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Information or Insurance? On the Role of Loan Officer Discretion in Credit Assessment

Martin Brown (), Matthias Schaller (), Simone Westerfeld () and Markus Heusler ()
Additional contact information
Matthias Schaller: University of St. Gallen
Simone Westerfeld: University of Applied Sciences Northwestern Switzerland
Markus Heusler: Risk Solution Network AG

No 67, Mo.Fi.R. Working Papers from Money and Finance Research group (Mo.Fi.R.) - Univ. Politecnica Marche - Dept. Economic and Social Sciences

Abstract: We employ a unique dataset of 6,669 credit assessments for 3,542 small businesses by nine banks using an identical rating model over the period 2006-2011 to examine (i) to what extent loan officers use their discretion to smooth credit ratings of their clients, and (ii) to assess whether this use of discretion is driven by information about the creditworthiness of the borrower or by the insurance of clients against fluctuations in lending conditions. Our results show that loan officers make extensive use of their discretion to smooth clients' credit ratings: One in five rating shocks induced by changes in the quantitative assessment of a client is reversed by the loan officer. This smoothing of credit ratings is prevalent across all rating classes, is independent of whether the borrower experiences a positive or a negative rating shock, and is independent of whether the shock is firm-specific or market-related. We find that discretionary rating changes have limited power in predicting future loan performance, indicating that the smoothing of credit ratings is only partially driven by information about creditworthiness. Instead, in line with the implicit contract view of credit relationships loan officers are more likely to smooth ratings when rating shocks have stronger implications for interest rates.

Keywords: Asymmetric information; Credit rating; Implicit contracts; Relationship banking (search for similar items in EconPapers)
JEL-codes: D82 G21 L14 (search for similar items in EconPapers)
Pages: 51
Date: 2012-05
New Economics Papers: this item is included in nep-ban, nep-cta and nep-ias
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