The problem of adverse selection helps to explain ________.
A) why banks prefer to make loans unsecured
B) why banks do not have advantage in raising funds for businesses
C) why borrowers are willing to offer collateral to secure their promises to repay loans
D) why the financial system is so heavily regulated

Question

Quizplus · Accepted Answer

Adverse selection is the tendency for borrowers who are more risky (i.e. more likely to default on their loans) to be the ones who apply for loans. This can make lenders wary of lending without some form of collateral or other security, which borrowers may offer to show their commitment to repaying the loan. This explains why borrowers may be willing to offer collateral to secure their promises to repay loans.

The Problem of Adverse Selection Helps to Explain ________