Borrower-Lender Distance, Credit Scoring, and the Performance of Small Business Loans

FDIC Center for Financial Research Working Paper No. 2006-04

60 Pages Posted: 13 Mar 2006

See all articles by Robert DeYoung

Robert DeYoung

University of Kansas School of Business

Dennis Glennon

Government of the United States of America - Office of the Comptroller of the Currency (OCC)

Peter J. Nigro

Bryant University - Department of Finance

Date Written: March 2006

Abstract

We develop a theoretical model of decision-making under risk and uncertainty in which bank lenders have both imperfect information about loan applications and imperfect ability to make decisions based on that information. We test the loan-default implications of the model for a large random sample of small business loans made by U.S. banks between 1984 and 2001 under the SBA 7(a)loan program. As predicted by our model, both borrower-lender distance and credit-scoring contribute to greater loan defaults; the former finding suggests that distance interferes with information collection and monitoring, while the latter finding implies production efficiencies that encourage credit-scoring lenders to make riskier loans at the margin. However, we also find that credit-scoring dampens the harmful effects of distance, consistent with the conjecture that information generated by credit scoring models improves the ability of lenders to assess and price default risk.

Keywords: borrower-lender distance, credit scoring, small business loans

JEL Classification: D81, G21, G28

Suggested Citation

DeYoung, Robert and Glennon, Dennis and Nigro, Peter J., Borrower-Lender Distance, Credit Scoring, and the Performance of Small Business Loans (March 2006). FDIC Center for Financial Research Working Paper No. 2006-04 . Available at SSRN: https://ssrn.com/abstract=888576 or http://dx.doi.org/10.2139/ssrn.888576

Robert DeYoung (Contact Author)

University of Kansas School of Business ( email )

Capitol Federal Hall
1654 Naismith Drive
Lawrence, KS 66045
United States
785-864-1806 (Phone)

Dennis Glennon

Government of the United States of America - Office of the Comptroller of the Currency (OCC) ( email )

250 E Street, SW
Senior Financial Economist; Economics Department
Washington, DC 20219-0001
United States
202-874-4725 (Phone)
202-874-5394 (Fax)

Peter J. Nigro

Bryant University - Department of Finance ( email )

1150 Douglas Pike
Smithfield, RI 02917
United States

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