VDCUVermont Development Credit Union
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To determine loan allocation for a randomly selected applicant, loan officers at the VDCU collect and analyze three types of information.
Presumably, clients with better financial resources and fewer financial obligations are less likely to default, as are those with stronger relationships with the VDCU. We additionally expect that the loan terms, as measured by loan amount and length of loan (loan duration measured in months), may potentially affect the likelihood of default.
Only 268 of all Working Wheels applicants (44% of the entire sample) had any recorded credit score; the remaining applicants had an insufficient credit record so that the VDCU could not obtain a standardized credit rating.
It is notable that 12 applicants with neither a credit score nor a reliable, stable monthly income were granted Working Wheels loans, a clear sign that the VDCU is extending loans to a traditionally "high risk" and "unlendable" population.
"Months in VDCU," the number of months that the applicant has been a member of the VDCU at the time of application, is used as one of two measures of the strength of the lender/client relationship: the length of one's relationship with the bank is the standard proxy for the strength of this relationship in the banking literature (e.g., Berger and Udell 1995; Cole 1998; Chakravarty and Scott 1999; Chakravarty and Yilmazer 2004).
How good is "months in VDCU" as a measure of the strength of the lender/client relationship?
[The high correlation (r = 0.64) between "months in VDCU" and "previous application" preclude their inclusion in the same model but suggest that both are alternative proxies for the extent of one's relationship with the VDCU.]
Table 1 suggests that those with credit scores have been VDCU members for more than twice as long as those without credit scores (7.5 and 2.8 months, respectively), and this difference is statistically significant (p < 0.001).
We test this hypothesis by including in our loan approval model an additional variable, "last five loans," which measures the share of the previous five Working Wheels loans that were approved by the VDCU. Again, "last five loans" is omitted in the default model because the outcome of the previous five loan decisions should not affect the probability of default of any given approved applicant many months later.
The loan officer responsible for the majority of applications at the VDCU indicated that applications are filled out completely for every potential applicant, eliminating the concern for either type of selection bias.
As noted earlier, our hypothesis is that loan officers at the VDCU, when assessing the creditworthiness of a Working Wheels applicant without a complete set of financial information, will rely more heavily on personal information and the nature of the applicant's established relationship with the VDCU preceding this loan application.
The marginal effects reported in columns (1) and (2) verify that many of the covariates behave as expected; they also highlight the differences in the determinants of loan approval between the two subsamples, particularly when "months in VDCU" is used as the measure of the strength of relationship.