Distance and information asymmetries in lending decisions

Abstract

Using a unique data set of loan applications by small businesses, we study the determinants of lending decisions and, especially, the roles of private information and physical distance between a bank and its borrowers. Although credit availability and the loan rate decrease in the bankborrower distance and increase in the borrower-competitor distance, the inclusion of a proxy for the bank’s proprietary information reduces these effects to the point of insignificance. Analyzing loan rates and borrowers’ decision to switch lenders we find strong evidence for the informational capture of good credit risks consistent with adverse-selection problems. Our results shed new light on the importance of soft information in informationally opaque credit markets and show how borrower proximity facilitates the production of proprietary information that helps banks to exploit information asymmetries and locally carve out captive markets.

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