Credit Line Usage, Checking Account Activity, and Default Risk of Bank Borrowers

Abstract

We investigate the link between account activity and information production on borrower quality. Based on a unique data set, we find that credit line usage, limit violations, and cash inflows exhibit abnormal patterns approximately 12 months before default events. Measures of account activity substantially improve default predictions and are especially helpful for monitoring small businesses and individuals. We also find that the early warning indications from account activity result in higher loan spreads, and in a higher likelihood of limit reductions and complete write-offs. Our results highlight that the information on account activity provides banks with a real-time window into the borrower’s cash flows, creating a unique advantage over non-bank lenders and capital markets.