Duration of consumer loans and bank lending policy: dormancy versus default risk

A bank that lends money to a household faces two types of risk. Most commonly mentioned is the risk of a default. Hardly ever referred to is the risk of an early redemption of the loan - leading to dormancy. We model consumer loans' transition from an active to a dormant state and estimate a semi-parametric duration model with a data set consisting of 4,733 individuals who were granted credit by a Swedish lending institution between 1993 and 1995. We analyze the factors that determine the time to maturity on a loan and investigate the model's ability to match the maturities observed in the data. The model is used to evaluate loan applicants by their expected durations and - profits, and to derive the distribution of conditional expected durations and - profits for the loan portfolio. This enables us to draw some conclusions about the efficiency of bank lending policy.