In order to reduce the possibility of adverse selection banks should raise their interest rates charged on the loans.

Question

Quizplus · Accepted Answer

Raising interest rates on loans could actually worsen adverse selection, as it would discourage low-risk borrowers from taking out loans, leaving only high-risk borrowers who are more likely to default. Banks could instead evaluate potential borrowers more thoroughly and use risk-based pricing to charge higher rates to higher-risk borrowers, while still attracting low-risk borrowers with lower rates.

In Order to Reduce the Possibility of Adverse Selection Banks