Can Credit Rating Affect Credit Risk? Causal Evidence from an Online Lending Marketplace

Abstract

Credit rating is determined by credit risk, but can the rating in itself change a borrower’s credit risk in an economically meaningful manner? Despite the theoretical and practical importance of this question, there is limited empirical evidence on this topic since obtaining variation in credit rating independent of a borrower’s underlying fundamentals is difficult. Using a regulatory change in March 2020 that provides a credibly exogenous variation in the credit ratings of household borrowers, we show that individuals with negative rating shock default at a 23 percentage point higher rate than otherwise identical borrowers in the year following the negative shock. Our findings suggest that empirical studies linking credit ratings to real outcomes should carefully consider the endogenous effect of ratings on future outcomes. These findings also show frequent erroneous credit bureau data incidents impose economically significant long-term consumer costs.

Keywords: Credit Ratings, Credit Reports, FinTech Lending

JEL Classification: G21, G23, G24, G51