Saturday, November 2, 2013

The Reality of the Principal-Agent Model

While interning a bank this past summer, I noticed a situation that acted more as a triangle, where the agent deals with two different principals. The agent in my example would be a banker of both the client and the bank. What the client wanted the banker to do for them was not always in favor of what the bank allowed or what would benefit the firm. Especially when dealing with pricing and the amount of money they are able to lend a client, it was hard for the banker and client to see eye to eye at times because there are certain things the banker was not allowed to tell the client. Specifically I saw the reactions that a client had when they received the right amount of money they were satisfactory with lending, but the pricing was not in their favor. This created an awkward tension, especially for the banker, since the banker was not the person calculating what that loan should be priced at. The bank has specific calculations and regulations that are set for these types of things and because of that the agent failed to satisfy the client while satisfying the bank. The banker was obviously not going to risk losing his job, which is why the relationship he built with that client is so important. He had to trust that their relationship was strong enough that this type of tension would not push the client away from the bank. Usually when this sort of tension arises, the banker will try to do something else for the client to make up for a price that the client was not happy with. For example maybe the banker would decrease the price on a different line of credit that the client has, create a better amortization schedule, etc.

After working there for 3 months I realized there were many types of ways to master this tension. Each banker had their own personal ways and even within that, clients was treated different. Because being a banker is so focused on relationship management, the ways to resolve the tension are not cookie cutter solutions. 


  1. In the example you gave there is a market. If the client didn't like the terms of the loan, the client could have taken his business elsewhere. Presumably the various banks monitor how other banks set terms for loans of similar risk. Likewise, potential clients can do comparison shopping.

    If that above is right, the situation you describe makes sense only if your bank was out of line with the terms that other banks would offer or, alternatively, that the client was willfully uninformed about what terms he could obtain elsewhere.

    Only if there is wiggle room in the terms is there really a possibility of a triangle problem here. Otherwise, the market determines the rates and that's that.

  2. I think you made an important point where you mentioned that the banker did not want to lose his job. Often times the triangle principal agent problem deals with discrepancies between the higher ups those at the edge. Authority will take precedent over choices in cases such as these. Dealing with clients can be especially frustrating especially when their needs conflict between standard protocol of the organization. The best way is to attend to the needs of the customers on a personal level but also working within the guidelines of the organization itself.