BANKING NETWORKS: UNVEILING SUPERVISORY INCENTIVES' INFLUENCE ON SOCIAL TIES IN LENDING

Abstract

Social ties play a pivotal role in shaping individuals' behavior and outcomes within lending contracts. This study explores the influence of acquaintances, extending beyond family connections, in lending relationships. Specifically, it examines two types of social ties allowed by acquaintances in lending contracts: endorsements by endorsers and sponsorships by sponsors. These endorsers and sponsors act as supervisors in a Principal-Supervisor-Agent model, a departure from the conventional perspective where supervisors are non-borrowing entities outside the lending institution. Our analysis delves into how the incentives of these supervisors impact borrowers' performance, focusing on the effort exerted to mitigate risk in their projects. We model endorsement and sponsorship practices within lending relationships and demonstrate their implications for borrower monitoring and project selection quality. Interestingly, we find that when endorsers and sponsors are members of the lending institution, their ability to resolve agency issues between the principal (lending institution) and the agent (borrower) is enhanced. This research sheds light on the intricate dynamics of social ties within lending contracts, offering valuable insights into their effects on project selection and borrower control.