Taylor A. Begley, Umit G. Gurun, Amiyatosh Purnanandam, Daniel Weagley
The use of risk-insensitive loan pricing by the Small Business Administration’s disaster loan program leads to significantly higher loan denials in areas with greater need for price discrimination: high minority share, high subprime share, and high income inequality areas. Even though these borrowers are often the intended targets of government programs such as disaster lending, they end up with lower availability of credit in this program compared to private markets. Our findings highlight the importance of using market prices as a mechanism to allocate credit across borrowers, a feature that is often absent from government lending programs around the world. Applicants that would likely receive a loan at a higher interest rate under a risk-sensitive pricing mechanism are instead denied credit altogether. Programs that limit the use of this mechanism to ensure a “fair” price of credit across borrowers may have unintended “unfair” consequences on the quantity of credit to marginal borrowers.