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The Organization of Lending and the Use of Credit Scoring Techniques in Italian Banks

Journal 32: Applied Finance

Giorgio Albareto, Michele Benvenuti, Sauro Mocetti, Marcello Pagnini, Paola Rossi

This paper examines the results of a survey carried out in 2007 by the Bank of Italy concerning different characteristics of the organization of lending activities. Between 2003 and 2006 the physical distance between the headquarters and the branches increased, the limits to the decision-making process of loan officers were eased, their mobility raised, and the use of economic incentives to reward their activity expanded. The huge heterogeneity in organizational structures persists even within relatively homogenous size classes. The diffusion of statistical models to assess credit risk (scoring) accelerated recently particularly among large banks, boosted by the new Basel Capital Accord. Scoring is either very important or determinant in decisions on credit extension while it is rarely influential in setting interest rates, the duration of the credit, and the amount and type of collateral required. The survey shows that banks have been progressively adapting their organizational structure in order to incorporate the credit scoring tools into their lending processes.

During the 1990s, two major factors affected the Italian banking industry: liberalization and an intensive wave of technological innovation originating in the ITC sector. As a result, the banking system underwent a process of consolidation, banks expanded and entered new markets, and internal decision-making processes for granting loans were completely overhauled. The ways in which households and firms accessed credit changed. In the wake of these transformations, banks grew in size and organizational complexity; they now found themselves having to manage their presence in a number of different geographical and product markets. Large banks were not the only ones affected by this trend, as small- and medium-sized banks frequently joined larger banking groups or expanded internally; in both cases, the leaps in size sometimes led to organizational discontinuity. The rapid advances in ICT technologies had a profound effect on the output of the entire banking industry. These transformations imply that we need to have an updated and deeper knowledge of how banks organize the many aspects of their lending activities (customer screening, the terms and conditions of lending, monitoring of the borrower’s conduct, etc.).

The literature on bank-firm relationships generally treats banks as unitary entities and neglects the characteristics of their internal structure. Recently, however, the literature on organization has spawned several papers that emphasize the importance of the strategic interaction among managers in charge of various functions within the banking organization; these managers have different information and are bearers of interests that do not necessary coincide. It has been shown, both theoretically and empirically, that the ways in which this interaction occurs can affect the effectiveness of credit allocation, especially in the case of SMEs.

One of the main consequences of technological change for credit markets was the introduction of credit scoring2 techniques based on standardized data. Despite their increasing importance, including in the Italian market, there are few studies on the diffusion and use of these procedures. To collect data useful for understanding these changes, the Bank of Italy conducted a survey in 2007 of over 300 banks, which represented the universe of intermediaries of a certain minimum size and organizational complexity. This report presents the results of that survey.

The analysis of banks’ internal organization revealed profound differences among the Italian intermediaries from four standpoints: the geographical distance between a bank’s headquarters and its branch network; the decision-making autonomy of the branch managers, proxied by the amount of small business credit that they are authorized to extend in proportion to that which can be approved by the CEO; the length of the branch managers’ tenure; and the use of incentives for their remuneration. Part of this heterogeneity is accounted for by the size and institutional differences of the banks surveyed. However, some heterogeneity still exists among homogenous groups of intermediaries. The results confirm how the internal structure of lending activities adapts to specific circumstances and forms a crucial component of banks’ competitive strategies. An implication of these findings is that an analysis of these phenomena must employ a broader and richer taxonomy than the traditional one that is based on the banks’ size. For most of the participating banks, the distance between their headquarters and the branch network increased between 2003 and 2006. Bank managers enjoyed greater mobility and autonomy in decision-making, and economic incentives were more frequently used for their remuneration. The results do not support the thesis that the advent of new technologies greatly diminished the role of bank managers with negative repercussions for banks’ direct interaction with SMEs. On the contrary, it is possible that lower communication costs favored the greater autonomy of local managers in the periphery (branches or local decision-making centers). Increased mobility could be the result of events that were partially exogenous to the bank’s strategy (i.e., mergers and acquisitions or tough competition in the local credit markets). It could also be the result of an active policy by banks to reduce the costs of opportunistic practices by local branch managers.

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