How and Why Credit Assessors "Get it Wrong" When Judging the Risk of Borrowers: Past and Present Evidence at Home and Abroad

This chapter presents empirical and theoretical evidence that lending decisions are fundamentally and systematically flawed. The first part summarizes a decade of individual and joint research on credit risk and lending based on behavioral and political models rather than "eobjective" economic models alone. It shows individual, organizational, and broader competitive, even institutional, factors consistent with behavioral and political explanations of risk and decision making can significantly and substantially distort credit assessment in a variety of contexts. The second part presents current research combining insights from both behavioral and political models of risk and decision making in an international context. It develops and tests an integrated theoretical framework for understanding how two forms of rivalry shape risk assessments by firms active in developing countries (DCs). One form of rivalry relates to DC electoral politics and their impact on firms making sovereign government credit assessments. The other relates to firm rivalry for market share in rating DC sovereign bond issuances. It is proposed that both matter for assessing the creditworthiness of DC sovereigns during election years. The chapter concludes with a summary of key findings and their implications for research, policy, and practice related to prudential credit assessment.