Nobel Prize Worthy Lending

Nobel Prize Worthy Lending

In the wake of Nobel prize winners Al Roth and Lloyd Shapley, it’s worth analyzing the matching algorithms to see their application to banking. I’ll walk through the basics of the matching algorithm here, but Alex Tabarrok provides a much better and more thorough primer here. The Basics The Nobel prize winning algorithm deals with matching. For example, men and women to get married or transplant recipients. Essentially, the algorithm allows one group to select its ideal match, allow the other group to reject or retain the offer, then rejected first group members make their offer to their second choice, which in turn rejects or retains the offer. This continues until there are no more offers. The reason the algorithm is good is because it “converges.” That means there is actually a solution in the vast majority of cases. But, it also has this great property that there are no pairs that would rather be together but are not. There may be disappointed first parties and disappointed second parties, but no mutually disappointed pairs. In my case, I want to discuss the algorithm for lenders and borrowers. The big problem we have in both consumer and commercial lending right now is a mismatch. Banks want to lend to those businesses that need the lending least of all. But of course, banks want to lend to someone, because if they don’t, they don’t make money. On the flip side, borrowers would like the best choice – and given the fear that banks may be left out – borrowers may benefit from bank offers that otherwise wouldn’t be made. Of course, banks don’t just make one loan. Fortunately, Roth has extended...