Among other things, 2020 will probably be remembered as the year that trained the spotlight on some of society’s deep-seated inequalities. The Covid-19 pandemic affected almost every corner of the globe. That said, due to prevailing societal conditions, women and minorities suffered more than others during the health crisis. Then came a series of events that sparked massive protests against systemic racism and injustice all over the world. The unprecedented outcry forced people everywhere to take a good hard look at themselves and confront their inner biases.
And the sad, uncomfortable truth is that we all have biases. These may be implicit (unconscious) in nature, but they are biases, nevertheless. As the German poet Johann Goethe put it, "Man can promise to be upright, but not to be without bias." In the wake of these realizations, financial institutions and investors too must take a good hard look at the part they play in perpetuating these social and economic stereotypes. More importantly, as the cornerstones of societal growth, they must be at the forefront of negating them by making financial inclusion an uncompromising agenda.
The truth of the matter – How biases work their way into the credit system
Stereotypes are said to be cognitive shortcuts that our brains take to cope with the massive amounts of information coming in. In other words, instead of evaluating someone on an individualistic level (which takes time and is harder), our brains take the lazy way out by quickly forming an opinion on someone based on factors such as their gender, race, or age. Bankers and investors themselves have been on the receiving end of such generalizations with Hollywood regularly type-casting them as untrustworthy, conniving, and cold-blooded individuals whose only aim in life is to make a quick buck (blame movies such as Wall Street, The Wolf of Wall Street, and Boiler Room, just to name a few.) These cognitive side steps become problematic when they go from being an innocent generalization to an ingrained ‘fact’ that people use to make important decisions.
Nowhere is this truer than within the financial system. Stereotypes such as ‘Minorities are financially irresponsible’ or ‘Women are bad at business’ are age-old generalizations that have worked their way into the credit system with many accepting them as unspoken truths. A few years ago, the CEO of a VC firm in the United States found himself in hot water when he told a leading publication: “I can be fooled by anyone who looks like Mark Zuckerberg.” The embattled CEO later issued a clarification that his statement was made in jest. Whether he was joking or not, his words were an overt acknowledgment that stereotypes on what a successful entrepreneur should like do exist in the financial industry.
Unfortunately, these biases have created an uneven playing field for many. An eye-opening report by Morgan Stanley reveals that historic and cultural biases do indeed create a disparity in financing. In the report, surveyed investors admitted to having different evaluating standards based on race and gender. Often, women and people of color had to go the extra mile and tick a few extra boxes than their white, male counterparts to secure credit.
So, while the former group could secure an investment only by demonstrating results and performance, the latter could get funding just by demonstrating potential. These unfair playing conditions make it harder for marginalized groups to exit their vicious cycle of poverty and debt.
How things stand – What does the data say?
There’s no doubt that financial inclusion policies introduced over the last 2 decades have opened new avenues for the traditionally underbanked sections of society. Even with these initiatives though, progress has been slow. Here are some statistics that reveal just that:
In 2018, equity investors spent nearly $1 million on average in funding businesses. Of that, minority-owned businesses received only around $185,000
According to the Harvard Business Review, only around 2.8% of women-led startups received funding in 2019. That number dropped to 2.3% in 2020
A survey of over 250 investors and bank loan officers revealed that financiers are 3 times more likely to review male-led ventures than they are others
In a study of over 400 loan applicants, female borrowers were found to have a lower loan approval rate of 18% as compared to 35% for men, when all other conditions matched.
The same study found that the women who did get loans had higher repayment rates than their male counterparts
Some might argue that these statistics are the result of a pipeline problem - that the lack of diversity is because not enough women and minorities start businesses. That simply isn’t true. According to the US Senate Committee on Small Businesses, minorities are behind roughly 50% of the new businesses launched over the last decade. And, the ratio of female to male entrepreneurs is 7:10. So, this is not a pipeline problem but a belief and a process problem with societal biases working for some but against others.
Why financial inclusion is the need of the hour - What’s in it for lenders?
The unprecedented global protests that the world saw last summer have served to heighten awareness of society’s ingrained preferences even amongst those who are unaffected by them. Amidst this uproar, financiers cannot afford to stay silent. Doing that would only perpetuate the negative stereotype that they are an uncaring lot. In fact, banks and other lenders now have the golden opportunity to show the public and their stakeholders that they care about social causes just as much as they do about profits.
But it’s not only about the reputational brownie points that investment institutions can make from pursuing a financially inclusive lending policy. There are several important fiscal benefits to it too. Contrary to popular belief, women-led businesses generate better ROIs than those led by their male counterparts. An analysis of over 350 companies conducted by the Boston Consulting Group found that for every dollar invested, women-led businesses gave an ROI of over 85 cents. Male-led businesses, on the other hand, had an ROI of around 30 cents. In addition, a McKinsey study of over 1000 companies revealed that ethnically diverse companies are over 35% more likely to turn a profit than businesses that are homogenous.
Let’s also not forget the bigger picture. There is a close correlation between financial inclusivity and positive economic growth. A study by Citi GPS found that closing prevailing inequity gaps can add a whopping $5 trillion to the US economy.
How do we get from where we are to where we should be?
Rooting out in-grained biases is admittedly not an easy task. The unconscious nature of it all is what makes the task so complicated. The first step, of course, is to admit that there is a problem. This can be followed by putting financial inclusion policies in place and teaching financiers to evaluate borrowers based on their unique attributes rather than on the group they belong to. Another important step would be to revamp a lending system that is heavily dependent on traditional benchmarks of creditworthiness that marginalized sections of society are ill-equipped to meet. These systems inadvertently favor serial entrepreneurs and those that have an established track record, further reinforcing the haves and have-nots paradigm.
Technology can level the playing field
One way to do this is by incorporating newer technology into the credit management system. Using AI-augmented systems will minimize the risk of conscious and unconscious stereotypes working their way into the decision-making equation. Technology is not biased and can see it as it is and that evens the playing field like never before. In addition, AI systems, with their ability to process large and non-traditional datasets, can help fill in a lot of the gaps left by traditional credit assessments. The use of alternate data such as a credit applicant’s payment history, digital footprint, and account transactions opens up new and more socially inclusive ways to assess credit eligibility. This way even individuals and businesses that do not have an established credit history stand a chance of advancing up the credit system.
Furthermore, using AI-augmented early-warning systems such as TRaiCE allows financiers to expand their risk monitoring capabilities. Opening the doors wider will naturally increase the number of borrowers a bank gets. A robust credit monitoring system will be able to bear the burden of this increased volume, ensuring that financial inclusion does not lead to financial negligence. Importantly, these systems can help banks make more accurate credit default predictions based on fact and not on irrelevant factors such as gender, race, and geographical location.
Conclusion - Make equal opportunities a reality for all
Perhaps one of the few silver linings to come out of all the economic and social upheaval that occurred in 2020 is that financial institutions and lenders are now looking for ways to be more socially responsible. Recently, JP Morgan Chase committed to investing around $350 million in minority and women-owned businesses over the next 5 years. TD Bank and Bank of America have also made similar commitments. These individual steps, however, are just a drop in the ocean. To have a society where equal opportunities and representation are a reality for all, the entire investing ecosystem needs to be involved. By making financial inclusion an uncompromising agenda, banks and other lenders can lead the fight against unfair stereotyping. Since money talks, the rest of society will surely follow suit.