Researcher examines inconsistent lending practices

Feb 27, 2013 by Judy Ashton

Research published in the European Economic Review finds that lenders' profits improve at an increasing rate with more intense screening of prospective borrowers; however, somewhat paradoxically, lenders experiencing a greater return on investment are less prone to closely screen an applicant's project.

When the economy tanked in 2008, lenders tightened borrowing practices, increased credit standards and began to closely scrutinize all funding requests, even from those with solid credentials.

In the wake of the , borrowers were subject to increased loan inspection, however lending policies fluctuated. That's according to research titled "Extreme Pricing Policies" published in Issue 8 of the 2012 European Economic Review.

According to Pal, the purpose of their research was to examine "why lenders implement variable levels of credit screening," he says.

Pal states that an underlying factor for increased lending inspection can be tied to screening standards. The group found that lenders who experience a greater return on investment were less prone to closely screen an applicant's project.  Their research also revealed that a lender's profits improved at an increasing rate with more intense screening, thereby reducing associated risks.

"So, the increasing marginal returns can lead a lender to implement either a very high or a very low level of screening accuracy," Pal says. "However, in deciding screening accuracy, the lender faces a trade-off, as better screening requires additional resources."

Pal also noted that small changes in industry parameters could produce large changes in a lender's screening .

"In other words, the lender 'rationally' overreacts," Bose says. "As a consequence, an initial mild in motivates lenders to substantially increase their lending standard and limit credits, causing further downturn in economic activities."

Explore further: Narcissistic CEOs and financial performance

More information: econpapers.repec.org/article/e… _3ap_3a1607-1620.htm

add to favorites email to friend print save as pdf

Related Stories

New study calls for global project finance reform

Dec 28, 2008

The worldwide financial crisis puts a new emphasis on infrastructure spending, seen by many governments as a way to head off economic downturn, and as a way of holding on to achievements made in the developing world. Recent ...

Recommended for you

Narcissistic CEOs and financial performance

Jul 24, 2014

Narcissism, considered by some as the "dark side of the executive personality," may actually be a good thing when it comes to certain financial measures, with companies led by narcissistic CEOs outperforming those helmed ...

Drugmaker GSK slashes annual profits forecast

Jul 23, 2014

British drugmaker GlaxoSmithKline on Wednesday slashed its 2014 profits forecast as second-quarter earnings sank on the back of weak US trade, adverse currency moves and a Chinese bribery probe.

User comments : 0