Costly Collateral and the Public Supply of Liquidity

Credit market imperfections, resulting from informational asymmetries between borrowers and lenders, create moral hazard and adverse selection problems that make lenders reluctant to lend and leave borrowers deprived from credit. Credit constraints disrupt the essential function of the financial system: to channel funds to those with the most productive investment opportunities. If this role is not performed well, the economy does not operate efficiently and economic growth will be...
More Description

Credit market imperfections, resulting from informational asymmetries between borrowers and lenders, create moral hazard and adverse selection problems that make lenders reluctant to lend and leave borrowers deprived from credit. Credit constraints disrupt the essential function of the financial system: to channel funds to those with the most productive investment opportunities. If this role is not performed well, the economy does not operate efficiently and economic growth will be hampered. One important way for society to deal with such problems has been to require collateral or net worth as a condition to the provision of finance.