Good Borrowers Research Articles

Identification Strategy: A Field Experiment on Dynamic Incentives in Rural Credit Markets

How do borrowers respond to improvements in a lender's ability to punish defaulters? This paper reports the results of a randomized field experiment in rural Malawi that examines the impact of fingerprinting borrowers in a context where a unique identification system is absent. Fingerprinting allows the lender to more effectively use dynamic repayment incentives: withholding future loans from past defaulters while rewarding good borrowers with better loan terms. Consistent with a simple model of borrower heterogeneity and information asymmetries, fingerprinting led to substantially higher repayment rates for borrowers with the highest ex ante default risk, but had no effect for the rest of the borrowers. The change in repayment rates is driven by reductions in adverse selection (smaller loan sizes) and lower moral hazard (for example, less diversion of loan-financed fertilizer from its intended use on the cash crop).

Comment on “US Credit Crisis and Spillovers to Asia”

Comment on “US Credit Crisis and Spillovers to Asia”

The supply- and demand-side impacts of credit market information

We utilize a unique pair of experiments to isolate the ways in which reductions in asymmetric information alter credit market outcomes. A Guatemalan microfinance lender gradually started using a credit bureau across its branches without letting borrowers know about it. One year later, we ran a large randomized credit information course that described the existence and workings of the bureau to the clients of this lender. This pairing of natural and randomized experiments allows us to separately identify how new information enters on the supply and the demand sides of the market. Our results indicate that the credit bureau generated large efficiency gains for the lender, and that these gains were augmented when borrowers understood the rules of the game. The credit bureau rewarded good borrowers but penalized weaker ones, increasing economic differentiation.

The Emergence of Information Sharing in Credit Markets

We provide the first systematic empirical analysis of how asymmetric information and competition in the credit market affect voluntary information sharing between lenders. We study an experimental credit market in which information sharing can help lenders to distinguish good borrowers from bad ones. Lenders may, however, also lose market power by sharing information with competitors. Our results suggest that asymmetric information in the credit market increases the frequency of information sharing between lenders significantly. Stronger competition between lenders reduces information sharing. In credit markets where lenders may fail to coordinate on sharing information, the degree of information asymmetry, rather than lender competition, drives actual information sharing behavior.

The emergence of information sharing in credit markets

We provide the first systematic empirical analysis of how asymmetric information and competition in the credit market affect voluntary information sharing between lenders. We study an experimental credit market in which information sharing can help lenders to distinguish good borrowers from bad ones. Lenders may, however, also lose market power by sharing information with competitors. Our results suggest that asymmetric information in the credit market increases the frequency of information sharing between lenders significantly. Stronger competition between lenders reduces information sharing. In credit markets where lenders may fail to coordinate on sharing information, the degree of information asymmetry, rather than lender competition, drives actual information sharing behavior.

Relationship Lending and the Transmission of Monetary Policy

This paper demonstrates that the banking notion of relationship lending matters for the transmission of monetary policy. I first construct an asymmetric information model with a continuum of heterogeneous borrowers and the possibility of lender learning through repeated interactions. I then derive the optimal credit contracts in this environment and analyze their implications for aggregate output. A variety of contracts are observed in equilibrium, with sufficiently good borrowers entering into multi-period lending relationships and economies that can sustain these relationships exhibiting a smoother steady state output profile and a more gradual response to certain monetary shocks. The results are consistent with empirical evidence so the model provides a basis for investigating the proportion of cross-country differences in monetary transmission that can be explained by cross-country differences in relationship lending.

Two stages credit evaluation in bank loan appraisal

Traditionally, banks conduct standard credit evaluation such as credit scoring following the receipt of loan request and make the accept/reject decision accordingly. This research explores the possibility of two stages credit evaluation in lending process. When the evaluation cost drops below the trigger cost, it pays to conduct the second-stage loan appraisal. We derive two trigger cost thresholds for borrowers who are rated as credible and default in the first stage, respectively. Contingent on the share of good borrowers relative to the bad ones, the optimal strategy of the bank can be differentiated to implement second-stage evaluation on either (1) both types, or (2) only one type, or (3) neither type of the borrowers. We find that during severe economic contractions or in geographic areas/industries which are in deep troubles, whilst the borrowers who repay the loan are out-numbered by the borrowers who fail to pay, the trigger cost for good borrower is higher than that of default borrower. In this scenario, the banks are more inclined to undertake the second-stage credit evaluation on good borrowers. On the other hand, if the percentage of credible borrowers is higher than that of default borrowers, the trigger cost for good borrower lies below the trigger cost of default borrower. As a result, the banks are less inclined to undertake the second-stage evaluation on good borrowers.

The Emergence of Information Sharing in Credit Markets

We examine how asymmetric information and competition in the credit market affect voluntary information sharing between lenders. We study an experimental credit market in which information sharing can help lenders to distinguish good borrowers from bad ones, because borrowers may exogenously switch locations. Lenders, however, are also engaged in spatial competition, and lose market power by sharing information with close competitors. Our results suggest that more asymmetric information in the credit market increases information sharing behavior significantly. Stronger competition between lenders reduces information sharing, but its impact seems to be only of second order importance.

Endogenous screening, credit crunches, and competition in laxity

A simple model of lending with endogenous screening predicts that risk-neutral banks tend to adopt tighter lending standards under several conditions commonly seen in recessions: lower interest rates (or spreads), higher default rates, or a smaller fraction of good borrowers. Historical data support these predictions. In addition, better information about borrower types encourages tighter lending standards, and competition in laxity can arise with multiple banks. Within the class of symmetric screening decisions, endogenizing the interest rates disrupts the existence of equilibrium in pure strategies, just as when screening decisions are assumed to be exogenous.

Divining Value with Relational Proxies: How Moneylenders Balance Risk and Trust in the Quest for Good Borrowers1

This analysis of the U.S. credit industry explores how lenders evaluate people during the loan application process. They use a variety of risk‐assessment techniques in conjunction with trust‐building mechanisms that I call relational proxies. The relational proxies that lenders rely on are behavioral impressions, reputation information, and financial narratives that explain information on credit reports. Lenders use this subjectively evaluated trust assessment interdependently with standardized financial information to enhance their decision‐making process. Face‐to‐face evaluation of potential borrowers is mediated by institutional rules meant to reduce the need for trust. However, for the lenders in this study, a good borrower is always a trustworthy borrower.

Do good or bad borrowers pledge more collateral?

Purpose – The purpose of this article is to determine the optimal use of collateral in order to maximize the borrower's wealth by reducing the interest rate payments. This analysis is to shed light on the fundamental question whether good or bad borrowers pledge more collateral.Design/methodology/approach – The analysis bases on a simple firm value model similar to Merton's but with the additional feature that the borrower can bring in collateral. This article not only presents the case with perfect information between borrowers and lenders but also regards the consequences arising from asymmetric information.Findings – A bad borrower, who is characterized by higher bankruptcy costs, riskier projects, and a lower contribution to the project value, typically pledges more collateral than a good borrower. These relationships base on the existence of perfect information between borrowers and lenders. If asymmetric information in terms of the project's riskiness or the contribution of the borrower to the proje...

A Theory of Discouraged Borrowers

This paper examines the implications for the SME financing market of Application costs that vary between firms, and of imperfect screening of applicants by Banks. Under these conditions 'Discouraged Borrowers' can exist. These are good borrowers who do not apply for a bank loan because they feel they will be rejected. The paper shows that, under a range of assumptions, the scale of discouragement in an economy depends upon the screening error of the banks, the scale of Application costs and the extent to which the bank interest rate differs from that charged by the moneylender. Discouragement is shown to be at a maximum where there is some, but not perfect, information.

The Impact of Liquidity Constraints on Bank Lending Policy

This paper examines banks' provision of liquidity to depositors and provision of loans. The problem identified is that banks may not be able to provide new funds for borrowers who are short of cash, because either the return on investments is poor, or because depositors withdraw more funds than expected. Banks subject to liquidity shortages may ration loans to good borrowers. This problem is shown to depend upon the nature of the deposit contract and banks' inability to issue subordinated deposits. State contingent renegotiation of loans and matching of the duration of project returns and investment needs mitigates the problem.

The Role of Credit Evaluation in Agricultural Finance: Dicussion

Although Chhikara pointed out some of the severe limitations of the linear probability model, he was very kind to discriminant analysis models. The linear discriminant model is appropriate only if the explanatory variables are normally distributed. A high proportion of the financial ratios and other variables used in credit evaluation are not normally distributed. For example, most solvency ratios, such as percent equity, have a high proportion of the observations near one end of the range, a long tail in one direction, and a very short tail or no tail in the other direction. Given the non-normality of the distributions of many of the explanatory variables, discriminant analysis is clearly not an appropriate choice for most analyses. Continued use of discriminant analysis was justifiable when there were no good alternatives. But the development of a wide variety of logit and probit models, and the increase in computing power that makes maximum likelihood estimation of these models technically and financially feasible, have provided good alternatives. Future use of discriminant analysis in credit evaluation should be limited to situations where the authors clearly demonstrate that the explanatory variables have normal or near normal distributions. Further, tests of the performance of newly developed models should not use discriminant analysis results as the basis of comparison. Another important characteristic of the current state of the art is the pathetic level of understanding of misclassification costs. All of the models reviewed are explicitly or implicitly based on a minimization of misclassification costs. Clearly, the misclassification costs are not the same for all types of decisions. The costs of making a loan to a borrower who ultimately defaults are much different in both character and magnitude than the costs of not making a loan to a farmer who would be a good borrower. However, most of the models conducted to date, particularly those dealing with agricultural loans, have either ignored or assumed away the differences in misclassification costs. While this is

APPLICATION OF EXPERT SYSTEMS IN EVALUATION OF CREDIT CARD BORROWERS

An appropriate approach to determine and measure the characteristics of “good” borrowers has always been the subject of inquiry by various lenders both in domestic and international financial markets. Cost of bad debts incurring from non‐payers and slow payers is a major source of loss which would affect profits and consequently the value of the lending firm. A carefully designed and economically feasible method to select the right borrowers is consistent with the goal of a modern lending institution which is to minimize the risk of bad debts and increase the wealth of its shareholders. The issue of selecting good borrowers is more serious in the case of potential credit card holders where the number of applicants is far greater than the number of commercial, real estate, and other institutional borrowers. Lending institutions cannot afford spending more than a certain limited amount of time to scrutinize the application of each applicant. Competition and increasing cost of information are other reasons that a lender should approve or reject submitted applications in a reasonably short period of time with minimum decision errors.

Financing Requirements for the Oil and Gas Industry - North America

The characteristics of good energy company borrowers are strong management, integrity, diversification, flexibility, a sound financial basis and business acumen. Acceptable reasons for borrowing include requirements for working capital, plant expansion, modernisation, oil and gas field development and the manufacturing of oil tools and related products. Security for loans is based on the company's reserves, the duration of the debt and priority over other indebtedness. Most loans are evaluated on the grounds of general corporate credit, that is, the overall credit standing of the borrower.

Considerations in Bank Financing of Producing Oil Properties

Abstract The chartered banks in Canada play an important part in the oil and gasindustry by providing a large source of funds through oil and gas productionloans, and these loans permit a number of advantages to producers in borrowingagainst production. Production loans are self-liquidating in that repayment of the loan isobtained from the proceeds of the sale of production from the same propertythat provides security for the loan. The development of engineering reservoir techniques and the practice ofproration has permitted forecasts of production and income under relativelystable marketing conditions which provide a sound basis for the loan. Three principal elements considered in a production loan are: 1. The factors which determine whether the borrower can be described as a"good borrower." 2. The engineering report and economic and loan evaluation of theproperties. 3. The legal documentation and registration of security. A number of criteria are used by the banks in determining the amount of aloan which can be advanced against a given property. These criteria relate tothe projected net income, reserves, and fair market value of the property. When all of the requirements have been satisfied and the amount of the loanagreed upon, security is taken by a very simple document which is provided forby Section 82 of the Bank Act. Oil payment loans are widely used in the United States for oil propertyfinancing. Canadian tax laws differ from those in the United States and thesedifferences, particularly the absence of a provision for cost depletion, haveprevented the application of oil payment transactions in Canada. Although the chartered banks in Canada provide loans to all phases of theoil and gas industry, from exploration through marketing and distribution, thepurpose of this paper is to discuss only those loans which are made to theproducing segment of the industry against the security of oil and gas in theground and retired from the sale of production of the same oil and gas -the socalled production loans. It is intended to describe the criteria generally usedby the bank to determine the amount which it can safely lend against thesecurity of an oil or gas property, in order to provide a guide for theevaluation engineer. He should be able to make a reasonable estimate of theamount which can be borrowed so that he can advise his management properly ofthe economic and engineering feasibility of any project. This is especiallyimportant where a decision between alternative investments must be made and allof the economic factors must be considered.