Streamline micro-merchant underwriting with personal credit scores

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December 17, 2013

Are you looking for a way to make micro-merchants profitable?

To make micro-merchants profitable, acquirers need to find a way to reduce the cost of boarding, without increasing the risk of their portfolio. The solution can be found by borrowing the automated boarding process that credit card issuers use.

Credit card issuers have used process automation to profitably extended credit to individuals for years. Using a combination of credit bureau scores and application scoring methods, card issuers have successfully and profitably built portfolios of credit card loans worth billions.

Personal credit scores are a better credit indicator for micro-merchants than commercial credit scores

Not only can acquirers use the same processes, they can use the same credit scores. Research conducted by Experian shows that for very small merchants, the beneficial owner’s personal credit scores are actually a better predictor of a coming default than commercial credit scores.

This makes sense because micro-merchants often blur the line between their personal and individual financials. They will often use personal credit cards for corporate expenses and pull income directly from their company’s earnings instead of taking a consistent wage.

Experian research shows that the smaller a business, the better the owner’s personal credit score is for predicting the likelihood of default. For example, personal credit reports indicated that the business would default before commercial credit reports 70% of the time for businesses with four employees or less.

Experian’s research also found that personal credit reports are twice as likely, compared to commercial credit reports, to predict a default for businesses that are less than two years old. For small and young companies, personal credit reports are a better indicator of creditworthiness than commercial reports.

How personal credit based micro-merchant underwriting works

Similar to credit card issuers, acquirers can automatically board customers using credit bureau scores, application scoring, or a combination of the two. Here’s how to do it:

1) The Merchant Fills Out An Application Online
– They answer questions about their personal income, residence, and credit history, and SSN; their business name, income, industry, delivery etc. They also authorize a credit check and sign a personal guarantee.

2) Card Issuer Builds a Risk Scorecard
– Each variable on the credit card application has a pre-assigned point value. After the merchant completes the application, their points are added together and the sum creates the merchant’s Application Score.
– The individual’s credit score is pulled from a credit bureau.

3) Approval Decision: Scores Are Compared to Cut-Off Values
– The credit bureau score and Application Score are compared to a cut-off value set by the bank’s management. The cut-off value is what protects the bank from taking on risky accounts.
– If both scores are greater than the cut-off value the account is approved. If both scores are less than the cut-off value the account is rejected. If one score passes, and one does not, a judgment call is made either by including another data point into the automated decision, or sending the application to an underwriter for review.

4) Customer Is Notified And Fulfillment Workflow Started
– The customer receives a notification that they have been approved, denied, or that their application requires further review.
– Approved accounts are sent to fulfillment, customer data is saved to their boarding platform, and a record of the application is saved for compliance.

Because personal credit scores are a better predictor of default for micro-merchants than commercial credit scores, acquirers can use the same boarding processes as card issuers to reduce their costs. Using a combination of individual credit bureau scores and Application Scoring methods, acquirers can maintain acceptable risk levels at less cost to make micro-merchants profitable.

Check out our blog to learn how to build your own micro-merchant channel.

Experian research here – Best Practices for Gathering Information on Small Businesses.