Sharing Default Information as a Borrower Discipline Device

Abstract

Creditors often share information about their customers' credit records. Besides helping them to spot bad risks, this acts as a disciplinary device. If creditors are known to inform one another of defaults, borrowers must consider that default on one lender would disrupt their credit rating with all the other lenders. This increases their incentive to perform. However, sharing more detailed information can reduce this disciplinary e!ect: borrowers' incentives to perform may be greater when lenders only disclose past defaults than when they share all their information. In some instances, by &"ne-tuning' the type and accuracy of the information shared, lenders can raise borrowers' incentives to their "rst-best level.

Information technology and the rise of household bankruptcy

“…In 1997 credit bureaus issued some 600 million reports about credit seekers, (Padilla and Pagano [20]), and in the following decade credit scores produced by the Fair Isaac and Company, known as FICO scores, became the industry's standard tool for assessing borrowers' credit worthiness. Moreover, Edelberg [12] shows that lenders increasingly used risk-based pricing of interest rates in consumer loan markets during the mid-1990s, and Berger [5] reports that improvement in the lending capacity was due to improvements in information technology used by the banks.…”

The Role of Comprehensive Information Sharing in Credit Market: Theoretical Analysis and New Evidence from the European Union

“…Theoretical research: Pagano and Jappelli (1993); Padilla and Pagano (1997;2000); Vercammen (1995) Empirical research: Behr and Sonnekalb (2012); Dierkes et al (2013) Houston et al (2010); Jappelli and Pagano (2002) Information sharing produces the negative "composition effects", leaving the credit risk increase: Brown et al (2009);Jappelli and Pagano (2005); Dell'Ariccia and Marquez (2006) "information rents" once the lending relationship is established. This leads to the "hold-up" problem (borrowers will be charged high interest rate, which reduces their effort to perform and increases the default) as well as moral hazard.…”

“…Even though the "information rents" no longer exist, information sharing among banks can also exert a kind of discipline effect, which means that the failure of payment would induce the exclusion of credit market. Thus, the moral hazard has been lowered (Padilla & Pagano, 2000).…”

“…Besides, views from Vercammen (1995) and Padilla and Pagano (2000) show that long-term positive credit record leaves an occasional default insignificant, as these "good" borrowers can still obtain credit from other banks. Thus, excessive positive information could reduce the "discipline effects" and increase the probability of default.…”

“…Theories at this stage suggested that information sharing is substantially relevant to overcome adverse selection and moral hazard arising from information asymmetry in credit market. This progress is mainly achieved through several aspects: (1) ameliorating the quality of the pool of borrowers to reduce adverse selection (Pagano & Jappelli, 1993); (2) depriving the bank's ability of extracting "information rents" to lower moral hazard (Padilla & Pagano, 1997); and (3) exerting "discipline constraint" on individual borrower to create incentives for repayments (Padilla & Pagano, 2000;Vercammen, 1995).…”