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

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Banks use credit rationing rather than simply raising the interest rate charged to borrowers with higher default risks because they are afraid of adverse selection problems. If they simply increased the interest rate, only high-risk borrowers would apply, leading to a higher likelihood of defaults and a riskier loan portfolio overall. By rationing credit, banks can selectively choose lower-risk borrowers to lend to, balancing their portfolio and reducing the risk of defaults.

Banks Use Credit Rationing Rather Than Simply Raising the Interest