2014). However, not all countries have credit bureaus, because of coordination problems between lenders; and where bureaus exist, the information they provide may be limited, for legal and institutional reasons. Meanwhile, loan applicants with bureausupplied information are often subject to a chicken-and-egg problem. Bureau information is most useful for making credit decisions regarding loan applicants with a detailed credit history, but applicants can only build that history by getting credit, for which they need a good credit history.

The Entrepreneurial Finance Lab (EFL) has thus developed an alternative credit information tool that can potentially be used by lenders to better screen loan applicants. This tool uses a psychometric application to predict entrepreneurs’ repayment behavior. This study looks at the effectiveness of this tool in reducing the risk of lending to SMEs, as well as in expanding access to credit for small firms, in the context of a pilot exercise conducted in Peru. The financial

> 5 Numerous studies have documented the important role played by small and medium enterprises (SMEs) in the process of industrialization and economic development (Liedholm, 2002; Beck, Demirguc-Kunt, and Levine, 2005; Beck and Demirguc-Kunt, 2006; Ayyagari, Beck, and Demirguc-Kunt, 2007; Nichter and Goldmark, 2009; Liedholm and Mead, 2013). In many countries, such firms employ the majority of the workforce (Ayyagari et al., 2007; Haltiwanger and Krizan, 1999; Hijzen, 2010; Ibsen and Westergaard-Nielsen, 2011; Haltiwanger, Jarwin, and Miranda, 2013). In Latin America, Lecuona Valenzuela (2009), Solimano et al. (2007), and Ferraro and Stumpo (2010) provide evidence on the role of SMEs in Colombia, Mexico, Chile, and Brazil, respectively.

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