The effect of interfirm financial transactions on the credit risk of small and medium‐sized enterprises

Despite the recognised importance of inter-firm financial links in determining
a company’s performance, only few studies have incorporated proxies for inter-firm links into credit risk models, and none of these use real financial transactions. In this paper, we estimate a credit risk model for small and medium-sized enterprises, augmented with information on observed inter-firm financial transactions. We exploit a novel data set on about 60000 companies based in the UK and their financial transactions over the years 2015 and 2016. We develop a number of network-augmented credit risk models and compare their prediction performance with that of a conventional credit risk model that only includes a set of financial ratios. We find that augmenting a default risk model with information on the transaction network makes a significant contribution to increasing the default prediction power of risk models built specifically for small and medium-sized enterprises. Our results may help bankers and credit scoring agencies to improve the credit scoring of these
companies, ultimately reducing their propensity to apply excessive lending restrictions.