Does Discretion in Lending Increase Bank Risk? Borrower Self-Selection and Loan Officer Capture Effects

R. Gropp, C. Grundl, A. Guttler

Research output: Working paperDiscussion paperOther research output

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Abstract

Abstract: In this paper we analyze whether discretionary lending increases bank risk. We use a panel dataset of matched bank and borrower data. It offers the chief advantages that we can directly identify soft information in banks’ lending decisions and that we observe ex post defaults of borrowers. Consistent with the previous literature, we find that smaller banks use more discretion in lending. We also show that borrowers self-select to banks depending on whether their soft information is positive or negative. Financially riskier borrowers with positive soft information are more likely to obtain credit from relationship banks. Risky borrowers with negative soft information have the same chance to receive a loan from a relationship or a transaction bank. These selection effects are stronger in more competitive markets, as predicted by theory. However, while relationship banks have financially riskier borrowers, ex post default is not more probable compared to borrowers at transaction banks. As a consequence, relationship banks do not have higher credit risk levels. Loan officers at relationship banks thus do not use discretion in lending to grant loans to ex post riskier borrowers.
Original languageEnglish
Place of PublicationTilburg
PublisherEBC
Number of pages51
Volume2012-010
Publication statusPublished - 2012

Publication series

NameEBC Discussion Paper
Volume2012-010

Fingerprint

Loans
Bank risk
Lending
Discretion
Self-selection
Bank relationships
Soft information
Bank lending
Lending decisions
Competitive market
Selection effects
Credit
Credit risk

Keywords

  • soft information
  • discretionary lending
  • relationship bank
  • bank risk

Cite this

Gropp, R., Grundl, C., & Guttler, A. (2012). Does Discretion in Lending Increase Bank Risk? Borrower Self-Selection and Loan Officer Capture Effects. (EBC Discussion Paper; Vol. 2012-010). Tilburg: EBC.
Gropp, R. ; Grundl, C. ; Guttler, A. / Does Discretion in Lending Increase Bank Risk? Borrower Self-Selection and Loan Officer Capture Effects. Tilburg : EBC, 2012. (EBC Discussion Paper).
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Gropp, R, Grundl, C & Guttler, A 2012 'Does Discretion in Lending Increase Bank Risk? Borrower Self-Selection and Loan Officer Capture Effects' EBC Discussion Paper, vol. 2012-010, EBC, Tilburg.

Does Discretion in Lending Increase Bank Risk? Borrower Self-Selection and Loan Officer Capture Effects. / Gropp, R.; Grundl, C.; Guttler, A.

Tilburg : EBC, 2012. (EBC Discussion Paper; Vol. 2012-010).

Research output: Working paperDiscussion paperOther research output

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AB - Abstract: In this paper we analyze whether discretionary lending increases bank risk. We use a panel dataset of matched bank and borrower data. It offers the chief advantages that we can directly identify soft information in banks’ lending decisions and that we observe ex post defaults of borrowers. Consistent with the previous literature, we find that smaller banks use more discretion in lending. We also show that borrowers self-select to banks depending on whether their soft information is positive or negative. Financially riskier borrowers with positive soft information are more likely to obtain credit from relationship banks. Risky borrowers with negative soft information have the same chance to receive a loan from a relationship or a transaction bank. These selection effects are stronger in more competitive markets, as predicted by theory. However, while relationship banks have financially riskier borrowers, ex post default is not more probable compared to borrowers at transaction banks. As a consequence, relationship banks do not have higher credit risk levels. Loan officers at relationship banks thus do not use discretion in lending to grant loans to ex post riskier borrowers.

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Gropp R, Grundl C, Guttler A. Does Discretion in Lending Increase Bank Risk? Borrower Self-Selection and Loan Officer Capture Effects. Tilburg: EBC. 2012. (EBC Discussion Paper).