Credit rationing reduces adverse selection problems.

Question

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Credit rationing limits the amount of credit available to borrowers, which makes it more difficult for high-risk borrowers (who are more likely to default) to obtain credit. This reduces adverse selection problems because it makes it more difficult for low-quality borrowers to be mistakenly identified as high-quality borrowers, which would cause lenders to offer them loans at lower interest rates than they should. With credit rationing, only the most creditworthy borrowers are able to obtain loans, which reduces the likelihood of default and improves the overall quality of the borrower pool.

Credit Rationing Reduces Adverse Selection Problems