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WORKING PAPER NO. 178 Information Sharing and Credit: Firm-Level Evidence from Transition Countries Martin Brown, Tullio Jappelli and Marco Pagano May 2007 University of Naples Federico II University of Salerno Bocconi University, Milan CSEF - Centre for Studies in Economics and Finance – UNIVERSITY OF SALERNO 84084 FISCIANO (SA) - ITALY Tel. +39 089 96 3167/3168 - Fax +39 089 96 3167 – e-mail: csef@unisa.it WORKING PAPER NO. 178 Information Sharing and Credit: Firm-Level Evidence from Transition Countries Martin Brown*, Tullio Jappelli** and Marco Pagano*** Abstract We investigate whether information sharing among banks has affected credit market performance in the transition countries of Eastern Europe and the former Soviet Union, using a large sample of firm-level data. Our estimates show that information sharing is associated with improved availability and lower cost of credit to firms, and that this correlation is stronger for opaque firms than transparent firms. In cross-sectional estimates, we control for variation in country-level aggregate variables that may affect credit, by examining the differential impact of information sharing across firm types. In panel estimates, we also control for the presence of unobserved heterogeneity at the firm level and for changes in selected macroeconomic variables. Keywords: information sharing, credit access, transition countries JEL Classification: D82, G21, G28, O16, P34 Acknowledgements: We benefited from the comments of Mariassunta Giannetti, Luigi Pistaferri, Alessandro Sembenelli, Greg Udell and seminar participants at the University of Turin, the Swiss National Bank, the Ancona Conference on the Changing Geography of Banking, the 8th Conference of the ECB-CFS Research Network on Financial Integration and Stability in Europe, and the 2007 Skinance conference. We also thank Caralee McLiesh of the World Bank and Utku Teksov of the EBRD for kindly providing us with data, Lukas Burkhard for research assistance and the Unicredit Group for financial support. * Swiss National Bank (e-mail: martin.brown@snb.ch) ** University of Naples Federico II, CSEF and CEPR (e-mail: tullioj@tin.it) *** University of Naples Federico II, CSEF and CEPR (e-mail: mrpagano@tin.it) Contents 1 Introduction 2 Effects of Information Sharing 3 2.1 Theory 2.2 Empirical Evidence Data 3.1 Information Sharing 3.2 Credit Access 3.3 Regression Specification 4 Cross-sectional Estimates 5 Panel Estimates 6 Conclusions References Appendix 1 Introduction When banks evaluate a request for credit, they can either collect information on the applicant first-hand or source this information from other lenders who already dealt with the applicant. Information exchange between lenders, can occur voluntarily via “private credit bureaus” or be enforced by regulation via “public credit registries”, and is arguably an important determinant of credit market performance. Theory suggests that information sharing may overcome adverse selection in the credit market (Pagano and Jappelli, 1993) and reduce moral hazard, by motivating borrowers to exert high effort in projects and repay loans (Padilla and Pagano, 2000). Empirical work has identified a positive correlation between measures of information sharing, aggregate credit and default risk (Jappelli and Pagano, 2002; Djankov, McLiesh and Shleifer, forthcoming). Information sharing should be particularly relevant for credit market performance in countries with weak company law and creditor rights. Lack of transparency in corporate reporting, due to weak company law, increases information asymmetries in the borrowerlender relationship, reducing incentives for banks to lend. Moreover, weak creditor rights make banks more reluctant to lend to risky firms, as contract enforcement is costly or impossible. The screening and incentive effects of information sharing can mitigate both of these problems. In this paper we attempt to shed light on the role of information sharing in countries with weak company law and creditor rights. We analyze the impact of private credit bureaus and public credit registries on the availability and cost of credit to firms in 24 transition countries of Eastern Europe and the former Soviet Union.1 Pistor, Raiser and Gelfer (2000) document that in these countries the legal environment is particularly unfavourable for lending. Moreover, transition countries are an interesting sample to study because some of them have recently experienced both strong credit market development and considerable institutional change, including the introduction of information sharing systems. Private sector credit has 1 We examine data from 24 transition countries, which we classify into three groups according to their status in 2005: European Union (Czech Republic, Estonia, Hungary, Latvia, Lithuania, Poland, Slovak Republic, Slovenia); Commonwealth of Independent States (Armenia, Azerbaijan, Belarus Georgia, Kazakhstan, Kyrgyzstan, Moldova, Russia, Ukraine); Other European Countries (Albania, Bosnia & Herzegovina, Bulgaria, Croatia, Macedonia, Romania, Serbia & Montenegro). We exclude the CIS countries Tajikistan, Turkmenistan and Uzbekistan due to lack of data. 7 climbed from just 15% of GDP in 1999 to 25% at the end of 2004.2 The quality of lending has also strongly improved, with the ratio of non-performing loans in banks’ portfolios falling from more than 20% in 1999 to just 10% at the end of 2004. Over the same period, seven public registries and seven private credit bureaus have emerged in these countries. To measure credit market performance, we use firm-level data on credit access and cost of credit, drawn from the EBRD/World Bank “Business Environment and Enterprise Performance Survey” (BEEPS), a representative and large sample of firms. We relate this firm-level credit data to country-level indicators of information sharing, compiled from the “Doing Business” database of the World Bank/IFC (World Bank, 2006). There are two main benefits from investigating the impact of information sharing using our data set. First, firm-level data allow us to identify the firms that benefit more from information sharing arrangements. For instance, firms that are opaque and costly to screen may gain greater access to credit after the introduction of a credit registry or bureau. We can thus overcome the limitations of aggregate data, which confound the effect of information sharing on individual firms with that arising from compositional changes in the set of firms who obtain credit. The second reason for using the BEEPS data is methodological: it allows us to control for unobserved heterogeneity at the firm level and for changes in other macroeconomic variables, using panel data constructed from the 2002 and 2005 surveys. As far as we are aware, this is the first study to use firm-level panel data to investigate the relation between information sharing and credit availability. Previous analyses are either based on country-level data (Jappelli and Pagano, 2002; Djankov et al., forthcoming) or on cross-sectional firm-level data (Galindo and Miller, 2001; Love and Mylenko, 2003). Both our cross-sectional estimates and our panel estimates show that on average information sharing is associated with more abundant and cheaper credit. Moreover, the cross-sectional correlation between credit availability and information sharing is stronger for opaque firms than transparent ones, where transparency is defined as the reliance on external auditors and the adoption of international accounting standards. Panel estimates also suggest that small firms benefit more from information sharing than larger ones. Taken together, these two results are consistent with the view that information sharing is particularly valuable in guiding banks to evaluate credit applicants who would otherwise be too costly to screen. 2 The statistics in this paragraph are unweighted country averages, drawn from the EBRD Transition Report (EBRD, 2003; EBRD, 2005). 8 Finally, our evidence confirms previous findings that information sharing is more effective in countries with weaker legal environments. The rest of the paper is organized as follows. Section 2 provides a literature review and presents the hypotheses to be tested. Section 3 describes the data and the specification to be estimated. Sections 4 and 5 present the results obtained with cross-sectional and panel data, respectively. Section 6 summarizes our findings. 2 Effects of Information Sharing In this section we review the models proposed in the literature to capture the effects of information sharing on credit market performance, using them to draw testable predictions for our empirical analysis. We also set our work against the existing empirical evidence in this area, to highlight the value added of our contribution. 2.1 Theory By exchanging information about their customers, banks can improve their knowledge of applicants’ characteristics, past behavior and current debt exposure. In principle, this reduction of informational asymmetries can reduce adverse selection problems in lending, as well as change borrowers’ incentives to repay, both directly and by changing the competitiveness of the credit market. It can also reduce each bank’s uncertainty about the total exposure of the borrower, in the context of multiple-bank lending. The implied effects on lending, interest rates and default rates have been modeled in several ways.3 Pagano and Jappelli (1993) show that information sharing reduces adverse selection by improving bank’s information on credit applicants. In their model, each bank has private information about local credit applicants, but no information about non-local applicants. If banks exchange information about their client’s credit worthiness, they can assess also the quality of non-local credit seekers, and lend to them as safely as they do with local clients. The impact of information sharing on aggregate lending in this model is ambiguous. When 3 See Jappelli and Pagano (2006) for a comprehensive overview of theory and evidence on information sharing. 9 banks exchange information about borrowers’ types, the increase in lending to safe borrowers may fail to compensate for an eventual reduction in lending to risky types. Information sharing can also create incentives for borrowers to perform in line with banks’ interests. Klein (1982) shows that information sharing can motivate borrowers to repay loans, when the legal environment makes it difficult for banks to enforce credit contracts. In this model borrowers repay their loans because they know that defaulters will be blacklisted, reducing external finance in future. Vercammen (1995) and Padilla and Pagano (2000) show that if banks exchange information on defaults, borrowers are motivated to exert more effort in their projects. In both models default is a signal of bad quality for outside banks and carries the penalty of higher interest rates, or no future access to credit. Padilla and Pagano (1997) show that information sharing can also mitigate hold-up problems in lending relationships, by eliciting more competition for borrowers and thereby reducing the informational rents that banks can extract. The reduced hold-up problems can elicit higher effort by borrowers and thereby make banks willing to lower lending rates and extend more credit.4 Finally, when a customer can borrow from several banks, each of these may be uncertain about the customer’s total exposure, and therefore about his ability to repay. Bennardo, Pagano and Piccolo (2007) show that the danger of overlending that stems from this uncertainty may result in inefficiently scarce credit. Insofar as it makes lending safer, information sharing about seniority or debt exposure can raise investment and welfare. Given the variety of the informational problems considered in these models, it is not surprising that the predicted effects of information sharing on the volume of lending are not identical across models. For instance, in the adverse selection model of Pagano and Jappelli (1993) the effect on lending is ambiguous, while it is positive in the hold-up model of Padilla and Pagano (1997) and in the multiple-bank lending model of Bennardo et al. (2007). The effect on lending also depends on the type of information being shared: in the model by Padilla and Pagano (2000), sharing only default information increases lending above the level reached when banks also share their data about borrowers’ characteristics. Therefore, whether information sharing is associated with increased lending is left to the empirical evidence. 4 Bouckaert and Degryse (2004) and Gehrig and Stenbacka (2007) show that if banks compete ex ante for clients and customers face switching costs, future informational rents foster banking competition. Since information sharing reduces these rents, in these models it reduces competition, in contrast to Padilla and Pagano (1997). 10