We all agree that small and medium-sized enterprises (SMEs) play a crucial role in the economy, and effective governance practices are instrumental in their success. At INBONIS RATING we wanted to go further and show scientifically and using AI models the significance of implementing proper governance practices in small and medium-sized enterprises (SMEs) and its impact on the financial capital of the company, specifically focusing on credit ratings and access to diversified and suitable funding sources.
Thanks to our comprehensive database that includes over 500 European SMEs rated by INBONIS RATING and contains a wealth of information we gathered a valuable resource for advanced AI models, with over 50,000 data points, hundreds of rating drivers analysed, and more than 50 qualitative questions recorded for each SME.
How we used AI
Technically, to analyse the correlation between environmental, social, and governance (ESG) practices and credit ratings, ESG scores were developed for each of the 500+ rating reports using Natural Language Processing (NLP) models. NLP, a subset of Artificial Intelligence (AI), focuses on processing and understanding human-written text. In this study, three models built upon Google’s Bidirectional Encoder Representations from Transformers (BERT) model were utilized: FinBert, FinBert-ESG, and FinBert-ESG-9. Credit Rating Reports, which provided detailed information on companies and their methodologies, were analysed using these models.
To obtain the scores, over 500 Credit Rating Reports with detailed information on companies and their working methodologies where studied. Each sentence of the report was run through the models and scored based on the prevalence of each subject and the sentiment of the sentence itself. E.g. a company with a high mention of Climate Change but a high negative sentiment would score poorly in this subsection. To score each company the scores of either positive or negative sentences were averaged to obtain a final score for each of the identified sectors.
The key findings are striking
Our findings indicate a strong correlation between governance practices, as defined in this analysis, and credit ratings, consequently influencing the availability of financial capital for the company. Analysis of the rating distribution among the 500+ sample revealed that companies with lower governance scores obtained credit ratings ranging from CCC- to BB-, while those with higher governance scores achieved ratings from BB- to BBB, representing an average improvement of four notches.
This analysis further underscores the importance of SMEs having a credit rating, as it highlights the limited visibility of good governance practices through simple quantitative scores alone. Instead, it emphasizes the value of more comprehensive evaluations conducted by credit rating agencies (CRAs) such as Inbonis Rating, which delve deeper into assessing and understanding the intricacies of a company’s governance practices.
Israel Pérez
Israel was the COO of INBONIS and responsible for the development of multi-platform analytical strategies. With more than 20 years of experience in international banking, he has worked at BBVA for 18 years, the last 12 in the United States, assuming different responsibilities, such as credit risk management of retail portfolios or fraud detection processes for different payment systems. He has extensive experience in product and channel development, risk management and analytical development teams in the US. He has also served on the boards of financial technology (Fintech) entities such as Upturn and non-profit organisations such as Ronald McDonald House. He holds a degree in Economics from the University of Alcalá, is certified as a ‘Financial Risk Manager’ by the GAAP Institute and has completed his higher education at Northwestern University in Evanston, Illinois.