Cultural Affinity and Lending Discrimination: The Impact of Underwriting Errors and Credit Risk Distribution on Applicant Denial Rates

Authors: Ferguson M.F.¹; Peters S.R.²

Source: Journal of Financial Services Research, Volume 11, Number 1, 19 February 1997 , pp. 153-168(16)

Publisher: Springer

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Abstract:

We examine the impact of underwriting errors on marginal loan denial rates when these errors or average creditworthiness differ across racial groups. We find that the noise in evaluating applicant credit risk can have a differential impact on marginal borrowers across racial groups. Consequently, discrimination can go undetected in an examination of relative loan denial rates when it is present. We also show that discrimination can be “detected” where none exists. Furthermore, we argue that it is likely that the errors a bank makes in assessing applicant credit risk are a consequence of its skill or affinity, which, in turn, is shaped by the underwriting experiences in the bank’s market. A resulting implication is that banks that develop affinities in serving different market segments may have substantially different denial rate experiences across racial groups. This observation can shed light on the puzzling result that minority-owned banks tend to perform poorly in studies of lending discrimination. We conclude that underwriting errors call into question the reliability of the “fair-lending” guidelines used to assess all banks.

Language: English

Document Type: Regular paper

Affiliations: 1: Department of Finance School of Business Indiana University Bloomington IN 47405 2: Department of Finance School of Business Administration University of Connecticut Storrs CT 06269

Publication date: 1997-02-19