Recently, the head of the Small Business Administration, Maria Contreras-Sweet, gave a speech at the Center for American Progress where she detailed the agency’s expanded use of small business credit scores in an effort to streamline the lending process, improve accuracy, ensure fairness and, most importantly, facilitate the provision of more small loans to the nation’s entrepreneurs. This brought smiles to us at FICO, however, it was clear from the resulting media coverage there’s still some confusion about what exactly is a small business credit score. In this post, I hope to shed some additional light on this topic.
Perhaps the biggest misconception to clear up is that a small business credit score is not the same as a consumer’s FICO® Score. Unlike the FICO Score, which leverages information solely from the consumer credit report, small business credit scores consider multiple types of data from different sources. First is data about the business principal. While this may include information from the principal’s consumer credit report, small business credit scores also consider loan application details as well as items from the principal’s financial statements. Second, small business credit scores also include data about the business. This may include loan application details and information from the financial statement of the business, such as audited and management accounts.
In addition, small business credit scores may consider information, when available, in the business bureau credit report as well as from databases that track small business account information from financial institutions. There is a key distinction between business bureau credit report information and the data found in business data repositories. The former contains information on how the business pays its suppliers and vendors, while the latter provides a record on how the business pays its financial obligations (e.g., credit products like a bank loan). The blending of commercial, business-related data with consumer data about the business principal(s) is what distinguishes small business credit scores from consumer credit scores like the FICO® Score.
Another area that differentiates small business scores from consumer credit scores is the score range. FICO’s small business credit scores use a different range -- from 0-300 -- compared to the FICO® Score which generally has 300-850 score range.
Most importantly, small business credit scores are measuring risk and predicting performance on small business financial products. In contrast, consumer credit scores are designed to predict performance on obligations related to consumer financial products. FICO has built more than 100 different scoring models that serve very specific segments of the small business market, ranging from start-ups and micro lending to agriculture and leasing.
There are two main types of small business scores used today, both of which assess the likelihood of loan repayment. The first is an origination score used by lenders to accept or decline an application, determine the credit line as well as terms of the loan. The second type is an account management score which monitors account performance of the business and serves as an early warning sign of future credit risk.
While there are distinct differences between small business credit scores and consumer credit scores, they play the same role in the underwriting process – to assess credit risk. The components of sound underwriting -- often referred to as the “4 Cs” – involve a lender’s objective review of the following: Character, Capacity, Collateral and Creditworthiness. It’s important to remember that while credit scores are integral to determining creditworthiness, they are only a part of the underwriting process.
Few doubt the impact of credit scores on the expansion and democratization of the consumer credit market. Small business scores haven’t reached that level of adoption and understanding just yet. But, as Ms. Contreras-Sweet noted, they are playing a vital role in expanding the credit markets for America’s entrepreneurs, who are the backbone to growing our nation’s economy. There is certainly no confusion over these positive contributions which are definitely worthy of a big smile.
