Loan Officer Incentives, Internal Rating Models and Default Rates

63 Pages Posted: 16 Mar 2012 Last revised: 19 Aug 2019

See all articles by Tobias Berg

Tobias Berg

Frankfurt School of Finance & Management

Manju Puri

Duke University - Fuqua School of Business; NBER; FDIC

Jörg Rocholl

ESMT European School of Management and Technology

Multiple version iconThere are 2 versions of this paper

Date Written: August 19, 2019

Abstract

Manipulation of hard information has been at the center of a wave of investigations into fraudulent bank behavior, such as mis-selling of mortgages and rigging of LIBOR and FX rates. Despite these prominent cases, little is known as to why employees manipulate hard information. Using almost a quarter million retail loan applications, we show that loan officers who face volume-based incentives significantly manipulate ratings even in settings where ratings are computed using hard information only. Manipulation is widespread across loan officers, with low-performing loan officers manipulating more toward the end of the year. These incentives have a first-order effect on bank profitability, reducing return on equity by 1.5 percentage points. We conclude that reliance on hard information does not overcome loan officer agency problems, and it is important for banks and regulators to take manipulation of hard information into account when using hard information for risk assessment and regulation.

Keywords: loan officer incentives, internal ratings, hard information, Lucas critique

JEL Classification: G21

Suggested Citation

Berg, Tobias and Puri, Manju and Rocholl, Joerg, Loan Officer Incentives, Internal Rating Models and Default Rates (August 19, 2019). AFA 2013 San Diego Meetings Paper. Available at SSRN: https://ssrn.com/abstract=2022972 or http://dx.doi.org/10.2139/ssrn.2022972

Tobias Berg

Frankfurt School of Finance & Management ( email )

Sonnemannstraße 9-11
Frankfurt am Main, 60314
Germany

Manju Puri (Contact Author)

Duke University - Fuqua School of Business ( email )

100 Fuqua Drive
Box 90120
Durham, NC 27708-0120
United States
919-660-7657 (Phone)

NBER

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

FDIC ( email )

550 17th Street NW
Washington, DC 20429
United States

Joerg Rocholl

ESMT European School of Management and Technology ( email )

Schlossplatz 1
Berlin
Germany

HOME PAGE: http://www.esmt.org/en/159244

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