Banks use credit rationing rather than simply raising the interest rate charged borrowers with higher default risks because

Question

Quizplus · Accepted Answer

Banks use credit rationing rather than simply raising the interest rate charged borrowers with higher default risks because of fear of adverse selection problems. When interest rates are raised, only the riskiest borrowers are willing to pay them, leading to adverse selection and the bank being stuck with a pool of high-risk borrowers. Credit rationing allows banks to limit the number of risky borrowers they take on, without having to raise interest rates and encourage adverse selection.

Banks Use Credit Rationing Rather Than Simply Raising the Interest