What Do a Million Observations Have to Say About Loan Defaults? Opening the Black Box of Relationships

40 Pages Posted: 17 Mar 2010 Last revised: 30 Jan 2017

See all articles by Manju Puri

Manju Puri

Duke University - Fuqua School of Business; NBER; FDIC

Jörg Rocholl

ESMT European School of Management and Technology

Sascha Steffen

Frankfurt School of Finance & Management

Multiple version iconThere are 2 versions of this paper

Date Written: January 30, 2017

Abstract

Using a unique dataset of more than 1 million loans made by 296 German banks, we evaluate the impact of many aspects of customer–bank relationships on loan default rates. Our research suggests a practical solution to reducing loan defaults for new customers: Have the customer open a simple transactions account – savings or checking account. Observe for some time and then decide whether to make a loan. Loans made under this model have lower default, as banks can use historical data about their borrowers to establish a baseline against which new client-related information can be evaluated. Banks assemble this historical information through relationships of different forms. We define relationships in many different ways to capture non-credit relationships, transaction accounts, as well as the depth and intensity of relationships, and find each of these can provide information that helps reduce default – even establishing a simple savings or checking account and observing the activity prior to loan granting can help reduce loan defaults. Our results show that banks with relationship-specific information act differently compared with banks that do not have this information both in screening and subsequent monitoring borrowers which helps reduce loan defaults.

Keywords: Bank lending, relationship specific information, discretion, loan defaults, monitoring, screening

JEL Classification: G20, G21

Suggested Citation

Puri, Manju and Rocholl, Joerg and Steffen, Sascha, What Do a Million Observations Have to Say About Loan Defaults? Opening the Black Box of Relationships (January 30, 2017). Available at SSRN: https://ssrn.com/abstract=1572673 or http://dx.doi.org/10.2139/ssrn.1572673

Manju Puri

Duke University - Fuqua School of Business ( email )

100 Fuqua Drive
Box 90120
Durham, NC 27708-0120
United States
919-660-7657 (Phone)

NBER

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

FDIC ( email )

550 17th Street NW
Washington, DC 20429
United States

Joerg Rocholl

ESMT European School of Management and Technology ( email )

Schlossplatz 1
Berlin
Germany

HOME PAGE: http://www.esmt.org/en/159244

Sascha Steffen (Contact Author)

Frankfurt School of Finance & Management ( email )

Adickesallee
32-34
Frankfurt, 60322
Germany
16097326929 (Phone)

HOME PAGE: http://www.sascha-steffen.de

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