The effect of organizational hierarchy on loan rates and risk assessments

We examine whether loan decisions are affected by the internal decision structure of the bank. Banks typically grant decision rights on straight-forward loans entirely to individual loan officers. For more risky loans these officers have to seek ratification for their loan proposals at higher hierarchical levels within banks (e.g., a credit committee). As banks typically provide loan officers with incentives to make loans, loan officers can increase the likelihood of loan approval by communicating the risk-return characteristics of the loan request favorably. Using internal records from a bank, our sample consists of approved loan requests coming from small firms. Our evidence suggests that loan contracts approved at higher hierarchical levels vis-à-vis those approved by loan officers feature lower loan rates and a greater likelihood of an adverse risk re-classification one year after the loan approval.