Learning by lending

Abstract

This paper studies bank learning through repeated interactions with borrowers from a new per-spective. To understand learning by lending, we adapt a methodology from labor economics to analyze how loan contract terms evolve as banks acquire new information about borrowers. We con-struct “proxy” variables for this information using data from borrowers’ out-of-sample, future credit performance. Due to the timing of their construction, banks could not have used these variables directly to price loans. We nonetheless find that these proxies increasingly predict loan prices as elationships progress, even after controlling for possible omitted variable bias. Our methodology provides strong evidence that: (a) bank learning a˙ects loan prices, and (b) relationship benefits are heterogeneous. In particular, higher quality borrowers face di˙erentially lower spreads as their rela-tionship with lenders develop – and banks learn about their quality – while lower quality borrowers see loan prices increase and their loan mounts fall. We further find suggestive evidence that banks incorporate CEO-specific information into loan prices