Journal of Credit Risk

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Are lenders using risk-based pricing in the Italian consumer loan market? The effect of the 2008 crisis

Silvia Magri

  • This paper analyzes whether in Italy the price of consumer loans is based on borrower specific credit risk. This issue is important because mispricing could threaten financial stability through negative effects on lenders' profitability; risk-based pricing also leads to a more efficient allocation of credit through less rationing and lower prices for low-risk borrowers who are hence more able to smooth their consumption, with positive effects on economic growth and financial stability.  
  • The analysis is based on the Survey on Household Income and Wealth, which has collected data on interest rates paid on consumer credit along with information on households’ characteristics since 2006. 
  • The evidence shows that consumer loan pricing has been more risk-based since the 2008 financial crisis. Households' economic and financial conditions - above all, net wealth, but also number of income earners and education as a proxy of permanent income - become significant and economically important in influencing the interest rates during the period 2010-12. 
  • These are also the most important drivers of the probability of delinquency on consumer loans; lenders also focus on these variables in selecting borrowers. As a consequence of the 2008 crisis, lenders have therefore paid more attention to borrowers' credit risk not only in the selection process, but also in deciding the price of the loan.
     

This paper analyzes whether in Italy the price of consumer loans is based on borrower-specific credit risk. This issue is important because mispricing could threaten financial stability through negative effects on lenders’ profitability; risk-based pricing also leads to a more efficient allocation of credit through less rationing and lower prices for low-risk borrowers, who are thereby better able to smooth their consumption, with positive effects on economic growth and financial stability. The evidence available from data collected since 2006 via the Survey on Household Income and Wealth shows that consumer loan pricing has been more risk-based since the 2008 financial crisis. Households’ economic and financial conditions (above all, net wealth, but also number of income earners and education as a proxy for permanent income) become significant and economically important in influencing interest rates during the period 2010–12. These are also the most important drivers of the probability of delinquency on consumer loans; lenders focus on these variables in selecting borrowers. As a consequence of the 2008 financial crisis, lenders have therefore paid more attention to borrowers’ credit risk not only in the selection process, but also in deciding the price of the loan.

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