Measuring The Importance Of Information In Lending Decisions [Study]

Measuring The Importance Of Information In Lending Decisions [Study]

It’s pretty clear that giving banks less information about potential borrowers makes lending riskier, but you don’t get many opportunities to measure the effect because there are so many competing factors that go into assessing a firm’s credit worthiness. The State Bank of Pakistan created an opportunity to study the effect in the real world when it stopped publishing certain types of credit information, creating a natural experiment where different banks had different levels of information about Pakistani companies so that changes in lending behavior could be observed.

In their paper How Public Information Affects Asymmetrically Informed Lenders: Evidence from a Credit Registry Reform, Ali Choudhary from the State Bank of Pakistan and Anil K. Jain of the Federal Reserve use the opportunity to quantify how a specific difference in information affects both lending decisions and loan size.

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Lending decisions: Loans both larger and more likely from ‘informed’ banks

Before 2006 the State Bank of Pakistan disclosed a firm’s group (all the companies with which it shared at least one director) along with other credit information, giving banks some information about the firm’s important corporate relationships. When it stopped making that information publicly available it meant that some banks (those who were more aware of existing corporate relationships) had an informational advantage over their peers.

One way for a bank to be ‘informed’ is to have two different companies in the same group as client (since they know the board of directors of both companies they should be aware of the overlap at the board level). Choudhary and Jain study this effect by looking at companies that borrowed from two banks before the regulatory change that would later be classified as ‘informed’ and ‘uninformed’ to see how the banks’ lending behavior changed.

They found that informed banks were 5.4% more likely to renew the firm’s loan and that the loans from informed banks were 11% – 14% larger on average.

Large firms less impacted than small ones

The effect wasn’t uniform across different types of firms, large firms in particular were less impacted presumably because it’s easier to get reliable information about their board of directors. The combination of a weak credit history also exacerbated the effect, the presence of negative information in a company’s credit report made them 18% more likely to borrow from an informed bank instead of an uninformed one.

Probably the most surprising finding is that a prior relationship between an uninformed bank and a company didn’t mitigate the change in lending decisions: the loss of information about a firm’s group made it less likely for a bank to give loans even if they already had a working relationship.

See full report here.

Lending Decisions

Lending Decisions

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