Regulatory pressure, allocating decision rights, and the use of soft information

This paper examines how the centralization of loan decisions affects decision making in a bank. To that end, we combine field data with a lab experiment to study how loan officers change their effort to collect and share soft information about small to medium-sized applicants when their decision rights are taken away under regulatory pressure. Our field study exploits a quasi-natural experiment at a large European bank who reallocated the loan officers' decision rights to the risk department following regulatory pressure to improve SME lending frictions and risk controls. Using a difference-in-differences design we find that the use of soft information in SME loan decisions improves following the reallocation of decision rights. Additional tests show that this result is driven by a change in behavior of the incumbent loan officers and that the interest rate adjustments become more predictive of future loan performance, which is consistent with an improvement in loan evaluation quality. Furthermore, our lab experiment provides empirical evidence consistent with these improvements being driven by the presence of regulatory pressure justifying the need for internal change. Our study informs financial institutions, regulators, and academics about the importance of considering contextual characteristics, in our case the existence of regulatory pressure, when evaluating the outcomes of internal organizational change