If borrowers with the most risky investment projects are more likely to seek bank loans than borrowers with the safest investment projects,banks face the problem of ________.

Question

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Adverse selection is the problem that arises when borrowers with the riskiest projects are more likely to seek loans than those with safer projects. This causes a misallocation of funds and an increase in default risk for the bank. Adverse credit risk refers to the risk of default by borrowers, moral hazard refers to the risk that borrowers may take on excessive risk after receiving the loan, and conflict of interest refers to a situation where the bank's interests are in conflict with those of its clients.

If Borrowers with the Most Risky Investment Projects Are More