Loan Pricing Research Articles

Monitoring and Loan Pricing: Do Microfinance Institutions Extract Rents from Entrepreneurs?

Microfinance institutions (MFIs) have been criticized for charging high interest rates on loans. Building on multiple-principal agency theory, we argue that when an MFI acquires proprietary information about its clients through monitoring, it gains an information advantage over other lenders enabling it to extract rents by charging higher interest rates. Using data from 712 MFIs across 62 countries from 2010 to 2018, we find this to be the case. Furthermore, we find that MFIs that make more relationship-based loans, operate in less competitive markets, and those driven by for-profit commercial banking logic are more likely to extract even greater rents.

Sunshine and bank lending

This study uses a unique proprietary loan-level dataset from a state-owned Chinese commercial bank to examine how sunshine-induced emotions influence loan pricing decisions made by high-level loan officers who would be punished for loan defaults. Our findings reveal that an increased intensity of sunshine at loan officers' workplace can increase loan pricing for borrowers. The result can be explained by the mood channel: sunshine induces a positive mood among loan officers leading to greater risk aversion in their loan pricing decisions, known as the mood maintenance effect. This effect is magnified for firms with high risk, high bank–firm information asymmetry, and in locations characterized by less bank competition. Our main results are still valid after taking into account various robustness issues and endogeneity concerns.

Factors of Credit Ratings for Transfer Pricing of Loans in European Conditions

Factors of Credit Ratings for Transfer Pricing of Loans in European Conditions

Abnormal Temperatures, Climate Risk Disclosures and Bank Loan Pricing: International Evidence

Abnormal Temperatures, Climate Risk Disclosures and Bank Loan Pricing: International Evidence

How does regional carbon transition affect loan pricing? Evidence from China

Existing research on carbon risks mainly focuses on firm-level transition risks and regional physical risks, while the impact of regional transition risks on banks has been neglected. This study fills this gap by revealing the pricing effect of regional carbon transition risk in bank lending. Using syndicated loan data, we find a significant premium in loans in high carbon emission areas after the Paris Agreement. Moreover, the regional carbon risk premium is relatively low in areas with higher product marketization, lower legalization, and higher forest coverage levels. Our evidence suggests that banks have considered regional carbon transition risk.

Gambling preference, information risk, and the pricing of bank loans

ABSTRACT Our study explores the effect of local gambling preferences (LGP) on bank loan pricing, revealing that lenders impose significantly higher interest rates on firms situated in areas characterized by stronger gambling tendencies. Our results remain robust after conducting a series of sensitivity tests that account for firm-, county-, and loan-specific attributes, as well as several identification robustness checks. Specifically, our relocation analysis shows that firms moving to areas with higher (lower) gambling preferences experience higher (lower) costs of bank loans compared to control groups. Our channel analysis further reveals that local gambling preferences exacerbate a firm's information risk environment, as captured by poorer earnings quality, heightened earnings risk, and greater managerial concealment of bad news, resulting in higher borrowing costs. Finally, we observe that firms in areas with higher LGP encounter more stringent non-price loan terms. However, institutional ownership and the threat of takeovers significantly mitigate the adverse effect of LGP on bank loan pricing.

Financial statement disaggregation and bank loan pricing

We analyze whether the disaggregation quality (DQ) of a borrower's financial statement is associated with its bank loan pricing. We find that firms with high DQ have low spreads on their bank loans. This result is more pronounced for firms with positive financial prospects, higher risk, and no prior banking relationship with the lenders. Moreover, a high DQ is associated with a low total cost of borrowing, high credit rating, and low spreads on bond issues. Overall, our results show that disaggregated financial statements facilitate bank loan pricing by enabling lenders to make better predictions of their borrowers’ future performance.

Does firm carbon risk matter to banks? Evidence from the US syndicated loan market

Using two measures of firm carbon-risk exposure to capture convergent materiality, we examine whether the syndicated loan market considers borrowers’ carbon-risk exposure in loan pricing. We find that carbon intensity does not constitute material information for banks, whereas environmental scores have a statistically significant but incidental economic effect on loan spreads. We also find inconclusive evidence that the market differentiates between firms in high and low environmentally sensitive industries. Finally, we show that green banks charge higher loan spreads to more environmentally responsible firms. Overall, we provide strong evidence that environmental scores matter in loan pricing decisions.

Seller-Orchestrated Inventory Financing Under Bank Capital Regulation

To help small firms secure bank financing, large sellers often orchestrate joint finance programs, linking their small dealers with major banks that lend to all participating dealers based on the information the seller provides. We examine supply chain decisions (pricing and inventory) and lending terms under such seller-orchestrated financing programs. In loan pricing, we highlight a form of financial friction that is of particular importance under such schemes—bank capital regulation. Banks are globally mandated to maintain regulatory capital to mitigate unforeseen loan losses, using either the standardized approach (where regulatory capital is a fixed percentage of the loan amount) or the internal rating-based (IRB) approach (where it depends on the loan’s value-at-risk). We consider a game-theoretic model consisting of a large seller and multiple capital-constrained newsvendor-type dealers, who obtain financing from banks that are subject to capital regulation. The seller decides the wholesale price and whether to orchestrate a joint finance program for its dealers by collaborating with a bank, and the dealers choose their inventory level and the financing channel. We find that a seller should only orchestrate the joint financing program when the bank adopts the IRB approach and the dealers are of low risk. Such a program is more profitable to the seller when the demand correlation among dealers is low, and there is a large number of dealers. Although always benefiting the seller, these programs may hurt dealers with intermediate risk. Facing dealers with varying financial situations, the terms under the joint finance program should be designed as if the financially strong dealers subsidize the weak ones. Finally, allowing the seller to share part of the loan loss could further enhance the performance of joint financing, but only when the seller’s opportunity cost of capital is low. Our findings provide guidance to large sellers on how to orchestrate joint finance schemes, and to small dealers on making their corresponding operational decisions.

Strategic Alliances and Lending Relationships

ABSTRACT We study how proprietary information flows in strategic alliances facilitate banks’ information collection in private debt markets. We argue that lenders that have previously worked with a borrower’s alliance partners have an information advantage and show that firms entering a strategic alliance receive a lower interest spread on loans from banks that have previously lent to their strategic partners than loans from other banks. Cross-sectional tests on alliances’ economic importance and participants’ information environment support our hypothesis that the loan price effect is driven by reduced information asymmetry between borrowers and their partners’ relationship banks. Last, we find borrowers are more likely to obtain debt financing from alliance-related banks than from other banks. Overall, our findings are consistent with lenders that have previously worked with an alliance counterparty possessing debt contracting-relevant information about the soft nature of alliance value and the partners’ commitment to alliances. Data Availability: Data are available from the public sources cited in the text. JEL Classifications: G10; G21; G32.

Loan Pricing in Peer-to-Peer Lending

Loan Pricing in Peer-to-Peer Lending

Factors Influencing the Use of Property Titles as Security for Lending in Rural Kenya: A Case Study of Kivani Location, Machakos County

The development of the world's economies, especially in emerging countries, depends significantly on land. Despite being a crucial tool for obtaining loans, the use of land as collateral is relatively low in rural Kenya. This has largely been attributed to lack of formal ownership documents attributable to poor titling, which has subsequently hindered investments and development in these areas. The research gap, therefore, lies in the need to understand and address the reasons behind the low uptake of land as collateral in rural Kenya, despite its potential as a valuable asset and its significant role in rural livelihoods and development. This study set out to establish factors influencing the use of property titles as loan security in a rural setting using Machakos County as a case study. Employing a descriptive research design, the study targeted 724 households in Kivani and 30 financial institution officers. Data was collected using questionnaires and topical discussions, achieving response rates of 96% and 100%, respectively. Findings reveal that 67 percent of respondents have never used land titles as collateral. Several factors were identified: social relations, lending conditions, and loan pricing. Social relations factors included communal land ownership, land succession problems, cultural norms, and sentimental attachment to land. Lending conditions encompassed land valuation processes, borrower creditworthiness requirements, collateral quality, and the need for family consent. Loan pricing factors involve the costs and fees associated with credit financing. The study recommends increasing awareness of individual land ownership, exploring alternative collateral options, establishing insurance markets for collateral assets, and improving loan evaluation processes to better support rural residents. These measures aim to enhance access to financing, thereby promoting rural development

Effect of Corporate Environmental Performance on Banks’ Loan Pricing

Effect of Corporate Environmental Performance on Banks’ Loan Pricing

Shadow banking and loan pricing of commercial banks: Evidence from China

We examine the role of regulatory arbitrage via wealth management products (WMPs) in the determination of lending rates in China. We find WMP yields are positively associated with lending rates whereas the effect of WMP scale varies across bank size. For the big-5 state-owned banks, the negative “transfer-effect” of high-risk high-yield loans into shadow bank credit dominates the positive “funding-cost-effect” of banks becoming more dependent on wholesale funding. For smaller banks, the positive funding-cost effect dominates. Our study provides insights into the role of regulatory arbitrage on asset structure and profit margins in the interest of banks and the regulators.

An Age–Period–Cohort Framework for Profit and Profit Volatility Modeling

The greatest source of failure in portfolio analytics is not individual models that perform poorly, but rather an inability to integrate models quantitatively across management functions. The separable components of age–period–cohort models provide a framework for integrated credit risk modeling across an organization. Using a panel data structure, credit risk scores can be integrated with an APC framework using either logistic regression or machine learning. Such APC scores for default, payoff, and other key rates fit naturally into forward-looking cash flow estimates. Given an economic scenario, every applicant at the time of origination can be assigned profit and profit volatility estimates so that underwriting can truly be account-level. This process optimizes the most fallible part of underwriting, which is setting cutoff scores and assigning loan pricing and terms. This article provides a summary of applications of APC models across portfolio management roles, with a description of how to create the models to be directly integrated. As a consequence, cash flow calculations are available for each account, and cutoff scores can be set directly from portfolio financial targets.

Do Capital Asset and Labor Conditions Matter in Loan Pricing? Evidence From Capital and Labor Redeployability

This article offers the novel insight that loan pricing is affected by the redeployability of borrowers’ capital assets and labor. We find that both capital and labor redeployability are negatively related to loan spread, suggesting that borrowers with higher redeployability enjoy more favorable loan pricing. This finding is consistent with redeployability promoting reduced cost stickiness and enhanced liquidity, which in turn reduces borrowers’ probability of default and lenders’ loan losses given default. Our cross-sectional test results reveal that the relation between redeployability and loan pricing is stronger for firms with more growth opportunities, which is consistent with lenders viewing redeployability as an important way to minimize potential loan losses from risky investments. Also, the relation between redeployability and loan pricing is weaker for loans with more stringent nonpricing terms, suggesting that strict terms may protect lenders and make redeployability less important in loan pricing. JEL Classification: D22, G21, G32, J62.

Replicating the suitability rule and economic theory in pursuit of microfinance inclusion of women micro-agribusinesses in rural financial markets

PurposeWith reference to the global financial crisis and lessons learned, advocacy for distributing suitable financial products by financial intermediaries remain key if consumers, especially the illiterate in underdeveloped financial markets, are to be absorbed into the formal financial system. Financial intermediaries such as microfinance banks should provide suitable financial products, with full disclosure of information and customer protection relating to distribution of all financial products within the financial market to prevent financial vulnerability. The main purpose of this study is to establish the mediating role of financial product suitability in the relationship between access to microfinance products and survival of women micro-agribusinesses in rural Uganda.Design/methodology/approachSmartPLS with bootstrap based on 5,000 samples was used to test for the mediating role of financial product suitability in the relationship between access to microfinance products and survival of women micro-agribusinesses in rural Uganda.FindingsThe results revealed that financial product suitability improves access to microfinance products by 29 percentage points to promote survival of women micro-agribusinesses in rural Uganda. In reality, delivering suitable financial products that suit the economic condition of poor women micro-agribusiness borrowers, can allow them to use these products to generate income to meet timely repayment obligations and business demands.Research limitations/implicationsThe current study selected samples from only women micro-agribusinesses operating in rural Uganda, with a specific focus on the northern region. Thus, studies involving samples selected from other rural developing countries may be necessary in future. Additionally, while the findings are significant, the data were collected from only women microenterprises who are clients of microfinance banks. Future studies focusing on women microenterprises who are clients of other financial institutions may offer insightful comparative data.Practical implicationsThe findings from this study offer strategies for managers of microfinance banks to invent and design financial products that suit the economic status and condition of different microcredit clients, especially the women micro-agribusinesses. This can help them to solve the problem of defaults in loan repayment and delinquency common while lending to the rural poor. In fact, microfinance banks should adopt a customized loan pricing model that can promote the operational sustainability and commercial viability of women micro-agribusinesses in the current situation of mission adrift.Originality/valueThe current study uses the suitability rule and economic theory to elucidate the importance of microfinance product suitability to increase microfinance inclusion of women micro-agribusinesses in rural areas in developing countries. The novelty in this paper is in combining the suitability rule and economic theory with microfinance theory to promote access to microcredit by the women micro-agribusinesses in rural Uganda under the situation of mission adrift. This is limited in the existing microfinance literature and theory, especially in developing countries like Uganda.

Loan Price Prediction

Loan Price Prediction

Informationally advantaged lenders and the credit derivative market: Evidence from Loan only Credit Default Swap (LCDX)

This paper explores the informational role of the Loan Only Credit Default Index (LCDX) on the pricing of syndicated loans. Despite an extensive body of research on credit indices and loan pricing, limited studies have comprehensively assessed the complex relationship between the LCDX and individual loan spreads. Contrary to indices like the CDX, which are largely linked to corporate bonds, the LCDX directly pertains to the syndicated secured loan market, offering valuable insights about the overall credit default market and the cost of credit risk insurance. Preliminary results reveal a pronounced positive correlation between the LCDX spread and the syndicated loan spread, particularly noticeable amongst borrowers with lower credit quality. The paper highlights the LCDX's pivotal role in conveying secondary credit market information, with critical implications for credit risk management and financial regulations.

Loan origination and risk underpricing: The role of lending incentives

This paper investigates how volume-based lending incentives affect the pricing of loans. Using a comprehensive loan record from a large Chinese bank, we examine the response of loan origination behavior to volume-based lending incentives. We observe a direct effect of volume-based lending incentives, with the number and volumes of loans rising near the month-end. Moreover, we identify a significant underpricing of risk in loans originated at the end of the month. Specifically, these loans exhibit higher risk, yet they are initially priced at a lower interest rate. This underpricing occurs through a combination of ranking pressure and overstate of hard information in loan screening.