Too Little Lending: A Problem of Symmetric Information

In a simple model of the consumer credit market, we show that asymmetric information may enhance welfare relative to full information. The advantage of hidden types is that solvency and default constraints are relaxed, allowing beneficial lending. Prohibiting the use of observable information may therefore be efficient. It is also shown that rather than the nature of borrower heterogeneity, whether asymmetric information involves adverse or advantageous selection depends on the magnitude of default costs. Even when selection is adverse, lending and welfare may be higher under asymmetric information than under symmetric information.