Predicting SMEs’ default risk: evidence from bank-firm relationship data

This paper uses a probit model on a unique dataset including 13,081 Italian firms and 111 co-operative banks involved in the lending process to provide empirical evidence suggesting that the use and violations of credit lines and long-term loans overruns predict the 1-year and 2-year probability of default (PD), controlling for balance sheets indicators and time varying bank characteristics, captured by bank-time fixed effects. In addition, when combined with accounting data, credit-related indicators obtained from private internal banking sources improve the SMEs’ default prediction. The marginal benefit of the bank-firm specific information is also assessed by comparing the default prediction accuracy of a model that incorporates the accounting information with that of a full model, including also private information. In terms of heterogeneity, our results reveal that the association between the balance sheet indicators and data on bank-firm relationships and the default probability can vary across sectors and geographies, highlighting the importance for banks of specific analysis to better assess risk at the firm level.