Improving Access to Finance for Entrepreneurs in Developing Countries

One of the most important issues in developing countries is how to finance small and medium enterprises (SMEs). Although microcredit and new forms of financial inclusion are increasingly prominent in the literature, much empirical evidence shows that banks are still the main financial actors. This study focusses on loan officers’ risk propensity and finds among other conclusions, that performance incentives affect lending decisions. The researchers conduct an experiment with commercial bank loan officers to test how performance compensation affects risk-assessment and lending. High-powered incentives lead to greater screening effort by loan officers and more profitable lending decisions. This effect is, however, muted by deferred compensation and limited liability, two standard features of loan officer compensation contracts. This project finds that career concerns and personality traits affect loan officer behaviour, but response to incentives does not vary with traits such as risk-aversion, optimism or overconfidence. Finally, it presents evidence that incentive contracts distort the assessment of credit risk, even among trained professionals with many years of experience.

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