The Surprising Use of Credit Scoring in Small Business Lending by Community Banks and the Attendant Effects on Credit Availability and Risk

Federal Reserve Bank of Atlanta Working Paper 2009-9

25 Pages Posted: 17 Jul 2009

See all articles by Allen N. Berger

Allen N. Berger

University of South Carolina - Darla Moore School of Business; Wharton Financial Institutions Center; European Banking Center

Adrian Cowan

Saint Mary's University of San Antonio

W. Scott Frame

Federal Reserve Bank of Dallas

Date Written: March 1, 2009

Abstract

The literature has documented a positive relationship between the use of credit scoring for small business loans and small business credit availability, broadly defined. However, this literature is hampered by the fact that all of the studies are based on a single 1998 survey of the very largest U.S. banking organizations. This paper addresses a number of deficiencies in the extant literature by employing data from a new survey on the use of credit scoring in small business lending, primarily by community banks. The survey evidence suggests that the use of credit scores in small business lending by community banks is surprisingly widespread. Moreover, the scores employed tend to be the consumer credit scores of the small business owners rather than the more encompassing small business credit scores that include data on the firms as well as on the owners. Our empirical analysis suggests that credit scoring is associated with increased small business lending after a learning period, with no material change in the quality of the loan portfolio. However, these quantity and quality results appear to vary depending on the way in which credit scores are implemented in the underwriting process.

Keywords: banks, small business, credit scoring

JEL Classification: G21, G28, L23

Suggested Citation

Berger, Allen N. and Cowan, Adrian and Frame, W. Scott, The Surprising Use of Credit Scoring in Small Business Lending by Community Banks and the Attendant Effects on Credit Availability and Risk (March 1, 2009). Federal Reserve Bank of Atlanta Working Paper 2009-9. Available at SSRN: https://ssrn.com/abstract=1434232 or http://dx.doi.org/10.2139/ssrn.1434232

Allen N. Berger

University of South Carolina - Darla Moore School of Business ( email )

1705 College St
Francis M. Hipp Building
Columbia, SC 29208
United States
803-576-8440 (Phone)
803-777-6876 (Fax)

Wharton Financial Institutions Center

Philadelphia, PA 19104-6367
United States

European Banking Center

P.O. Box 90153
Tilburg, 5000 LE
Netherlands

Adrian Cowan

Saint Mary's University of San Antonio ( email )

1 Camino Santa Maria
San Antonio, TX 78228
United States

W. Scott Frame (Contact Author)

Federal Reserve Bank of Dallas ( email )

2200 N Pearl Street
Dallas, TX 75201
United States
214-922-6984 (Phone)

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