Edited by Adrian R. Bell, Chris Brooks and Marcel Prokopczuk
Chapter 9: Using heteroskedastic models to analyze the use of rules versus discretion in lending decisions
Little is known about the procedures and processes through which banks decide to grant loans and to price credit. For example, even after one takes into account the differences in borrowers, lenders and markets, loan rates still often exhibit substantial dispersion. This dispersion suggests that frictions in the credit market enable banks (i.e., through their loan officers) to price loans in a discretionary manner. The banks’ use of ‘discretion’ should affect aggregate welfare as well as its distribution across different market participants. Consequently, understanding the nature of discretion is crucial for any analysis of the credit market. This chapter demonstrates how to investigate the use of discretion by banks in the loan rate setting process with a heteroskedastic regression model. With such a model one can investigate what factors determine the dispersion in banks’ loan rates to small and medium-sized enterprises, for example. One can then attribute this dispersion to the bank and loan officers’ exploitation of market imperfections and assess the relevance of firm, loan officer and bank characteristics, as suggested by the theoretical literature, in explaining discretion.
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