Incentive Mechanisms, Loan Decisions and Credit Rationing: A Framed Field Experiment on China's Responsibility System for Rural Credit

69 Pages Posted: 19 Nov 2013

See all articles by Jessica (Ying) Cao

Jessica (Ying) Cao

University of Guelph

Calum G. Turvey

Cornell University - School of Applied Economics and Management

Jiujie Ma

Renmin University of China

Rong Kong

Northwest Agricultural and Forestry University - College of Economics and Management

Guangwen He

China Agricultural University

Jubo Yan

Cornell University

Date Written: November 17, 2011

Abstract

Incentive mechanisms are important attributes to financial decision-making. A framed field experiment was conducted to test loan decision behaviors. It showed that lenders’ risk-aversion and behavioral responses resulted in credit rationing under certain incentive schemes. In the experiment, loan officers from Rural Credit Cooperatives (RCCs) in Shandong, China were recruited to evaluate randomly selected loan applications and make lending decisions. All the loan files were previously approved with known performance and repayment status. Each loan officer was randomly assigned to one of two incentive groups. One was analogous to pure Personal Responsibility System (PRS), which provided bonuses to loan officers for approved loans that were in performance and imposed penalties on non-performing loans (NPLs). And the other was PRS with additional penalties for Type II error (i.e. rejecting loans that would have been good). The two groups were further randomized over prior knowledge about probability distribution of the application pool. Results showed that PRS made a risk-averse loan officer inclined to reject loans to avoid risk of penalty. This side effect generated credit rationing, increased Type II error in loan classification and lowered the interest returns of RCCs. Providing prior information about the application pool helped to increase decision accuracy. In theory, this study extended the incentive mechanism design under uncertainty to a behavioral scope. In practice, it can lead to increased profitability in financial institutes, alleviated credit rationing and stabilized credit supply in the market.

Keywords: Micro Finance and Banking, Decision under Risk and Uncertainty, Framed Field Experiment

JEL Classification: G21, D03, C93

Suggested Citation

Cao, Jessica (Ying) and Turvey, Calum G. and Ma, Jiujie and Kong, Rong and He, Guangwen and Yan, Jubo, Incentive Mechanisms, Loan Decisions and Credit Rationing: A Framed Field Experiment on China's Responsibility System for Rural Credit (November 17, 2011). Available at SSRN: https://ssrn.com/abstract=2356113 or http://dx.doi.org/10.2139/ssrn.2356113

Jessica (Ying) Cao (Contact Author)

University of Guelph ( email )

50 Stone Rd. E.
Dept. of FARE
Guelph, Ontario N1G2W1
Canada
1-519-824-4120 x.58274 (Phone)
1-519-767-1510 (Fax)

HOME PAGE: http://www.uoguelph.ca/fare/users/ycao01

Calum G. Turvey

Cornell University - School of Applied Economics and Management ( email )

248 Warren Hall
Ithaca, NY 14853
United States

Jiujie Ma

Renmin University of China ( email )

Room B906
Xianjin Building
Beijing, Beijing 100872
China

Rong Kong

Northwest Agricultural and Forestry University - College of Economics and Management ( email )

Yangling
China

Guangwen He

China Agricultural University ( email )

Beijing
China

Jubo Yan

Cornell University ( email )

Ithaca, NY 14853
United States

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