Financial Update (July-September 2001)


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2000 Annual Report

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Board Changes

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Credit Scoring


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Study Looks at Large Banks’ Use of Small Business Credit Scoring

Innovation is widely recognized as vital to improving productivity in the financial system. But there have been few quantitative studies of financial innovation and even fewer that examine the diffusion of these new technologies.

Atlanta Fed Working Paper 2000-9, by Jalal Akhavein, Scott Frame and Lawrence White, makes a significant contribution to the literature on the diffusion of financial innovations. The authors examine the diffusion of banks’ use of credit scoring for small business lending.

Credit scoring is the process of assigning to a potential borrower a single quantitative measure, or score, representing an estimate of the borrower’s future loan performance. While credit scoring has been used for some time in underwriting consumer loans, it has been applied to commercial lending only during the past decade.

The authors examine the responses of 95 large banking organizations to a survey that asked whether they had adopted credit scoring for small business lending as of June 1997 and, if so, when. The study estimates hazard and tobit models to explain the diffusion patterns.

The hazard model, which examines data over the 1993–97 period, makes it possible to determine simultaneously the institutional factors that influence both the probability that small business credit scoring is adopted and the rate at which adoption occurs. The results indicate that larger banking organizations and those located in the New York Federal Reserve district introduced the innovation earlier. These results are consistent with theories that economies of scale and the geographic proximity of institutions increase the likelihood that an innovation will be adopted.

The tobit model, which supplements the results of the hazard model, confirms these results. It also shows that organizations with fewer separately chartered banks but more branches introduced small business credit scoring earlier, a finding consistent with theories stressing the importance of bank organizational form for lending style.