Answer to Question #106163 in Economics for amy

Question

a. Information asymmetry that exists in lending creates what type of risk for banks? Explain.

b. Examine how banks apply the technique of ‘screening and monitoring’ to minimize the credit risk.

Answer 1

a. The informational asymmetry that exists in lending creates what type of risk for banks? Explain.

Information asymmetry effects for banks exist in the form of adverse selection risk and moral hazard risk. The first risk arises at the stage of concluding a contract and is associated with errors in determining the quality of a product or service, and the second type of risk is associated with the fact that the fact of a transaction can lead to a change in the behavior of one of the parties. Their reason is the presence of information asymmetry in the financial market, when the contracting parties are not aware of the actions after the conclusion of the loan contract.

b. Learn how banks use the “screening and monitoring” technique to minimize credit risk.

Screening and monitoring are elements of a risk management system. Credit risk monitoring based on quantitative and qualitative methods should include a comprehensive analysis of changes in the following data:

- overdue debt;

- rates of growth of "bad" debts;

- compliance with credit risk limits;

- assessment of the assets of the borrower;

- assessment of the intended use of the loan;

- assessment of compliance with the terms of the loan agreement;

- analysis of the status of collateral, etc.