Distance and Private Information in Lending

Abstract

We study the effects of physical distance on the acquisition and use of private information in informationally opaque credit markets. Using a unique data set of all loan applications by small firms to a large bank, we show that borrower proximity facilitates the collection of soft information, leading to a trade-off in the availability and pricing of credit, which is more readily accessible to nearby firms albeit at higher interest rates ceteris paribus. Analyzing loan rates and firms' decision to switch lenders provides further evidence for banks' strategic use of private information. However, distance erodes our lender's ability to collect proprietary intelligence and to carve out local captive markets, suggesting that the requisite soft information is primarily local. (JEL G21, L11, L14, D44) Private information and its distribution are among the fundamental forces shaping economic exchange. Agents often devote considerable resources in terms of time, effort, and money to its acquisition in order to gain a strategic advantage in the ensuing transaction, especially by collecting soft information. At the same time, very little is known about the origins, use, and consequences of such subjective intelligence despite its economic importance Its defining attributes-it is not readily transferable, verifiable, or interpretable-also imply that it is difficult to identify, measure, and analyze in practice. However, technological progress coupled with operational procedures in commercial lending allow us to overcome these analytic challenges in one particular industry-credit-market transactions in-