Rules Versus Discretion in Bank Lending Decisions

This paper analyzes the importance of discretion in bank lending decisions. We use a unique dataset of more than 1 million loan applications to customers of German savings banks and can observe accept and reject decisions as well as loan performance. We document that discretion is widespread and economically significant, in particular for customers with an existing relationship with their bank and medium credit quality. This discretion is based on soft information mainly for customers with no credit history (e.g. younger customers) and on hard information mainly for customers with a given credit history (e.g. with significant use of their credit lines). Finally, we find no evidence that loans approved based on the loan officer’s discretion perform any differently than other loans. These results help us in better understanding the loan making process and thus to shed light on an important, open question of interest to academicians, banks, consumers and regulators.