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Bank Lending Policy, Credit Scoring, and the Survival of Loans

  • Kasper Roszbach

    (Sveriges Riksbank)

To evaluate loan applicants, banks increasingly use credit scoring models. The objective of such models typically is to minimize default rates or the number of incorrectly classified loans. Thereby they fail to take into account that loans are multiperiod contracts, for which reason it is important for banks not only to know if but also when a loan will default. In this paper a bivariate tobit model with a variable censoring threshold and sample selection effects is estimated for (1) the decision to provide a loan or not and (2) the survival time of granted loans. The model proves to be an effective tool to separate applicants with short and with long survival times. The bank's loan provision process is shown to be inefficient: loans are granted in a way that conflicts with both default risk minimization and survival time maximization. There is thus no trade-off between higher default risk and higher return in the lending policy. © 2004 President and Fellows of Harvard College and the Massachusetts Institute of Technology.

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Article provided by MIT Press in its journal Review of Economics and Statistics.

Volume (Year): 86 (2004)
Issue (Month): 4 (November)
Pages: 946-958

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Handle: RePEc:tpr:restat:v:86:y:2004:i:4:p:946-958
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  1. Shumway, Tyler, 2001. "Forecasting Bankruptcy More Accurately: A Simple Hazard Model," The Journal of Business, University of Chicago Press, vol. 74(1), pages 101-24, January.
  2. Jacobson, Tor & Roszbach, Kasper, 1998. "Bank Lending Policy, Credit Scoring and Value at Risk," Working Paper Series 68, Sveriges Riksbank (Central Bank of Sweden).
  3. Carling, Kenneth & Jacobson, Tor & Roszbach, Kasper, 2001. "Dormancy risk and expected profits of consumer loans," Journal of Banking & Finance, Elsevier, vol. 25(4), pages 717-739, April.
  4. Montserrat Guillen & Manuel Artis, 1994. "Count Data Models For A Credit Scoring System," Risk and Insurance 9407004, EconWPA.
  5. Gale, Douglas & Hellwig, Martin, 1985. "Incentive-Compatible Debt Contracts: The One-Period Problem," Review of Economic Studies, Wiley Blackwell, vol. 52(4), pages 647-63, October.
  6. Williamson, Stephen D, 1987. "Costly Monitoring, Loan Contracts, and Equilibrium Credit Rationing," The Quarterly Journal of Economics, MIT Press, vol. 102(1), pages 135-45, February.
  7. Stiglitz, Joseph E & Weiss, Andrew, 1981. "Credit Rationing in Markets with Imperfect Information," American Economic Review, American Economic Association, vol. 71(3), pages 393-410, June.
  8. Boyes, William J. & Hoffman, Dennis L. & Low, Stuart A., 1989. "An econometric analysis of the bank credit scoring problem," Journal of Econometrics, Elsevier, vol. 40(1), pages 3-14, January.
  9. Townsend, Robert M, 1982. "Optimal Multiperiod Contracts and the Gain from Enduring Relationships under Private Information," Journal of Political Economy, University of Chicago Press, vol. 90(6), pages 1166-86, December.
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