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The surprising use of credit scoring in small business lending by community banks and the attendant effects on credit availability and risk

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Author Info

  • Allen N. Berger
  • Adrian M. Cowan
  • W. Scott Frame

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.

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Bibliographic Info

Paper provided by Federal Reserve Bank of Atlanta in its series Working Paper with number 2009-09.

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Date of creation: 2009
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Handle: RePEc:fip:fedawp:2009-09

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Keywords: Small business - Finance ; Credit ratings ; Community banks ; Risk;

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References

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  1. Allen N. Berger & W. Scott Frame, 2005. "Small business credit scoring and credit availability," Working Paper 2005-10, Federal Reserve Bank of Atlanta.
  2. Kenneth P. Brevoort & Timothy H. Hannan, 2004. "Commercial lending and distance: evidence from Community Reinvestment Act data," Finance and Economics Discussion Series 2004-24, Board of Governors of the Federal Reserve System (U.S.).
  3. Allen N. Berger & W. Scott Frame & Nathan H. Miller, 2002. "Credit scoring and the availability, price, and risk of small business credit," Finance and Economics Discussion Series 2002-26, Board of Governors of the Federal Reserve System (U.S.).
  4. Robert DeYoung & William C. Hunter & Gregory F. Udell, 2003. "The past, present, and probable future for community banks," Working Paper Series WP-03-14, Federal Reserve Bank of Chicago.
  5. Berger, Allen N. & Espinosa-Vega, Marco A. & Frame, W. Scott & Miller, Nathan H., 2011. "Why do borrowers pledge collateral? New empirical evidence on the role of asymmetric information," Journal of Financial Intermediation, Elsevier, vol. 20(1), pages 55-70, January.
  6. Berger, Allen N. & Udell, Gregory F., 2006. "A more complete conceptual framework for SME finance," Journal of Banking & Finance, Elsevier, vol. 30(11), pages 2945-2966, November.
  7. Frame, W Scott & Srinivasan, Aruna & Woosley, Lynn, 2001. "The Effect of Credit Scoring on Small-Business Lending," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 33(3), pages 813-25, August.
  8. W. Scott Frame & Michael Padhi & Lynn Woosley, 2001. "The effect of credit scoring on small business lending in low- and moderate-income areas," Working Paper 2001-6, Federal Reserve Bank of Atlanta.
  9. Timothy Hannan, 2003. "Changes in Non-Local Lending to Small Business," Journal of Financial Services Research, Springer, vol. 24(1), pages 31-46, August.
  10. Loretta J. Mester, 1997. "What's the point of credit scoring?," Business Review, Federal Reserve Bank of Philadelphia, issue Sep, pages 3-16.
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Cited by:
  1. W. Scott Frame & Lawrence J. White, 2009. "Technological change, financial innovation, and diffusion in banking," Working Paper 2009-10, Federal Reserve Bank of Atlanta.
  2. Cristina Bernini & Paola Brighi, 2011. "Relationship Lending, Distance and Efficiency in a Heterogeneous Banking System," Working Paper Series 41_11, The Rimini Centre for Economic Analysis.

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