Lower Default Rates Research Articles

Evaluating the impact of demographic characteristics on residential mortgage default risk: Evidence from Lebanon

Purpose: This study aims to examine the relationship between borrower's demographic characteristics and default risk in mortgage loans to help financial institutions develop more effective lending policies. Design/Methodology/Approach: Cross-sectional data were elicited from randomly selected 6743 individual accounts from Lebanese housing banks. This study applied the binary logistic and stepwise regression models to analyze the dataset using the Stata statistical software. Model diagnosis is performed using the Hosmer-Lemeshow goodness of fit test, likelihood ratio test, model accuracy classification table and statistically significant test-ROC curve. Findings: The findings revealed that there is a significant relationship between residential loan default risk and borrower’s marital status, nature of job occupation, job economic sector, job location and loan purpose. The performance of the binary logistic regression analysis demonstrates the overall percentage who is correctly classified is 91.61%. Conclusion: The log odds of default risk for widowed borrowers are about 90 percent higher than those of divorced borrowers and that of self-employed borrowers is about 54 percent higher than that of employed borrowers. Borrowers working in the banking and real estate sectors have lower default rates than borrowers working in other economic sectors. In addition, loans granted for renovation purposes have the lowest default rates compared to loans provided for purchase, under-construction and construction purposes. Practical Implications: The empirical results help financial institutions to have early warning signals in detecting financial distress and to differentiate between a high- and low-risk group of borrowers, helping in the development of tailored risk mitigation strategies and adjusting the lending criteria.

Responsible access to credit for sole-traders and micro-organizations under unstable market conditions with psychometrics

In a context of market volatility, the growing complexity of financial products, and a shift towards self-employment, there is an increasing demand for inclusive financial services for sole traders and micro-organizations. To address this need, we conducted a study using real-time data from a Fintech lender in the Czech Republic to assess the effectiveness of a new financial literacy based psychometric credit scoring model (PSM) in improving access to finance for micro, small and medium sized enterprises (MSME) sector, particularly sole traders, and micro-organizations, during volatile market conditions. This study affirms that PSMs play a significant role in responsibly including this underserved sector. Specifically, we observed a 30% higher approval rate and a 23% lower default rate when utilizing the PSM versus the traditional credit scoring model (TCSM). Moreover, during the period of substantial market volatility and instability, such as the state-of-emergency during the COVID-19 pandemic, the PSM exhibited a 13% higher approval rate at a 20% lower default rate than the TCSM. This evidence supports the proposition that PSMs offer a viable option for promoting financial inclusion and targeted financial education among MSMEs in the face of instable financial markets.

Interaction Effect Between Loan Officers’ Characteristics and Loan Default Rate on Crowdfunding Approval

MicroFinance Institution (MFI) officers screen loans for a prosocial crowdfunding campaign in developing economies. However, loan officers’ screening decision is influenced by loan officers’ default rate, hence the loan officers are likely to focus on the better borrowers. However, crowdfunding emerged to provide finance to entrepreneurs who are less likely to meet the loan screening requirements. Thus, this study examined the interaction effect between loan officers’ characteristics and loan defaults on crowdfunding approval. We usedordered logistic regression to primary data collected from loan officers in microfinance institutions that are registered by the largest prosocial crowdfunding platform Kiva asfield partners. The study found a significant interaction effect of loan officers’ default rate and gender, experience and crowdfunding awareness. Thus, the results implied that, the demographic characteristics of the loan officers are interacted by the loan officers’ default rate when deciding to approve a loan for a crowdfunding campaign. Therefore, the findings recommended imparting loan officers with techniques that will help them keep a low default rate and those loan officers with a low default rate should work on crowdfunding approval

Rise of the Machines: The Impact of Automated Underwriting

Using a randomized experiment in auto lending, we find that algorithmic underwriting outperforms the human underwriting process, resulting in 10.2% higher loan profits and 6.8% lower default rates. The human and machine underwriters show similar performance for low-risk, less complex loans. However, the performance of human underwritten loans largely declines for riskier and more complex loans, whereas the machine performance stays relatively stable across various risk dimensions and loan characteristics. The performance difference is more pronounced at underwriting thresholds with a high potential for agency conflict. These results are consistent with algorithmic underwriting mitigating agency conflicts and humans’ limited capacity for analyzing complex problems. This paper was accepted by Will Cong, finance. Supplemental Material: The online appendix and data files are available at https://doi.org/10.1287/mnsc.2024.4986 .

The Impact of Risk Retention on Moral Hazard in the Securitization Market

Based on European RMBS deals with 24 million quarterly loan observations, we examine the effect of risk retention on bank behavior. We show that retention deals perform better due to improved monitoring effort and workout processes. We find that the probability of rating changes and collateral revaluations is higher for retention loans, and ratings are more accurate; retention loans have a lower probability of becoming non-performing, a lower delinquency amount, and a shorter time in arrears. Moreover, non-performing and defaulted retention loans are more likely to recover. Reduced losses for deals with retention are associated with lower default rates, lower exposures at default, and higher recovery rates. Our results suggest that retention reduces moral hazard and incentivizes banks to exert higher effort, which results in superior securitized asset performance.

Role of Domestic Banking and Financial Institutions in Project Finance: Insights from Hydropower Sector in Nepal

Hydropower is a low carbon renewable energy alternative for replacing carbon emission energy sources. In Nepal, this infrastructure sector is being developed for fulfilling the internal demand of electricity. Previous studies emphasized public-private partnership (PPP) utilizing project finance (PF) model in infrastructure sector. Recognizing the importance of domestic banking and financial institutions (BFIs) in project finance this study delves into factors significantly affecting the role of BFIs in project finance. Cross-sectional survey utilizing questionnaires was conducted among respondents representing the independent power producers (IPPs) and BFIs in Nepal. Regression analysis showed predictor variables like economic environment, guidelines of the central bank and low default rate have significant impact on project finance. issues related to adequate legal provision for non-recourse financingrole of BFIs for project finance arrangement. Credibility of hydropower project sponsors is an important determinant in financing hydropower project. The availability of comparatively more bankable projects in other investment sectors against the investible fund constraints resulted in limited complete project finance arrangement of hydropower projects. Detail investigation on guarantees to the lenders against the project loan and improvements needed in legal frameworks to accommodate the non-recourse finance and making economic and legal environment friendlier to private sector is the limitation of this study left for future researches.

Repayment Flexibility and Risk Taking: Experimental Evidence from Credit Contracts

Abstract A widely held view is that small firms in developing countries are prevented from making profitable investments by lack of access to credit and insurance markets. One solution is to provide repayment flexibility in credit contracts. Repayment flexibility eases both the credit constraint, as it allows for increased spending during the start-up phase, and offers insurance, in case of fluctuations in income. In a field experiment among traditional microfinance clients and larger collateralized borrowers in Bangladesh, we randomly assign the option to delay up to 2 monthly repayments at any point during a 12-month loan cycle. The flexible contract leads to substantial improvements in the traditional microfinance clients’ business outcomes, driven by borrowers in the upper tail of the distribution. In addition, we find a significant impact on socio-economic status, combined with lower default rates. We show theoretically and empirically that these effects are induced by an increase in entrepreneurial risk taking, implying that the primary mechanism is insurance provision. Repayment flexibility also attracts less risk-averse borrowers interested in business expansion. At the same time, the effects for the larger loan are much more modest. Our findings suggest that lack of insurance is an important constraint for small firms but that a simple financial product that increases repayment flexibility can be an effective tool for enabling enterprise growth.

Optimal Capital Structure and Risk Management Policies of Banks That Use CoCo Futures to Hedge Financial-Sector Risk

Abstract We investigate the joint optimal risk management and capital structure decisions of banks when they use contingent-convertible (CoCo) futures contracts to hedge financial-sector risk. In spite of banks choosing significantly higher leverage ratios, their default probabilities drop appreciably while their equity values increase, allowing banks to compete more favorably with the shadow-banking system. Banks’ value-maximizing decision to hedge financial-sector risk unintentionally leads to an economy with extremely low aggregate bank default rates across all future states of nature. Thus, CoCo futures offer a powerful microprudential and macroprudential policy tool. That banks choose not to hedge financial-sector risk in practice is consistent with managers internalizing bank bailouts.

Reconciling Algorithmic Fairness Criteria

Reconciling Algorithmic Fairness Criteria

Climate change and credit risk: The effect of carbon tax on Italian banks' business loan default rates

Climate change poses severe systemic risks to the financial sector through multiple transmission channels. In this paper, we estimate the potential impact of different carbon taxes (€50, €100, €200 and €800 per ton of CO2) on the Italian banks’ default rates at the sector level in the short term using a counterfactual analysis. We build on the micro-founded climate stress test approach proposed by Faiella et al. (2022), which estimates the energy demand of Italian firms using granular data and simulates the effects of the alternative taxes on the share of financially vulnerable agents (and their debt). Credit risks stemming from the introduction of a carbon tax - during periods of low default rates - are modest for banks: on average, over a one-year horizon, the default rates of firms increase but remain below their historical averages. The effect is heterogeneous across different sectors and rises with the tax value; however, even assuming a tax of €800 per ton of CO2, the default rates are below their historical peaks.

A household-based community health worker programme for non-communicable disease, malnutrition, tuberculosis, HIV and maternal health: a stepped-wedge cluster randomised controlled trial in Neno District, Malawi

BackgroundCommunity health worker (CHW) programmes are a valuable component of primary care in resource-poor settings. The evidence supporting their effectiveness generally shows improvements in disease-specific outcomes relative to the absence...

Impact of income diversification strategy on credit risk and market risk among microfinance institutions

PurposeThis study explores the effect of income diversification strategy on credit risk and market risk of microfinance institutions (MFIs) in Ghana as an emerging market.Design/methodology/approachThe study is based on quarterly data of averagely 271 MFIs that have operated from 2016 to 2018. The dataset is unbalanced and pooled cross-sectional with 3,259 data points. The study measures the diversification strategy using income diversification indices, and accounting ratios to measure the other variables. We utilised the weighted least squares (WLS) approach to explore the nexus.FindingsThe findings show that income diversification is associated with better loan quality and credit risk management. Market risk increases with the level of income diversification of microfinance firms. It is evident that large MFIs can manage their credit risks well and can have a low default rate, depicting an overall U-shaped nexus. On the other hand, the effect of size on market risk is an inverted U-shaped. The effect of asset tangibility on credit risk is positively significant while the effect on market risk is negatively significant. High profitability enhances credit risk management leading to lower loan losses while in the case of diversified and profitable MFIs, they tend to invest more in government securities. The results suggest that MFIs that hold more cash and cash equivalents tend to have high loan loss provision and more government securities suggesting much attention should be paid to optimal cash management.Practical implicationsThe results throw light on the credit risk and market risk profile of the firms and the effect of diversification strategies on them. The findings are relevant for effective macroprudential regulation, market regulation and prudential regulation of the microfinance sector.Social implicationsThe findings reveal the nature of income diversification strategy of MFIs in emerging markets such as Ghana, pointing out how they affect the risk exposure of MFIs that lend to the pro-poor population.Originality/valueThis is a premier formal assessment of the nexus between income diversification strategies and risk management among MFIs that serve the pro-poor population in the emerging market context.

Social Capital, Trusting, and Trustworthiness: Evidence from Peer-to-Peer Lending

AbstractHow does social capital affect trust? Evidence from a Chinese peer-to-peer lending platform shows that regional social capital affects the trustee’s trustworthiness and the trustor’s trust propensity. Ceteris paribus, borrowers from regions with higher social capital receive larger bids from individual lenders and have higher funding success, larger loan sizes, and lower default rates, especially for low-quality borrowers. Lenders from regions with higher social capital take higher risks and have higher default rates, especially for inexperienced lenders. Cross-regional transactions are most (least) likely to be realized between parties from regions with high (low) social capital.

Cooperative lenders and the performance of small business loans

This study reports that small business loans advanced by cooperative lenders have a significantly lower probability of default than those disbursed by mainstream banks—at least for the first four years post disbursement, during which default costs are highest. Default rates are particularly low among loans to younger, and, to an extent, smaller, firms; and loans to firms that had experienced significant changes in their business environment post-disbursement. These results are consistent with the argument that cooperatives face relatively less severe information asymmetry because their close community ties facilitate soft information production and their governance structures embed self-selection and peer monitoring mechanisms (e.g., Angelini, Di Salvo & Ferri, 1998). Comparison of loan portfolio performance between co-ops and small regional banks suggest that both close community ties and governance structure contribute to cooperatives’ lower default rates. Results are robust to distance and competition effects, and to various alternative explanations.

How Does Peer-to-Business Lending Affect Financial Policy of SMEs?

We study how alternative sources of financing, Peer to Business (P2B) platforms, affect the financial policy of small and medium-sized enterprises (SMEs). We find that firms obtaining P2B loans are higher quality firms as they are large, more profitable, with higher sales growth, higher bank debt, and lower default rates. We conclude that P2B platforms are serving the same type of firms than traditional banks. While P2B loans do not seem to affect investment policy and performance, it does affect financial policy. Firms use the availability of P2B to reduce long-term bank debt, while they increase short-term bank debt following P2B lending. In addition, SMEs increase the number of lending relationships and reduce their dependence on a single bank, in particular those with less stable funding and lower liquidity. Our findings suggest that FinTech lending complements the debt financing choices of SMEs and allows them to diversify away from traditional banks.

Financing Infrastructure with Inattentive Investors: The Case of US Municipal Governments

In the United States, building infrastructure (e.g., schools, roads, hospitals) is primarily the responsibility of state and local governments and financed by borrowing in the municipal bond market. Despite the governments' low historical default rate and statutory taxing power, prior empirical evidence suggests they are borrowing-constrained. This paper provides new evidence and theory that link the constraint to the dominance of retail investors in the market, who might not pay perfect attention to the financial needs of their municipal governments. It makes the capital available to more specialized investors, such as municipal mutual funds, a crucial determinant for the borrowing capacity of those governments. Supporting this hypothesis, I find that the mutual funds are among the first investors of municipal bond issues, and they gradually resell their bonds to other investors. Furthermore, in response to a 1% inflow to the mutual funds that are among the major investors of a county government, the government borrows more by 0.2% in the subsequent quarter, conditional on issuing new bonds, while the inflow reduces the interest rate by 0.002%. To rationalize these observations, I develop a model of the municipal bond market in which mutual funds act as the attentive intermediaries.'' By calibrating the model with the empirical estimates, I find that the elasticity of bond supply by the municipal governments is about 100; moreover, is at least one order of magnitude larger than the short-term elasticity of the bond demand. The results support market interventions by the federal government in times of crisis if they accompany massive outflows from municipal mutual funds.

In the interest of saving: Refugee‐led microfinance in Kampala, Uganda

ABSTRACTMotivationWhile livelihoods are increasingly promoted for refugees in long‐term situations of displacement, refugees can rarely access microfinance loans—the very start‐up capital generally considered necessary for creating businesses. Yet across Kampala, Uganda, refugees meet to place small amounts of money into group savings and take out and repay microloans.PurposeThis article sheds light on this underexplored phenomenon through an empirical study of refugee‐led microfinance groups in Kampala and an overview of the existing local landscape of refugee‐serving organizations and microfinance institutions providing loans. We analytically reflect on the role of trust in executing microfinance programmes both for and by refugees.Approach and MethodsWe conducted snowball and purposive sampling, semi‐structured qualitative interviews, focus group discussions, and non‐participant observation.FindingsOur study found that refugee‐led microfinance groups have created a loan structure that is successful for refugees—because it was developed by refugees—with low default rates. This success is underpinned by strong community trust between members. These groups access vulnerable populations important to humanitarian organizations, including women, single mothers, unregistered refugees and the very poor. However, despite filling an important gap in livelihoods assistance—the provision of business capital—refugee‐led microfinance groups lack large amounts of capital to loan members, and do not feel they provide adequate business, livelihoods and financial literacy trainings.Policy ImplicationsOur findings suggest that non‐governmental organizations (NGOs) should support existing groups through offering safe spaces to hold meetings, and with financial and business trainings. Debunking stereotypes of refugees held by financial providers, and advocating for refugees’ financial rights remains crucial. Providing loan capital to groups to enable members to take out larger loans may offer another means of support, but collaboration between formal microfinance institutions or NGOs and refugee‐led groups must reinforce rather than devalue the networks of trust that contribute to grassroots savings and loan groups’ success.

Human vs. Machine: Underwriting Decisions in Finance

Using a randomized experiment in auto lending, we show that algorithmic underwriting outperforms the human underwriting process, resulting in 10.2% higher loan profits and 6.8% lower default rates. The machine performance is more stable across various risk dimensions and loan characteristics, whereas the performance of human underwritten loans largely declines for riskier and more complex loans. Moreover, the performance difference is more pronounced at underwriting thresholds with a high potential for agency conflict. These results are consistent with algorithmic underwriting mitigating agency conflicts and humans' limited capacity for analyzing complex problems.

Analyst Distance and Credit Rating Consistency

We investigate the effect of analyst distance in the credit rating industry and show that issuers with analysts located in more distant offices have lower default rates than issuers with closer analysts and the same rating. Our results are robust to an analyst home bias and suggest that more distant analysts are subject to a local informational disadvantage when conducting their rating analysis. Given an asymmetric reputational cost function that implies penalizing an overestimation of credit quality more heavily than an underestimation, we can demonstrate that it is rational for analysts to assign more conservative ratings for higher levels of information uncertainty.

Mobile health to improve adherence to tuberculosis treatment in Khartoum state, Sudan.

Although tuberculosis is a treatable disease, the high frequency of treatment default remains a challenge. The use of mobile phones structurally in a TB program has the potential to lower the frequency of default. However, it’s impact on treatment outcome in Sudan has not yet been evaluated. The aim is to evaluate the potential use of cell phones for lowering treatment default. We conducted a controlled intervention pilot study during the period from 1st of May 2017 to 31st of March 2018, in eight TB treatment units in Khartoum state, Sudan. Newly diagnosed patient with positive sputum smear on DOTS therapy were enrolled in intervention and control groups. SMS reminder were sent to the intervention group.Assessments were done at the beginning and at the end of the treatment. One hundred and forty-eight patients were enrolled, seventy-four patients in each group.The participants in the two groups were similar in demographic characteristics and behavioral and knowledge related factors about TB disease at baseline. The patients in the intervention group had a lower default rate (6.8%), higher documented cure rate (78.4%), better knowledge compared to control group. SMS reminder was useful and facilitated good interaction between patients and health personnel. Mobile texting seemed useful and was highly accepted by participants. Further evaluation of it’s potential benefit was warranted.