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Credit risk management in banks: Hard information, soft Information and manipulation

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  • Godbillon-Camus, Brigitte
  • Godlewski, Christophe

Abstract

The role of information’s processing in bank intermediation is a crucial input. The bank has access to different types of information in order to manage risk through capital allocation for Value at Risk coverage. Hard information, contained in balance sheet data and produced with credit scoring, is quantitative and verifiable. Soft information, produced within a bank relationship, is qualitative and non verifiable, therefore manipulable, but produces more precise estimation of the debtor’s quality. In this article, we investigate the impact of the information’s type on credit risk management in a principalagent framework with moral hazard with hidden information. The results show that access to soft information allows the banker to decrease the capital allocation for VaR coverage. We also show the existence of an incentive of the credit officer to manipulate the signal based on soft information that he produces. Therefore, we propose to implement an adequate incentive salary package which unables this manipulation. The comparison of the results from the two frameworks (information hard versus combination of hard and soft information) using simulations confirms that soft information gives an advantage to the banker but requires particular organizational modifications within the bank, as it allows to reduce capital allocation for VaR coverage.

Suggested Citation

  • Godbillon-Camus, Brigitte & Godlewski, Christophe, 2005. "Credit risk management in banks: Hard information, soft Information and manipulation," MPRA Paper 1873, University Library of Munich, Germany.
  • Handle: RePEc:pra:mprapa:1873
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    File URL: https://mpra.ub.uni-muenchen.de/1873/1/MPRA_paper_1873.pdf
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    References listed on IDEAS

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    1. Berger, Allen N. & Klapper, Leora F. & Udell, Gregory F., 2001. "The ability of banks to lend to informationally opaque small businesses," Journal of Banking & Finance, Elsevier, vol. 25(12), pages 2127-2167, December.
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    5. Bernardo, Antonio E. & Cai, Hongbin & Luo, Jiang, 2001. "Capital budgeting and compensation with asymmetric information and moral hazard," Journal of Financial Economics, Elsevier, vol. 61(3), pages 311-344, September.
    6. Brigitte Godbillon-Camus & Christophe J. Godlewski, 2005. "Gestion du Risque de Crédit dans la Banque : Information Hard, Information Soft et Manipulation," Working Papers of LaRGE Research Center 2005-02, Laboratoire de Recherche en Gestion et Economie (LaRGE), Université de Strasbourg.
    7. Frame, W Scott & Srinivasan, Aruna & Woosley, Lynn, 2001. "The Effect of Credit Scoring on Small-Business Lending," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 33(3), pages 813-825, August.
    8. Grunert, Jens & Norden, Lars & Weber, Martin, 2005. "The role of non-financial factors in internal credit ratings," Journal of Banking & Finance, Elsevier, vol. 29(2), pages 509-531, February.
    9. Jonathan Scott, 2004. "Small Business and the Value of Community Financial Institutions," Journal of Financial Services Research, Springer;Western Finance Association, vol. 25(2), pages 207-230, April.
    10. Fama, Eugene F., 1985. "What's different about banks?," Journal of Monetary Economics, Elsevier, vol. 15(1), pages 29-39, January.
    11. Loretta J. Mester, 1997. "What's the point of credit scoring?," Business Review, Federal Reserve Bank of Philadelphia, issue Sep, pages 3-16.
    12. Hakenes, Hendrik, 2004. "Banks as delegated risk managers," Journal of Banking & Finance, Elsevier, vol. 28(10), pages 2399-2426, October.
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    Cited by:

    1. Herve Alexandre & Aymen Smondel, 2012. "Substitution or complementarity between Information "soft" and information "hard": why and which effect on bank profitability?," Post-Print halshs-00538326, HAL.
    2. repec:dau:papers:123456789/5897 is not listed on IDEAS
    3. Giovanni Ferri & Raoul Minetti & Pierluigi Murro, 2018. "Credit Relationships in the Great Trade Collapse. Micro Evidence From Europe," CERBE Working Papers wpC26, CERBE Center for Relationship Banking and Economics.
    4. repec:wsi:ijitdm:v:14:y:2015:i:04:n:s0219622015500133 is not listed on IDEAS
    5. Cerqueiro, Geraldo & Degryse, Hans & Ongena, Steven, 2011. "Rules versus discretion in loan rate setting," Journal of Financial Intermediation, Elsevier, vol. 20(4), pages 503-529, October.
    6. Degryse, H.A. & Cerqueiro, G.M. & Ongena, S., 2007. "Distance, Bank Organizational Structure and Credit," Discussion Paper 2007-018, Tilburg University, Tilburg Law and Economic Center.
    7. Vitor Gonçalves & Francisco Vitorino Martins & Elísio Brandão, 2014. "The Determinants of Credit Default on Portuguese Start-Up Firms: .An Econometric model," FEP Working Papers 534, Universidade do Porto, Faculdade de Economia do Porto.
    8. Henselmann, Klaus & Scherr, Elisabeth, 2012. "Content analysis of XBRL filings as an efficient supplement of bankruptcy prediction? Empirical evidence based on US GAAP annual reports," Working Papers in Accounting Valuation Auditing 2012-2, Friedrich-Alexander University Erlangen-Nuremberg, Chair of Accounting and Auditing.
    9. repec:dau:papers:123456789/5068 is not listed on IDEAS

    More about this item

    Keywords

    Hard information; Soft information; risk management; Value at Risk; moral hazard; hidden information; manipulation;

    JEL classification:

    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages

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