What Do Banks Evaluate When They Screen Borrowers? Soft Information, Hard Information and Collateral

Abstract

By applying factor analysis to unique data on loan screening for small and medium-sized enterprises (SMEs) in Japan, we investigate the factors that banks actually evaluate when underwriting commercial loans. We find that banks emphasize three factors when they decide whether to grant loans: the relationship factor, the financial statement factor, and the collateral/guarantee factor. We also find that smaller banks place greater emphasis on the relationship and the collateral/guarantee factors, and that banks under competitive pressure emphasize the relationship factor to a greater extent. We interpret these findings based on the theory of relationship lending and lending technologies.

Keywords: Bank lending, Real estate collateral, Financial statements, Relationship lending, Small and medium-sized enterprises

JEL Classification: G21, L14, D82, L22