New credit cards signal creditworthiness, expanding access for emerging borrowers

Utilizing a novel TransUnion credit-bureau dataset, researchers document how emerging borrowers expand their credit access.

An emerging borrower is defined as having an oldest line of credit at most six months old.

The study reveals that these borrowers experience a substantial increase in credit limits on their original cards when they open additional credit cards.

This increase is more significant than for those who do not open new cards, with the incumbent lender contributing more to total credit-limit growth than the new lender.

This positive reaction from incumbent lenders occurs almost immediately upon the new card appearing on the borrower's credit record, preceding any repayment history on the new card.

This empirical observation suggests that lenders interpret the act of obtaining new credit from another institution as a favorable signal of creditworthiness, leading to an improved assessment of the borrower's profile.

To capture this information aggregation, the paper develops a novel theoretical model featuring multiple competing lenders with heterogeneous private information about a consumer's creditworthiness.

This heterogeneity stems from diverse statistical models and data sources, particularly vital for emerging borrowers.

The model illustrates how dispersed private information is aggregated across lending stages.

Borrowers accepting offers from positively informed lenders in the first stage transmit this favorable signal.

Other lenders, observing an accepted loan, update their assessment of the borrower's creditworthiness upwards, leading to better subsequent credit terms.

This mechanism, termed 'credit-history building,' is central to the model.

It also yields a counterintuitive prediction: 'more dilution, lower default risk,' where a larger additional loan from another lender is associated with a lower probability of default due to a dominant selection effect.