Loan Officer Incentives and the Limits of Hard Information

There is increasing reliance on quantitative complex models, such as internal ratings based (IRB) models for bank regulation, with much resources being spent on model validation exercises. We argue that a significant cost of IRB models that is not well understood or monitored is the change in loan officer incentives down the line. Using proprietary data on almost a quarter million loan applications, we show loan officer incentives significantly...