Building Credit Histories

Building Credit Histories Building Credit Histories Project Summary Overview: Consumer finance received a lot of attention in the policy debate since the financial crisis of 2008. The crisis itself, the preceding credit boom and the subsequent credit contraction have highlighted the importance of access to credit for individual households and the importance of the composition of borrowers (lending standards) for the health of the financial system. Policy proposals aimed at expanding access to credit include allowing credit-reporting agencies to use non-traditional sources of information to better assess the risk profiles of emerging borrowers. To guide such policy proposals, we need to better understand behavior of emerging borrowers and their lenders. This research program analyzes novel data and proposes new theory to better understand the behavior of emerging borrowers and their creditors. The empirical analysis provides new insights into how emerging borrowers expand their access to credit, and how their behavior differs from that of more mature borrowers. Importantly, the new data obtained by the researchers allow for an examination of the behavior of individual lines of credit (credit cards) for a borrower over time. Preliminary analysis of this evidence reveals the importance of borrowing from multiple creditors for emerging borrowers. The authors hypothesize that emerging borrowers with access to multiple lenders accumulate credit quickly because their credit history aggregates information across their lenders, a mechanism the authors refer to as building a credit history. The research proposes a new theory consistent with this hypothesis which allows us to better understand the selection and signaling mechanisms that may manifest when credit records convey information across lenders. This theoretical model has a at least one stark implication that, despite the fact that additional credit dilutes the value of existing loans (by raising default risk), borrowers that receive larger additional loans pose lower default risk to their incumbent lenders than those who receive smaller additional loans. This stark theoretical prediction is actually borne out in our data. Intellectual Merit: To date, research on consumer credit has predominantly focused on the middle-to-end of a consumers credit life cycle by studying the impact of borrowers repayment behavior on subsequent access to credit. In contrast, we focus on emerging borrowers and the evolution of their access to credit. We will use our novel dataset to document stylized facts about behavior of emerging borrowers and their lenders (compared to that of established borrowers). Preliminary analysis of the data points to the importance of using credit as a signaling device. We offer a parsimonious model of credit-history building and show that the key theoretical predictions are borne out in the data. We will expand on and utilize this model to analyze the implications of recent developments in credit market and data availability, as well as inform policies and practices aimed at improving credit access for emerging borrowers. This research team brings together scholars with expertise in consumer credit, finance, and intermediation with experience in developing and confronting theory with empirical evidence to provide the first systematic analysis of consumer credit markets for emerging borrowers. Broader Impact: There is growing interest among both public and private entities in understanding and improving the credit risks associated with providing credit to emerging borrowers. Our analysis will inform approaches to better educate these borrowers on how to manage their credit record to attain better access to credit. Private creditors are employing new types of data and data analytics to predict the credit risk associated with emerging borrowers. Moreover, public institutions that provide or subsidize credit to borrowers, such as the Federal Housing Authority, rely on the signals and information provided by credit reporting agencies and private creditors to determine borrowers access to public support. While the research program studied here emphasizes a novel analysis of selection and signaling that underlies the consumer credit markets for emerging borrowers, the findings provide the groundwork for a host of important policy and business applications. By examining which aspects of a consumers credit record induce a rapid expansion of available credit, the research will inform policies intended to improve access to credit through improving consumers financial literacy. The research findings on the importance of multiple borrowing has important implications for how financial and public institutions assess and price borrowers credit risk.