1 Information sharing between banks: theory and evidence from transition countries Marco Pagano Università di Napoli Federico II, CSEF and CEPR Conference on “The Changing Geography of Banking” Ancona, 22 – 23 September 2006

2 1.Information sharing between banks Rather than collecting data about loan applicants, banks may get it from other banks, via:  private arrangements: credit bureaus (CB)  public arrangements: public credit registries (PCR) Information sharing (IS) arrangements feature:  Obligation to (i) reciprocity; (ii) timely and accurate data  CB or PCR consolidates data by borrower and, when requested, feeds data back to banks (credit reports)  Type of information reported: Negative: past defaults (black lists) Positive: credit exposure, maturity structure, collateral, etc.

3 The main issues IS systems have become increasingly widespread, and their activity has increased Often CBs and PCRs coexist: complementarity (reporting threshold, degree of detail) Three main research questions:  How does IS affect credit market performance?  Why (and when) do banks agree to do this?  Does the type of information shared matter?

4 The rest of this talk Brief account of past research:  Theoretical predictions  Empirical findings Two new pieces of research:  Information sharing with non-exclusive lending with Alberto Bennardo and Salvatore Piccolo  Information sharing and credit market performance: firm- level evidence from transition countries with Martin Brown and Tullio Jappelli

5 2. Past research: theory Three main effects of IS among lenders: 1.IS about borrowers’ types can reduce adverse selection towards non-local applicants  raises efficiency, but has ambiguous effect on lending (Pagano-Jappelli, 1993). 2.IS about types fosters competition  reduces lenders’ future informational rents  mitigates hold-up problems  sharpens borrowers’ incentives, lowers default and interest rates, increases lending (Padilla-Pagano, 1997). 3.With both adverse selection and moral hazard, default signals bad quality to outside banks  IS about past defaults (but not about types) raises incentives to repay  lowers default and interest rate (Padilla-Pagano, 2000).

6 Past research: theory (2) These models indicate also when banks should find it more worthwhile to share information:  High geographic mobility of potential credit applicants  many non-local customers.  High entry barriers arising from non-information related factors (e.g., switching costs, regulation).  Low resource cost of setting up information sharing arrangement.  Poor protection of creditor rights, low accounting transparency  low incentives to perform for borrowers.

7 Gap in the theory So far IS always modeled under exclusive lending, i.e. each borrower borrows only from a single lender. But:  In practice, multiple lending relationships are widespread.  And, even if a borrower patronizes a single bank in equilibrium, the possibility of borrowing from others can affect equilibrium strategies and outcomes.  Particularly problematic for models of IS: most IS systems relay data about a borrower’s exposure to lenders. Perhaps this reveals concerns arising from multi-bank lending…

8 3. IS with non-exclusive lending Bennardo-Pagano-Piccolo (2006): entrepreneur can borrow simultaneously from many banks to fund fixed-size project. But if he can borrow in excess of his needs, he consumes the “free cash flow” and defaults on corresponding lender. Two settings:  Each bank can fund whole project  exclusivity is possible but cannot be enforced without IS  bank knows that entrepreneur has the incentive to borrow from other banks too.  No bank can fund whole project  exclusivity ruled out  bank must consider that the entrepreneur has the incentive to borrow in excess of his needs. In both settings, each bank produces a negative contracting externality  may cut or deny loan to avoid “overlending”.

9 A new role for information sharing Consider situations where IS would entail a unique perfectly competitive equilibrium and efficiency. Without IS, instead, we have:  Multiple equilibria, many of which imperfectly competitive. Even monopoly can be sustained: if one bank plays the monopolistic strategy, others banks may not undercut it for fear of overlending.  Insufficient lending: for fear of overlending, banks may offer so little that the project is under-funded and cannot be implemented. IS plays two roles:  fostering competition  ensuring financing of investment project Borrowing from several banks may also produce positive contracting externalities. If so, IS helps exploit them.

10 4. Past research: empirical findings IS helps to predict defaults:  Chandler-Parker 1989,  Barron-Staten 2003  Kallberg-Udell 2003, etc. IS sharpens borrowers’ incentive to repay:  experimental evidence by Brown and Zender (2006) IS increases lending and lowers default rate:  aggregate data: Jappelli-Pagano (2002): 43 countries Djankov-McLiesh-Shleifer (2006): 129 countries  firm-level data: Love-Mylenko (2003), using 1999 World Bank data.

11 Problems with the existing evidence Mostly based on aggregate data:  effects on individual firms may be confounded by composition effects  impossible to explore whether effects of IS differ depending on firm characteristics Neglect possible correlation between IS and other country-level macro or institutional variables. Little work on transition countries, in spite of their interest due to:  poor creditor protection  IS might play a substitute role  rapid and uneven change in institutions and credit markets

12 5. Firm-level study on transition countries Brown-Jappelli-Pagano (2006) tap firm-level data for transition countries:  EBRD/World Bank survey designed for transition countries (BEEPS data)  data on credit access and cost of credit for 2002 and 2005 Merge them with  country-level data from World Bank / IFC “Doing Business” survey to measure information sharing  data on other country-level macroeconomic and institutional variables, such as banking reform

13 Rapid development of IS in transition countries

14 Dependent variables Access to credit:  Answer to question “how problematic is your access to financing for the operation and growth of your business?” Cost of credit:  Answers to question: “how problematic is the cost of financing for the operation and growth of your business?” Construction of dependent variables:  Code answers on a scale from 1 to 4 (1=major obstacle, 2=moderate obstacle, 3=minor obstacles, 4=no obstacles)  Higher values indicate an improvement in the terms at which credit is available: easier access and lower cost.

15 Approach 1: cross-sectional estimates Cross-sectional estimates for 2002 data:  largest number of observations (9,655)  richest in terms of variables Specifications:  Baseline: explanatory variables include IS, other macro variables, and firm-level characteristics  Expanded: add interaction effects  Country effects: control for unobservable heterogeneity, IS enter only via interaction effects

16 Cross- sectional estimates Dependent variable: Access to finance

17 Cross- sectional estimates Dependent variable: Cost of credit

18 Approach 2: panel estimates Panel estimates for a subset of 1,457 firms sampled both in 2002 and The panel allows us to introduce country fixed effects and still estimate the effect of information sharing (not its effect via interactions with firm characteristics, as in cross-sectional estimate) Note: this is the first firm-level panel data evidence with country effects to relate IS and credit market performance!

19 Panel estimates

20 Overall results IS is associated with improved availability and lower cost of credit. Firm-level accounting transparency has qualitatively similar effects on credit market performance. IS and accounting transparency appear to be substitutes at the firm level: effect of IS stronger for more opaque firms. Results appear robust to controlling for possible spurious effects arising from other country-level variables.