Banks and FIs rely on which of the following contractual mechanisms to control the credit risks of lending?
A)requiring higher interest rate spreads and fees on loans to more risky borrowers.
B)restricting or rationing loans to more risky borrowers
C)requiring enhanced seniority for the bank over assets of risky borrowers
D)diversifying across different types of risky borrowers
E)all of the above are utilized.

Question

Quizplus · Accepted Answer

Banks and FIs use all of these contractual mechanisms to manage credit risk in their lending operations. Requiring higher interest rates and fees for more risky borrowers provides compensation for the higher risk of default. Restricting or rationing loans to more risky borrowers limits the exposure of the lender to that borrower's credit risk. Requiring enhanced seniority for the bank over assets of risky borrowers gives the bank the ability to recover assets in the event of default. Diversifying across different types of risky borrowers spreads the credit risk across a portfolio of loans, reducing the impact of any single default.

Banks and FIs Rely on Which of the Following Contractual