ECON 315 Lecture Notes - Lecture 14: Adverse Selection, Moral Hazard
23 Jun 2017
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High h is good for the bank -- high cost to escape makes it less likely. Screening by only loaning to non-risky poor people k= (rw)/(r-h) Young people cannot borrow because we have little collateral. No collateral limited liability if the loan fails they do not get repaid and there"s nothing they can take from the poor people that has any value. Limited liability incentivizes moral hazard from the borrower. The bank doesn"t observe how risky the individual is. If they make loans to risky individuals at low interest rates will lose money. If they can"t observe it leads to really high interest rates. Model 2: banks re-pay depositors d 1. 2, pay depositors (k-w)d, fixed screening fee c, total cost for the bank: d(k-w)+c, total benefit: (k-w)r, only make money if, r(k-w)> = d(k-w)+c. Banks still need to make sure that depositors re-pay.
