Credit Sales and Risk Scoring: A FinTech Innovation

This paper explores the effectiveness of an innovative risk scoring FinTech model to predict the risk appropriate return of short-term credit sales. The risk score serves to mitigate the information asymmetry between the seller of receivables (“Seller”) and the purchaser (“Funder”), at the same time provides opportunity to the Funder to earn returns as well as diversify their portfolio on a risk appropriate basis. Selling receivables/credit to potential Funders at a discount helps Sellers maintain their short-term financial stability and provide the necessary cashflow for operations and other immediate financial needs. We use 18,304 short-term credit sales transactions between April 23, 2020, and September 30, 2022, from a private FinTech startup, and its Sustainability, Underwriting, Risk, & Financial (SURF) risk-scoring system to analyze the risk return relationship. The data includes risk scores for both Sellers of receivables (e.g., invoices) along with the Obligors (firms purchasing goods and services from the Seller) on these receivables, and provides, as outputs, the mutual gains by the Sellers and the financial institutions or other investors funding the receivables. Our analysis shows that the SURF score is instrumental in mitigating the information asymmetry between the Sellers and the Funders and provides risk appropriate periodic returns to the Funders across industries. A comparative analysis shows that the use of SURF technology generates higher risk appropriate annual internal rate of returns (IRR) as compared to nonuse of the SURF scoring system in these transactions. While Sellers and Funders enter in a win-win relationship (in the absence of a default), generally Sellers of credit are not often scored based on the potential diversification by industry classification. Crowdz’s SURF technology does so and provides the Funders with diversification opportunities with numerous invoices of differing amounts and SURF scores in a wide range of industries. The analysis also shows that Sellers generally have lower financing stability compared to the Obligors (payers on receivables), a fact captured in the SURF scores.