Credit risk assessment in different contexts : The influence of local networks for bank financing of SMEs

Abstract: The Swedish banking crisis a decade ago was ultimately caused by the banks' failure in their assessments of the credit-risk of firms. Since then, Swedish banks have tried different organizational structures in order to safeguard the lending process. Practitioners in the field of banking often remind each other and those around them, about the need for banking to be local. Theory traditionally perceives banking as a phenomenon primarily dealing with risks at a macroeconomic level, where there is no provision for local decision-making. The fundamental question about why banking is local is rarely discussed. This thesis is an attempt to show why bankers perceive that credit-risk assessments need a local presence. The study incorporates 45 interviews with branch managers in all the major Swedish banks, and a survey of 313 responding branch managers all over Sweden. The results, both qualitative and quantitative, show that local social networks developed out of local business organizations influence credit-risk assessments of small- and medium-sized firms in certain contexts. There are fundamental differences between metropolitan districts, where the relationships between banks and their customers are direct, and non-metropolitan districts, where social networks are more important. In non-metropolitan districts branch managers are more active in local business organizations, and are generally more visible in the community. Through these social networks, branch managers in non-metropolitan districts recruit local branch board members, who serve as mediators between the bank and the local business community. By forming these relationships banks are also more apt to use third party actors (such as lawyers, auditors and other firms) in supporting local businesses. In the end, by using social networks and local branch boards, branch managers in non-metropolitan areas employ more qualitative information in the credit-risk assessment process. A number of organizational anomalies in banks are identified in the conclusions of the thesis. These do not necessarily support the generation of qualitative information locally. Metropolitan districts tend not to be aligned to the natural social networks that exist in those areas. In metropolitan districts, the main source of information tends to come from the firm that is being assessed, whereas in other districts there is also the possibility of using other actors as sources of information. It is of interest to note that the information gathered from third party actors does not replace information from the firm, but instead serves as a complementary source.