FINANCIAL SECTOR REFORMS
397
Systemic risk is the risk of the default associated with general
economy-wide or macroeconomic conditions that affect all
borrowers.
Idiosyncratic risks are risks arising from asymmetric informa-
tion about the default risk associated with a
specific
borrower.
As the interest rate charged on loans is raised, the financial
intermediary attracts bad borrowers. At some threshold rate
of interest, this results in higher default rates that offset the
repayments due to the bank and causes the expected return
to the bank to decline. The loan return frontier (LF) for a bank
thus has an inverted U shape.
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