Abstract
The paper explores the significance of a borrower’s socioeconomic network in assessing creditworthiness using a novel theoretical framework. We introduce a method for a lender to consolidate the individuals’ trustworthiness of the borrower within her socioeconomic network. From the borrower’s perspective, we consider the adverse social consequences of default within their socioeconomic network, which acts as a disincentive for the borrower to default on the credit obligation. This social pressure discourages credit default. Building on this connection between trust in a socioeconomic network, our paper develops a model that incorporates aggregate trust, project riskiness, and the social cost of default to evaluate credit risk. In this framework, a borrower with a secure project and a high social cost of default is more likely to honour their credit commitments. Conversely, for a similar project, a borrower with a low social cost of default may be more inclined to wilfully default on their credit obligations.
Similar content being viewed by others
Data Availability
The study is a theoretical model and does not use any data.
Notes
A graph is called strongly connected if for any two nodes there exist a walk.
References
Arrow, K.J. 1974. The limits of organization. New York: WW Norton & Company.
Berger, A.N., and G.F. Udell. 2002. Small business credit availability and relationship lending: The importance of bank organisational structure. The Economic Journal 112 (477): F32–F53.
Bygrave, W.D., and S.A. Hunt. 2005. GEM 2004 Financing report. Boston and London: Babson College and London Business School.
Coleman, J.S. 1988. Social capital in the creation of human capital. American Journal of Sociology 94: S95–S120.
Fried, J., and P. Howitt. 1980. Credit rationing and implicit contract theory. Journal of Money, Credit and Banking 12 (3): 471–487.
Frobenius, G., F.G. Frobenius, F.G. Frobenius, F.G. Frobenius, and G. Mathematician. 1912. Über Matrizen aus nicht negativen Elementen. Kön: Königliche Akademie der Wissenschaften Sitzungsber.
Galland, Z. 2006. Think Twice Before Borrowing from Family.
Ghatak, M. 1999. Group lending, local information and peer selection. Journal of Development Economics 60 (1): 27–50.
Glaeser, E.L., D.I. Laibson, J.A. Scheinkman, and C.L. Soutter. 2000. Measuring trust. The Quarterly Journal of Economics 115 (3): 811–846.
Granovetter, M. 1985. Economic action and social structure: The problem of embeddedness. American Journal of Sociology 91 (3): 481–510.
Guérin, I., M. Roesch, G. Venkatasubramanian, and B. D’espallier. 2012. Credit from whom and for what? The diversity of borrowing sources and uses in rural southern India. Journal of International Development 24: S122–S137.
Guiso, L., P. Sapienza, and L. Zingales. 2004. The role of social capital in financial development. American Economic Review 94 (3): 526–556.
Ho, K.-C., H.-P. Yen, Y. Gu, and L. Shi. 2020. Does societal trust make firms more trustworthy? Emerging Markets Review 42: 100674.
Holmstrom, B., and J. Tirole. 1997. Financial intermediation, loanable funds, and the real sector. The Quarterly Journal of Economics 112 (3): 663–691.
Howorth, C., and A. Moro. 2006. Trust within entrepreneur bank relationships: Insights from Italy. Entrepreneurship Theory and Practice 30 (4): 495–517.
James, H.L. 2023. Social capital and the riskiness of trade credit. Journal of Behavioral and Experimental Finance 39: 100832.
Kanagaretnam, K., G.J. Lobo, C. Wang, and D.J. Whalen. 2019. Cross-country evidence on the relationship between societal trust and risk-taking by banks. Journal of Financial and Quantitative Analysis 54 (1): 275–301.
Karlan, D., M. Mobius, T. Rosenblat, and A. Szeidl. 2009. Trust and social collateral. The Quarterly Journal of Economics 124 (3): 1307–1361.
Lee, S., and P. Persson. 2016. Financing from family and friends. The Review of Financial Studies 29 (9): 2341–2386.
Lins, K.V., H. Servaes, and A. Tamayo. 2017. Social capital, trust, and firm performance: The value of corporate social responsibility during the financial crisis. The Journal of Finance 72 (4): 1785–1824.
Moro, A., and M. Fink. 2013. Loan managers’ trust and credit access for SMEs. Journal of Banking and Finance 37 (3): 927–936.
Muduli, S., and S.K. Dash. 2018. Inter-temporal Calculative Trust Design to Reduce Collateral Need for Business Credits. Reserve Bank of India Occasional Papers 38 (1): 65–83.
Perron, O. 1907. Zur theorie der matrices. Mathematische Annalen 64 (2): 248–263.
Petersen, M.A., and R.G. Rajan. 1994. The benefits of lending relationships: Evidence from small business data. The Journal of Finance 49 (1): 3–37.
Sharpe, S.A. 1990. Asymmetric information, bank lending, and implicit contracts: A stylized model of customer relationships. The Journal of Finance 45 (4): 1069–1087.
Stiglitz, J.E., and A. Weiss. 1981. Credit rationing in markets with imperfect information. The American Economic Review 71 (3): 393–410.
Author information
Authors and Affiliations
Corresponding author
Ethics declarations
Conflict of Interest
All authors have no conflicts of interest.
Additional information
Publisher's Note
Springer Nature remains neutral with regard to jurisdictional claims in published maps and institutional affiliations.
We thank the anonymous reviewers for their insightful suggestions that helped to improve the paper. The views expressed in the paper are those of the author(s) and not necessarily those of the institution to which they belong.
Rights and permissions
Springer Nature or its licensor (e.g. a society or other partner) holds exclusive rights to this article under a publishing agreement with the author(s) or other rightsholder(s); author self-archiving of the accepted manuscript version of this article is solely governed by the terms of such publishing agreement and applicable law.
About this article
Cite this article
Muduli, S., Dash, S.K. Creditworthiness: The Role of Trust in the Socioeconomic Network. J. Quant. Econ. (2024). https://doi.org/10.1007/s40953-024-00393-y
Accepted:
Published:
DOI: https://doi.org/10.1007/s40953-024-00393-y