Abstract
This paper tests for bias in consumer lending using administrative data from a high-cost lender in the United Kingdom. We motivate our analysis using a new principal-agent model of bias where loan examiners are incentivized to maximize a short-term outcome, not long-term profits, leading to bias against illiquid applicants at the margin of loan decisions. We identify the profitability of marginal applicants using the quasi-random assignment of loan examiners, finding significant bias against immigrant and older applicants when using the firm’s preferred measure of long-run profits but not when using the short-run measure used to evaluate examiner performance. In this case, market incentives based on characteristics that vary across groups lead to inefficient group-based bias.
Highlights
In the United States, for example, blacks pay higher interest rates and are more likely to be rejected for a mortgage compared to observably similar whites, even after accounting for observable differences in credit history and earnings (e.g., Charles, and Hurst 2002, Bayer, Ferreira, and Ross 2017)
We find that our instrumental variable (IV) weights are largely uncorrelated with examiner-level estimates of bias against each group obtained from our marginal treatment effects (MTE) specification described below, indicating that our IV-weighted estimates of bias are likely to be very similar to estimates based on other weighting schemes
We find that the decisions made by loan examiners are strikingly consistent with a data-based decision rule minimizing short-run default, but inconsistent with a decision rule maximizing long-run profits
Summary
There are large disparities in the availability and cost of credit within many developed countries. Loan examiners in our setting have an incentive to minimize first-loan default, not maximize long-run profits, potentially leading them to discriminate against applicants where these outcomes systematically diverge Consistent with this explanation, we find no evidence of bias against immigrant and older applicants when using first-loan default as an outcome. Outcome tests based on standard OLS estimates suggest that black mortgage borrowers in the United States have, if anything, slightly higher default rates (e.g., Van Order, Lekkas, and Quigley 1993, Berkovec et al 1994) and similar recovery rates (e.g., Han 2004) compared to observably similar white mortgage borrowers, suggesting little bias in this market Both in-person and correspondence audit studies (e.g., Ross et al 2008, Hanson et al 2016) suggest that loan officers treat black and Hispanic mortgage applicants worse than identical white applicants. The Online Appendix provides additional results and detailed information on the outcomes used in our analysis
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