Credit checks are a low-cost way to reduce the number of borrowers who default on loans. But in India, where credit bureaus and checks are relatively new, some banks have been slow to adopt them, according to research by Prachi Mishra of Goldman Sachs, Johns Hopkins’s Nagpurnanand Prabhala, and Chicago Booth’s Raghuram G. Rajan.
Banks that faced lower competition in their formative years were less willing to adopt valuable new technologies or management practices, the researchers conclude. That insight, they say, could generally explain why some institutions fail to seize on new business tools.
India’s banking sector has grown significantly in recent years, as has access to credit. The total number of borrowers in the country increased by almost 20 percent between 2015 and 2016 alone. But unlike in the United States, banks in India hadn’t historically checked retail borrowers’ credit before making loans. Credit bureaus—the institutions that monitor and provide information about borrowers’ creditworthiness, and which play a large role in the US financial system—really only started operating in India around 2007, when legislation passed requiring banks to submit data to bureaus.
The researchers saw in this environment a way to study how organizations adopt—or don’t—a technology or practice. As of March 2015, the end of the data period studied, India had 96 major banks with a collective $1 trillion in outstanding credit. State-owned public-sector banks, many of them nationalized in 1969 and 1980, accounted for around 70 percent of that credit. New private-sector banks, which were authorized after 1991, had another 20 percent of the credit market.
Mishra, Prabhala, and Rajan analyzed data on lenders’ credit inquiries from one of the country’s biggest credit bureaus, with most of the analysis using data between the years 2006 and 2015, and find that new private banks adopted credit checks faster than state-owned banks. In 2015, new private banks ran credit checks before making 88 percent of their loans, double the rate at state-owned banks, the researchers calculate.
The gap was driven by checks on existing customers. Both types of banks were relatively quick to integrate credit checks into their business practices for new customers. Public-sector banks made credit inquiries for over 95 percent of loans to new customers, as did new private banks. But in 2015, new private banks inquired about 90 percent of loans to existing borrowers, while state-owned banks did so for only 48 percent. This was the case even though state-owned banks, had they adopted credit checks more widely, could have reduced loan-delinquency rates in their lending portfolios by 30–40 percent, the researchers argue.
Regulators looking for an early warning of a bank’s financial stress should monitor one simple metric: how far away it is from its borrowers.
When the Economy Is Overheating, Banks Lend Farther from HomeNeither state ownership nor size explains the slow pace of change, the researchers say, basing their conclusion on the behavior of a third type of banking institution: old private banks, private-sector institutions that were deemed too small to be nationalized. Much like public-sector banks, they quickly adopted the practice of performing credit checks for new clients, but not for existing customers.
Organizational culture may best explain why public-sector banks were slower to implement credit checks, the researchers conclude. “The legacy banks grew in an uncompetitive environment in which banks were protected from entry, which diminished profitability concerns and let them go the extra mile for the existing clients,” the researchers write. “The new private banks emerged in a more competitive era after India’s economic liberalization. In the post-reform environment, each transaction had to stand on its own merits.”
The narrowing gap between public-sector and new private banks’ use of credit inquiries suggests that public-sector banks may be feeling pressure to compete. But the broader finding suggests that the economic environment during which institutions emerge may have long-lasting effects on both the organization’s culture and its willingness to adopt valuable new offerings.
Prachi Mishra, Nagpurnanand Prabhala, and Raghuram G. Rajan, “The Relationship Dilemma: Organizational Culture and the Adoption of Credit Scoring Technology in Indian Banking,” Working paper, May 2019.
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