Borrower's Choice Research Articles

Lending competition, regulation, and nontraditional mortgages

AbstractWe examine the factors that determine the likelihood of borrowers using nontraditional mortgages (NTMs) prior to the Great Recession. Borrower choice depends on borrower characteristics such as income, levels of asset holdings, credit score, and age, and on market factors such as house price appreciation as shown in the literature. We add to the literature by showing that lending competition was significantly associated with the early growth of NTMs while growth of nonbank lending was associated with a later‐stage expansion of NTMs. We also find that state‐level antipredatory lending laws were more effective in restraining the origination of NTMs in markets with higher levels of lending competition.

A Cambodian smallholder farmer's choice between microfinance institutes and informal commercial moneylenders: the role of risk attitude

PurposeThe purpose of this paper is to examine the extent to which individual risk attitude determines a Cambodian smallholder's choice between a commercial informal loan and a credit from a licensed microfinance institution.Design/methodology/approachThe paper analyzes a sample of smallholder farmers in the Ratanakiri province in northeastern Cambodia, a country with a long history of microfinance and a saturated microcredit market. Employing a binary and a multinomial logit model, this paper assesses the effect of individual risk attitude on the choice of a financial instrument.FindingsThe results reveal a statistically significant relationship between the choice of a credit source and an individual's risk attitude: On average (c.p.) the less risk averse the smallholder is, the more they tend to prefer an unlicensed commercial lender.Practical implicationsThe findings suggest that less risk-averse individuals tend to take up riskier and generally more expensive informal loans. Measures to increase the safe access to financial services for less risk-averse borrowers as well as improvements in financial literacy should be undertaken to protect smallholders from taking risky choices.Originality/valueAlthough existing studies have examined the importance of risk attitudes between credit provider and borrower, they focus mainly on the lender's perspective. This paper provides new insights on how risk attitude influences the borrower's choice in Cambodia. Thus, this study is relevant for policymakers in countries with oversaturated microcredit markets and a high prevalence of informal lenders.

Avoiding Sovereign Default Contagion: A Normative Analysis

Should debtor countries support each other during sovereign debt crises? We answer this question through the lens of a two-country sovereign-default model that we calibrate to the euro-area periphery. First, we look at cross-country bailouts. We find that whenever agents anticipate their existence, bailouts induce moral hazard an reduce welfare. Second, we look at the borrowing choices of a global central borrower. We find that it borrows less than individual governments and, as such, defaults become less frequent and welfare increases. Finally, we show that central borrower's policies can be replicated in a decentralized setting with Pigouvian taxes on debt.

Heterogeneous preferences of Russian residential mortgage borrowers

PurposeThis paper aims to examine the heterogeneity of preferences of mortgage borrowers of Russian state-owned suppliers of residential housing mortgages.Design/methodology/approachAnalysis takes into account the underwriting process and the choice of contract terms of all loans originated from 2008 to 2012. The data set contains demographic and financial characteristics for all applications, loan terms and the performance information for all issued loans by one regional bank which operates government mortgage programs. The paper uses a multistep semiparametric approach to estimate the determinants of bank and borrower choice controlling for possible heterogeneity of preferences, sample selection and endogeneity of contract terms.FindingsThe study found that the demand of low-income households who are unable to afford to improve the housing conditions by other instruments than government mortgage is less elastic according to the change both in interest rate and maturity compared with higher-income households.Social implicationsGiven lower elasticities of the demand, the low-income group of borrowers has higher potential cost of loan and is usually rejected by commercial banks. The presence of the Agency of Housing Mortgage Lending special programs with subsidized interest rate for special constrained categories (young families, teachers, researchers etc.) widens the access for housing conditions’ improvements as a part of housing affordability government program.Originality/valueThe main contribution to the literature is modeling choice of contract terms as interdependent by the structural system of simultaneous equations with heterogeneous marginal effects.

What Middletown read: print culture in an American small city

The discovery of a large cache of circulation records from the Muncie, Indiana, Public Library in 2003 offers unprecedented detail about American reading behavior at the turn of the twentieth century. Frank Felsenstein and James J. Connolly have mined these records to produce an in-depth account of print culture in Muncie, the city featured in the famed oMiddletowno studies conducted by Robert and Helen Lynd almost a century ago. Using the data assembled and made public through the What Middletown Read Database (www.bsu.edu/libraries/wmr), a celebrated new resource the authors helped launch, Felsenstein and Connolly analyze the borrowing choices and reading culture of social groups and individuals. What Middletown Read is much more than a statistical study. Felsenstein and Connolly dig into diaries, meeting minutes, newspaper reports, and local histories to trace the libraryAEs development in relation to the cityAEs cosmopolitan aspirations, to profile individual readers, and to explore such topics as the relationship between childrenAEs reading and their schooling and what books were discussed by local womenAEs clubs. The authors situate borrowing patterns and reading behaviour within the contexts of a rapidly growing, culturally ambitious small city, an evolving public library, an expanding market for print, and the broad social changes that accompanied industrialization in the United States. The result is a rich, revealing portrait of the place of reading in an emblematic American community.

Identification of Mortgage Demand Function with Heterogeneous Preferences

This paper analyzes the mortgage borrowing process from a Russian state-owned supplier of residential housing mortgages concentrating on the estimation of demand function with heterogeneous borrowers’ preferences. Analysis takes into account the underwriting process and the choice of contract terms of all loans originated from 2008 to 2012. Our dataset contains demographic and financial characteristics for all applications, loan terms and the performance information for all issued loans by one regional bank which operates government mortgage programs.We use a multistep semiparametric approach to estimate the determinants of bank and borrower choice controlling for possible sample selection and endogeneity of contract terms. The main contribution to the literature is modeling choice of contract terms as interdependent by structural system of simultaneous equations with heterogeneous marginal effects.We found that demand of low-income households who are unable to afford improving of housing conditions by other instruments than government mortgage is less elastic according to the change both in interest rate and maturity.

The Underwriting, Choice and Performance of Government-Insured Mortgages in Russia

This paper analyzes the mortgage borrowing process from a Russian state-owned provider of residential housing mortgages concentrating on the choice of having government insurance. This analysis takes into account the underwriting process and the choice of loan limit by the bank, the choice of contract terms and the performance of all loans issued from 2008 to 2012. Our dataset contains demographic, financial, loan terms and the performance information for all applications. We use a multistep nonparametric approach to estimate the determinants of bank and borrower choice. The main finding that the probability of having government insurance is linked to riskier loans, but insured loans also are more likely to be approved by the bank. The bank, when approving a borrower, takes into account not the probability of default but the difference between the probability of default and having government insurance.

Informal Loans in Russia: Credit Rationing or Borrower's Choice?

This paper examines the strategies of Russian households for choosing either the formal or informal banking sector as a source of credit. We aim to learn why households refuse to become clients of a bank and prefer to instead raise funds by borrowing from individuals – friends, colleagues, relatives, and other private parties. We use the results of “Monitoring the Financial Behavior of the Population” (2009-2010), a national survey of Russian households. Our results suggest that a household’s choice of the informal credit market is based not only on economic factors, but also on some institutional ones, including financial literacy, trust in the banking sector, and credit discipline. We show that choosing the informal market is explained by a lack of financial literacy, measured by mathematical competence and home accounting, as well as by a lack of trust in the banking sector as a whole. Borrowers from private parties demonstrate a higher degree of credit discipline: those who believe that repaying a loan is not obligatory are less frequently among informal borrowers and they choose the bank credit market. Our findings, however, are still in line with credit rationing theory. We show that better financial conditions reduce a household’s probability to use both formal and informal credit markets in favor of pure bank borrowing.

The relationship between personal debt and specific common mental disorders

Personal debt is now recognized as one of the many factors associated with common mental disorders (CMD). We aim to estimate the prevalence of 'specific' mental disorders based on ICD-10 research diagnostic criteria by type of debt and quantify the additional influence of addictive behaviours. A random probability sample comprising 7461 respondents were interviewed for the third national survey of psychiatric morbidity of adults in England carried out in 2007. The prevalence of CMD was estimated from the administration of the CIS-R. Respondents were asked about sources of debt and their borrowing choices. In 2007, 8.5% of adults were in arrears. Adults in debt were three times more likely than those not in debt to have CMD. The increased likelihood of CMD among those in arrears was found for all CMD and was irrespective of source of debt--housing, utilities and purchases on credit. The situation was exacerbated among those with addictive behaviours--alcohol or drug dependence or problem gambling. Those with multiple sources of debt and who had to obtain money from pawnbrokers and moneylenders had the highest rate of CMD, ≈ 50%. Debt is one of the major risk factors for CMD. This has practical implications for both health services and financial services, which both need to be alert to the association and adapt and train their respective services accordingly so that people in debt can access help for mental disorders and people with mental disorders can access help for debt.

The Great Liquidity Freeze: What Does it Mean for International Banking?

In mid-September 2008, following the bankruptcy of Lehman Brothers, international interbank markets froze and interbank lending beyond very short maturities virtually evaporated. Despite massive central bank support operations and purchases of key assets, many financial markets remained impaired for a long time. Why was this funding crisis so much worse than other past major bank failures and why has it proved so hard to cure? This paper suggests that much of that answer lies in the balance sheets of international banks and their customers. It outlines the basic building blocks of liquidity management for a bank that operates in many currencies and then discusses how the massive development of foreign exchange (forex) and interest rate derivatives markets transformed banks’ strategies in this area. It explains how the pervasive interconnectedness between major banks and markets magnified contagion effects. Finally, the paper provides some recommendations for how strategic borrowing choices by international banks could make them more stable and how regulators could assist in this process.

Reducing Foreclosures: No Easy Answers

This paper takes a skeptical look at a leading argument about what is causing the foreclosure crisis and what should be done to stop it. We use an economic model to focus on two key decisions: the borrower's choice to default on a mortgage and the lender's subsequent choice whether to renegotiate or modify the loan. The theoretical model and econometric analysis illustrate that unaffordable loans, defined as those with high mortgage payments relative to income at origination, are unlikely to be the main reason that borrowers decide to default. In addition, this paper provides theoretical results and empirical evidence supporting the hypothesis that the efficiency of foreclosure for investors is a more plausible explanation for the low number of modifications to date than contract frictions related to securitization agreements between servicers and investors. While investors might be foreclosing when it would be socially efficient to modify, there is little evidence to suggest they are acting against their own interests when they do so. An important implication of our analysis is that policies designed to reduce foreclosures should focus on ameliorating the immediate effects of job loss and other adverse life events rather than modifying loans to make them more affordable on a long-term basis.

An empirical analysis of borrowing behaviour of higher education students in the Netherlands

Many higher education students combine their study with a job on the side instead of taking up a loan. This paper examines the factors underlying this apparently myopic behaviour. We find that standard economic factors explain observed borrowing decisions to some extent. Students with easier access to financial resources borrow less often. Students with good earnings prospects and/or a high discount rate borrow more often, as do students who are prepared to take risks. An important non-standard factor affecting borrowing choices is debt aversion. We also find that a reduction in working hours will only have a limited positive impact on the time spend on studying.

Accounting Quality and Debt Contracting

We study the role of borrower accounting quality in debt contracting. Specifically, we examine how accounting quality affects the borrower's choice of private versus public debt market and how the design of debt contracts vary with accounting quality in the two markets. We find that accounting quality affects the choice of the market, with poorer accounting quality borrowers preferring private debt, i.e., bank loans. This is consistent with banks possessing superior information access and processing abilities that reduce adverse selection costs for borrowers. We also find that accounting quality has an economically significant but differential impact on contract design in the two markets consistent with differences in recontracting flexibility across the two markets. In the case of private debt, since there is greater recontracting flexibility, both the price (i.e., interest) and non-price (i.e., maturity and collateral) terms are significantly more stringent for poorer accounting quality borrowers, unlike public debt where only the price terms are more stringent. The impact of accounting quality on interest spreads of public debt is 2.5 times that of the private debt, since the price terms alone reflect the variation in accounting quality.

Accounting Quality and Debt Contracting

We study the role of borrower accounting quality in debt contracting. Specifically, we examine how accounting quality affects the borrower's choice of private versus public debt market and how the design of debt contracts vary with accounting quality in the two markets. We find that accounting quality affects the choice of the market, with poorer accounting quality borrowers preferring private debt (bank loans). This is consistent with banks possessing superior information access and processing abilities which reduce adverse selection costs for borrowers. We also find that accounting quality has an economically significant but differential impact on contract design in the two markets consistent with differences in recontracting flexibility across the two markets. For private debt (which has greater recontracting flexibility), both the price (interest) and non-price (maturity and collateral) terms are significantly more stringent for poorer accounting quality borrowers, unlike public debt where only the price terms are more stringent. The impact of accounting quality on interest spreads of public debt is 2.5 times that of the private debt, since the price terms alone reflect the variation in accounting quality. Overall, the results are consistent with greater recontracting flexibility of banks enabling them to write more customized contracts relative to dispersed bondholders.

Banking Scope and Financial Innovation

We explore the implications of financial system design for financial innovation. We begin with assumptions about the investment opportunities of firms, their observable attributes, and the roles of commercial banks, investment banks, and the financial market. We examine the borrower's choice between bank and financial market funding, the commercial bank's choice of monitoring capacity, and the investment bank's choice of whether to invest in financial innovation. Our main result is that financial innovation in a universal banking system is stochastically lower than innovation in a financial system in which commercial and investment banks are functionally separated. Article published by Oxford University Press on behalf of the Society for Financial Studies in its journal, The Review of Financial Studies.

The Borrower's Choice of Fixed and Adjustable Rate Mortgages in the Presence of Nominal and Real Shocks

This paper concerns the conditions under which borrowers select fixed and adjustable rate mortgages. The novelty of the paper lies in its capability to analyze the effect of nominal and real shocks separately. The fixed rate mortgage (FRM) versus the adjustable rate mortgage (ARM) choice is determined by the expected real interest rate differential, initial wealth, income, expected real and nominal income risk exposure—measured by different parameters—the value of the house, the appreciation of the house and the influence of the variance of nominal and real shocks. Results differ according to whether or not borrowers are restricted by the loan‐to‐value constraint.

Capital requirements, loan renegotiation and the borrower's choice of financing source

The main objective of this paper is to theoretically examine the impact of bank capital requirements on a borrower's choice of financing source. Our focus is on the tension between regulatory taxes, such as bank capital requirements (that reduce the value of a bank loan to a borrower), and the bank's incentive to renegotiate debt terms with financially distressed borrowers (that increases the value of a bank loan to a borrower). We show that borrowers that approach banks are necessarily of intermediate quality. This set of borrowers diminishes as bank capital requirements increase. Surprisingly, this happens not only because bank capital requirements increase loan prices and hence reduce the value of the loan to the borrower, but also because they weaken the bank's incentive to restructure troubled loans, thereby causing a dampened loan demand. Additionally, holding quality fixed, growth-oriented borrowers are more likely to prefer the capital market than borrowers expecting high cash flows early when facing a sufficiently high capital requirement. Finally, the effect of capital requirement increases is asymmetric - growth-oriented borrowers are more likely than ‘cash cows’ to migrate from banks to the capital market when banks confront higher capital requirements.

State and Local Governments as Borrowers: Strategic Choices and the Capital Market

State and local governments issue securities to obtain financing for publicly desired projects or activities. A borrower's optimum economic goal is to obtain the lowest cost of capital over the desired repayment schedule. The role of the government's chief financial officer is to design appropriate strategies to achieve this goal within a context of changing market conditions, debt structures, and influences on borrowing choices.

Factors Affecting Borrower Choice Between Fixed and Adjustable Rate Mortgages

For this study, data were collected from 352 mortgage borrowers to determine whether mortgage decisions are economically rational with regard to the type of mortgage believed to have the higher expected cost, and how various factors affect mortgage choice. For many borrowers, the type of mortgage with actual higher expected cost (based on interest rates and residency expectations) is not the type of mortgage thought to have the higher expected cost. The financial planning aspect of a mortgage choice and the risk factor have a significant influence on this choice, whereas lender constraints and the financial cost aspect do not. These findings suggest that consumer education programs focusing on mortgage choice are needed.

Self‐Selection in the Fixed‐Rate Mortgage Market

This paper analyzes the effect of information asymmetry between the lender and the borrower (i.e., the borrower knows how long he will reside in his home, whereas the lender does not) on the borrower's choice among the interest rate‐discount points combinations available in the fixed‐rate mortgage market. The analysis shows that if the rate‐points trade‐off of the mortgage menu is either too steep or too flat, then all types of borrowers will choose the same loan contract from the menu. In addition, if the rate‐points trade‐off is not convex to the origin, then only the contracts with extreme rate‐points combinations will be chosen by borrowers; all contracts with intermediate rate‐points combinations are redundant and will not be chosen by any borrowers. Intermediate rate‐points combination mortgage contracts would be chosen by some borrowers only if the mortgage menu were to provide a self‐selection function. Several necessary conditions of a self‐selection mortgage menu are depicted.