Chapter 6: Credit Rationing & Information Problems

Question 1

What is credit rationing?

Answer 1

When banks refuse to lend to some borrowers—even those willing to pay high rates—because raising rates further would worsen their expected return by attracting only the riskiest applicants.

Question 2

Why can the supply of credit be backward‐bending?

Answer 2

As the interest rate rises, safer borrowers drop out, leaving a riskier pool; beyond a certain point, higher rates reduce expected repayments, so banks cut back lending instead of raising rates.

Question 3

In the Stiglitz–Weiss adverse‐selection model, why does raising rates eventually lower expected returns?

Answer 3

Higher rates drive out low‐risk firms, so the remaining borrowers are riskier and less likely to repay—making the bank’s average yield fall beyond a certain rate.

Question 4

What surprising result emerges from the de Meza–Webb model?

Answer 4

Under some parameter values, banks may overlend, funding projects whose social return is below cost, because entry forces rates so low that average success probability exceeds the break-even threshold.

Question 5

How does costly monitoring generate credit rationing?

Answer 5

Auditing each loan costs money; as rates rise, more borrowers default or trigger audits, driving up monitoring costs and eventually reducing net expected repayments, which leads banks to limit lending.

Question 6

What is the moral‐hazard channel of credit rationing?

Answer 6

At higher rates, borrowers switch from safe to risky projects because they keep the upside; this shift lowers the probability of repayment, so banks cap loan volumes rather than push rates into the range that induces reckless borrowing.