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Bank Lending Policy, Credit Scoring and Value at Risk

Author

Listed:
  • Jacobson, Tor

    (Research Department, Central Bank of Sweden)

  • Roszbach, Kasper

    (Department of Economics)

Abstract

In this paper we apply a bivariate probit model to investigate the implications of bank lending policy. In the first equation we model the bank´s decision to grant a loan, in the second the probability of default. We confirm that banks provide loans in a way that is not consistent with default risk minimization. The lending policy must thus either be inefficient or be the result of some other type of optimizing behavior than expected profit maximization. Value at Risk, being a value weighted sum of individual risks, provides a more adequate measure of monetary losses on a portfolio of loans than default risk. We derive a Value at Risk measure for the sample portfolio of loans and show how analyzing this can enable financial institutions to evaluate alternative lending policies on the basis of their implied credit risk and loss rate, and make lending rates consistent with the implied Value at Risk.
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Suggested Citation

  • Jacobson, Tor & Roszbach, Kasper, 1998. "Bank Lending Policy, Credit Scoring and Value at Risk," Working Paper Series 68, Sveriges Riksbank (Central Bank of Sweden).
    • Handle: RePEc:hhs:rbnkwp:0068
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    JEL classification:

    • C35 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Discrete Regression and Qualitative Choice Models; Discrete Regressors; Proportions
    • D61 - Microeconomics - - Welfare Economics - - - Allocative Efficiency; Cost-Benefit Analysis
    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G23 - Financial Economics - - Financial Institutions and Services - - - Non-bank Financial Institutions; Financial Instruments; Institutional Investors

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