Bank on Wipfli - Blog and Podcast


Heads or Tails?

Mar 09, 2016
Financial Institutions

My best friends and I are planning to celebrate one of those milestone birthdays this year with a weekend in Las Vegas. It sure would be fun to win a little cash at the casinos, so it’s a good thing I recently heard about the Gambler’s Fallacy. I’m hoping it will reduce my risk of losing everything in the first five minutes.

The Gambler's Fallacy is the incorrect belief that a random event is more or less likely to happen following another event or a series of events of the opposite result. Here’s an example: I flip a coin, and the first three outcomes are heads. Would you guess the next result is likely to be tails? If you do, you are not alone, but this would be an inaccurate understanding of probability. In fact, the likelihood of a coin turning up heads is always 50%, and all previous flips have no bearing on future flips.

Unfortunately, the Gambler’s Fallacy applies not only to gamblers but to loan officers. No, your loan officers are not gambling with your financial institution’s loan portfolio. However, they are human, with tendencies that can subconsciously influence their decisions. Here’s how:

A field experiment completed in 2014 explored how various incentive programs affect the quality of loan officers’ decisions on commercial loan applications.[1] The test group included loan officers with an average of 10 years of experience in lending. The loan officers screened randomly ordered loan files and decided whether to approve or reject the application.

The application files were actual loans previously approved or denied by a financial institution, and the approved loans were either performing or non-performing at the time of the experiment. Loan officers in the experiment were paid based on their ability to correctly classify the loans as performing (by approving them) or non-performing (by rejecting them). In the sample, the loan officers correctly classified the loans approximately 65% of the time. Factors that influenced the accuracy of the decisions included time spent reviewing the application and the years of experience of the loan officers.

But an interesting trend emerged in the analysis of the loan officers’ decisions. In every incentive program category, the loan officers were less likely to approve the application under review if they had recently approved other loan applications. The same applied to denials of applications. The analysis of the data (all math and statistics, which nobody wants to read about here) found that the loan officers were affected by the Gambler’s Fallacy, the negative correlation between one decision and prior decisions.

Maybe Las Vegas or gambling is not your cup of tea. As we head into spring, though, I should let you know the study also included the “called balls and strikes” by home plate umpires of Major League Baseball. The study analyzed over 1.5 million pitches and calls. Yes, even MLB umpires are affected by the Gambler’s Fallacy. Sorry, baseball fans.

Make sure your lending team is making the right call more than 65% of the time and that those decisions are based on solid credit underwriting. Our loan review team can help you:

  • Review the effectiveness of your lending policies and procedures.
  • Confirm the quality and consistency of your risk ratings.
  • Monitor credit more effectively.
  • Strengthen your overall portfolio management function.

Learn more about Wipfli’s loan review services.

[1] “Decision-Making under the Gambler’s Fallacy: Evidence from Asylum Judges, Loan Officers, and Baseball Umpires” by Daniel Chen, Tobias Moskowitz, and Kelly Shue, forthcoming in Quarterly Journal of Economics.


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