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The Organization of Credit Risk Management in Banks: Hard versus Soft Information

by Brigitte Godbillon-Camus of the Université Robert Schuman, and
Christophe J. Godlewski of the Université Louis Pasteu

October 2, 2006

Abstract: We investigate the impact of the information's type on credit risk management in a principal-agent 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 implement an adequate incentive salary package which prevent this manipulation. The comparison of the results from the two frameworks (hard information versus a combination of hard and soft information) using simulations confirms that soft information gives advantages to the banker but requires particular organizational modifications within the bank.

JEL Classification: D82, G21, G31.

Keywords: Hard information, Soft information, Risk management, Value at Risk, Moral hazard, Hidden information, Manipulation.

Previously titled: Credit Risk Management in Banks: Hard information, soft Information and manipulation

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