Risk/Return Analysis on Credit Exposure: Do Small Banks Really Apply a Pricing Risk-Based on Their Loans?

In the current economic scenario, an efficient and effective credit underwriting based on a pricing adjusted to the internal credit risk policies is a pillar for the existence of the banks. Despite the recent Regulator's indications and the advanced methodologies available, small banks prefer to adopt less structured for assessing the risk profile of their portfolio. Our study empirically analyzes a Small Bank portfolio of 16,216 loans (Retail and Corporate) underwritten in the last 5 years (2013–2017) and try to investigate the nature of the link between borrower credit worthiness and the effective price applied to the loans. The study finds out that the link between borrower credit worthiness and the price applied is opposite to what expected (the higher credit quality, the lower interest rate applied to loans).