You run a bank which gives out loans for mortgages. In order to simplify the process of approving mortgage loans, you do not require applicants to provide proof of income if their credit score is above 620. If their credit score is above 720, then a mortgage without any downpayment is allowed. You are worried that these policies are leading to an increase in mortgage defaults at your bank, but you are not sure how much.
(a) How would you test the impact of verifying income on the likelihood of default?
(b) How would you test the impact of not requiring any downpayment on the likelihood of default?
(c) Suppose you find that lack of income verification has a really big impact default probability, but lack of a downpayment does not seem to have much effect. Someone at your bank suggests getting rid of the downpayment requirement for all loans, regardless of the credit score of the applicants. Is there any reason why this might not work (use an econometric justification)?