Loan officer incentives and the limits of hard information

Policymakers have argued that part of the reason for the current financial crisis is the poor quality of loans made when loan officers were allowed to exercise their discretion bypassing hard information. one potential solution to minimize risks in loan making is to automate the process, basing it solely on hard information, taking out ambiguous soft information. Yet this can potentially affect loan officer incentives and outcomes. In this paper, we access date from more than 240,000 loan applications at a major European bank, in a setting where loans are made based on hard information alone. We analyze loan officers’ incentives as they input hard information into a scoring system and find that loan officers use more scoring trials for loan applications that do not pass the cut-off rating in the first trial. Furthermore, they use more scoring trials as they get closer to the cut-off rating, with a pronounced jump at the boundary.

We exploit a change in the cut-off rating and show that this jump moves to the new cut-off boundary after the change. Finally, we show that the number of scoring trials positively predicts default rates, in particular at the cut-off. These results suggest that loan officers strategically manipulate information when loan decisions are based on hard information and credit scoring alone, and point to the limits of hard information.