Citibank India and Akerlof

I came across this interview of Indian Bank heads on the interest rate scenario, bank lending etc.

Citi India head Sanjay Nayar responds to this question:

Q: In this high interest rate environment, how will you plan to manage your profitability and balance sheet growth?

SN: As money gets dearer, we are becoming very selective to whom we give out loans.The basic driving principle to lend is that the individual has to be a Citi client either today or a client worthwhile for us tomorrow, where we get long-term sustainable revenues.

Read the words in emphasis (emphasis is mine). It is classic Akerlof’s theory of information asymmetry.   As interest rates rise, so does the problem of adverse selection (whom to give) and Banks are never sure whether the borrower will pay back the loan. In times of higher int rates, people with good projects will wait for rates to ease, but one with bad projects might be more willing as he/she has nothing to lose. If latter is selected,  the chances of moral hazard (knowing he has nothing to loose, he might take more risks) also increase.

Great to see your concepts being revised reading newspaper articles.