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Authors:

• Chun CHANG
  China Europe International Business School

• Zheng Ni
  Renmin University of China

• Guanmin Liao
  Central University of Finance and Ecnomics

• Xiaoyun Yu
  Indiana University and Shanghai Advanced Institute of Finance

We study the economic role of banks' soft information, which evolved from repeated lending relationships, in predicting loan default. Using a proprietary database from one of the largest stateowned commercial banks in China, we find that the bank's internal credit rating scores play a significant role in default prediction. While the internal credit rating incorporates firm-specific hard information such as financial ratios, it is the soft information component of these ratings that contributes to the improvement in assessing credit quality. More importantly, the relative importance of soft information over hard information depends on the depth of the lending relationship. When evaluating loan delinquency, a sustained lending relationship allows soft information to substitute for, rather than complement, the role of hard information, especially hard information that is subject to easy manipulation.