Qin Gou (Central University of Finance and Economics): Incentives and Risk Taking: Evidence from Bank Lending in China
Co-authors: Yiping Huang (Peking University) and Zhong Xu (National Association of Financial Market Institutional Investors)
High-powered incentives may improve credit quality by remedying incentive problem, while improper incentives may be ineffective and even distortive. This study aims to evaluate the impact of performance-based incentives on risk-taking and lending outcomes of banks, employing a unique branch level dataset in China. We first show that different performance incentive schemes have different effects in reducing the non-performing loans ratio, where lifelong-responsibility scheme is most efficient in both significance and magnitude, followed by salary scheme, while the primary-responsibility scheme is ineffective. In addition, effective performance incentives lead to larger average loan size, lower share of credit loans, fewer origination to SMEs and shorter average loan maturity, which indicates more use of hard information in lending decisions and weaker motivation in risk-taking. Combined, this generates an interesting tradeoff in incentives design for banks between improving credit quality and providing inclusive finance. Last but not least, the ineffective primary-responsibility scheme reduces the number of new loans, implying less effort in loan origination in order to avoid responsibility. Our results highlight whether and how performance-based incentives affect risk-taking and loan outcomes in bank lending.
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