Family networks play a crucial role in credit access for the first time.
A bank loan is the first step to entering a trusted lending circle. The bank will use this loan to obtain credit reports. How does one get into this loop? Banks typically base their lending decisions on income documents such as pay slips and sales receipts. This is a problem in developing countries. Most people in developing countries work in the informal economy and need the information to give banks. Are banks able to continue trying to attract customers in these circumstances?
Figure 1: The virtuous lending network
We recently published Carpio and Keller 2022. This paper shows that banks may use family connections to attract new customers to their lending circles. First, we offer that first-time borrowers are more likely than others to get credit from a bank whose family is more connected. Additionally, borrowers with more family connections are more likely to receive recognition from a bank with lower interest rates and more significant loan amounts.
Data and method
How can we determine family connections within a banking system? To build family networks, we use Peru’s naming conventions. Our process is illustrated in Figure 2. Our procedure is shown in Figure 2. First, family refers to every combination of district surnames. A tie is the occurrence of paternal or maternal surnames within an individual’s name. Consider, for instance, Diego Ancco Puclla. This name signifies a tie between the nodes Ancco Puclla and Puclla, as shown in the figure. The third step is to use these definitions and the client’s portfolio of banks to create family networks, as shown in figure 2. The center is home to the most connected families. We then calculate each family’s centrality, which measures how connected and how many connections they have. This indicator is derived from network literature and determines the size of each node in our illustration.
Figure 2: Illustration of the family network
From 2010 to 2019, we used detailed data from Peru’s credit registry. We cannot compare people with different family connections to estimate the impact of network centrality on the likelihood of receiving loans. Family networks, personal characteristics, and differences in family connections could explain the different chances of two people getting credit. We cannot also compare foreign banks, regions, or times. An additional likelihood of getting a loan could also be explained by the characteristics of a particular bank or district and economic events that occurred at a given time. We compare (i) the likelihood of the same borrower getting a loan from different banks and (ii) whether the same bank in the same area at the same time gives loans to someone whose family is more connected than one who is less. Figure 3 illustrates our method—figure 3. A first-time borrower with a surname of “1” has a higher centrality in the bank (0.16) than in banking B (0.07). Therefore, we predict that “1” will get credit from bank A. The probability of obtaining a loan from bank A is higher for the person with surname one than the one with surname 3. However, it’s lower for the person with surname 8. “1
Figure 3: Illustration showing family networks in bank portfolios
Results and mechanisms
Our results are driven primarily by the cajas, banks that target informal workers. These informal-oriented banks are different from traditional banks. They are large, risky, and small banks operate in highly competitive environments. How do these banks generate the centrality effect on credit acceptance? Evidence shows that informal-oriented banks employ family ties to reach the unbanked. Through two channels, they bring the unbanked into a virtuous lending cycle: (i) The perk mechanism and(ii) The reputation transfer mechanism.
First, the perk system is where banks provide credit to first-time borrowers who are clients’ relatives to keep them from moving to another bank. Second, Informal-oriented banks may offer a first loan to a relative. We exploit the fact that multiple individuals have opened loans at more than one bank to explore this mechanism. We find that the family members who receive a first loan from a bank tend to stay there longer. This bank is more likely to have a positive credit balance, which happens only after the credit is issued.
The reputation transfer mechanism is second. It involves banks inferring the ability of borrowers to pay using their family’s reputation. Informal-oriented banks can use informal documents to determine the creditworthiness and income of prospective clients by assuming that they are similar to their families. Their family reputation influences the future behavior of an individual who gets the credit.
We conclude that informal-oriented banks use family networks to connect people with more connected families into the virtuous loan circle. Our research raises new questions. We are curious if banks in other countries even developed ones, use family networks to replace the lack of information about informal activity. Will they continue to use family networks? This may be true if banks with characteristics similar to the ones we call informal-oriented banks to serve the informal sector as well as minorities.
