Bank risk ratings and the pricing of agricultural loans

Abstract

This paper reviews the prevalence of the use of risk ratings by commercial banks that participated in the Federal Reserve’s Survey of Terms of Bank Lending to Farmers between 1997 and 2002. Adoption of risk rating procedures held about steady over the period, with a little less than half the banks on the panel either not using a risk rating system, or reporting the same rating for all their loans in the survey. However, most of these banks were small, and roughly four‐fifths of all sample loans carried an informative risk rating. After controlling for the size and performance of the bank and as many nonprice terms of the loan as possible, findings reveal that banks consistently charged higher rates of interest for the farm loans they characterized as riskier, with an average difference in rates between the most risky and least risky loans of about 1 and a half percentage points.