The Diffusion of Financial Innovations: An Examination of the Adoption of Small Business Credit Scoring by Large Banking Organizations

Jalal Akhavein, W. Scott Frame, and Lawrence J. White
Working Paper 2001-9
April 2001

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Financial innovation has been described as the “life blood of efficient and responsive capital markets.” Yet, there have been few quantitative investigations of financial innovation and the diffusion of these new technologies. Of the latter, there have been only three prior quantitative studies, and all three used the same data set on automated teller machines!

This paper makes a significant contribution to the financial innovation literature by examining the diffusion of a recent important innovation of the 1990s: banks’ use of credit scoring for small business lending. 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 (56 had done so) and, if they had adopted it, when they had done so. The authors estimate hazard and tobit models to explain the diffusion pattern of small business credit scoring models. Explanatory variables include several market, firm, and managerial factors of the banking organizations under study.

The hazard model indicates that larger banking organizations introduced innovation earlier, as did those located in the New York Federal Reserve district; both results are consistent with expectations. The tobit model confirms these results and also finds that organizations with fewer separately chartered banks but more branches introduced innovation earlier, which is consistent with theories stressing the importance of bank organizational form on lending style. Though the managerial variables signs are consistent with our expectations, none yields significant results.

JEL classification: G2, O3, L2

Key words: credit scoring, small business lending, financial innovation, technology diffusion

The author gratefully acknowledge William Greene and seminar participants at the 2000 Atlantic Economic Association meetings for helpful comments. The views expressed here are the authors’ and not necessarily those of the Federal Reserve Bank of Atlanta or the Federal Reserve System. Any remaining errors are the authors’ responsibility.

Please address questions regarding content to Jalal Akhavein, Wharton Financial Institutions Center, University of Pennsylvania, 3620 Locust Walk, Philadelphia, Pennsylvania 19104, 215-573-8074,; W. Scott Frame, Research Department, Federal Reserve Bank of Atlanta, 104 Marietta Street, N.W., Atlanta Georgia 30303, 404-498-8783,; or Lawrence J. White, Stern School of Business, New York University, 44 West 4th Street, New York, New York 10012-1126, 212-998-0880,