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An Analysis of Commercial Bank Lending Criteria for Small Business Loans: An Experimental Study
Abstract
This study examines two recognised bank lending criteria, security and management competence/ reputation, on lenders’ assessment of a small business applicant’s ability to repay debt. A limited amount of empirical research has been conducted from the banking sectors perspective on lending, to explain the existence of a small business ‘finance gap’ and the importance/or otherwise of the factors underlying the lenders’ judgement of assessment of repayment likelihood.Results of a field experiment indicate that security is not a major consideration in lenders’ loan assessments. However, lenders insistence upon security implies that lenders are concerned with borrowers who have an ability to repay loans, and who minimise the lenders’ risks. The results also indicate that management competence/reputation is a significant factor in the lenders’ assessment of a small business applicant’s repayment ability.
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Lenders use financial statements to assess the ability of corporate borrowers to repay loans in the normal course of business. By some criteria, such as a frequency count of the number of financial analyses performed for different purposes, this may be the most important use of external financial reports. This study provides a brief description of the use of accounting and other information for this purpose, and reports an experiment which provides insight on whether loan officers use a linear-additive or configural strategy when making the final judgement of ability to repay. Results also provide evidence of the extent of consensus between loan officers, the effect of individual and institutional differences, and the degree of insight by loan officers into their own cognitive processes.
This paper examines the impact of accounting information on the sequential judgements of experienced bank loan officers using realistic lending cases in an experimental setting. The findings suggest that loan officers reach a high level of confidence early in the lending process based on summarized accounting information and other general background data. When, later in the process, factors concerning the firm's financial plans and their underlying assumptions are varied, lenders adjust their confidence in whether or not to grant the loan in the expected directions, even when the subsequent evidence disconfirms their original positions.
This paper provides a critique of standard theories of money, in particular those based on money as a medium of exchange. Money is important because of the relationship between money and credit The process of judging credit worthiness, in which banks play a central role, invokes the collection and processing of information. Like many other economic activities involving information, these processes are not well described by means of standard production functions. Changes in economic circumstances can have marked effects on the relevance of previously accumulated information and accordingly on the supply of credit Changes in the availability of credit may have marked effects on the level of economic activity, while changes in real interest rates seem to play a relatively minor role in economic fluctuations.
This alternative view has a number of implications for policy, both at the macroeconomic level (for instance, on the role of monetary policy for stabilization purposes and the choice of targets) and at the microeconomic level.
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