CHAPTER 3 Information frictions in banking
3.1 Introduction
Both the economics of banking and banking in practice are heavily shaped by various information frictions. Participants in banking are not able to observe many things of interest, for example, depositors cannot observe the quality of their banks’ assets, so that they cannot tell whether the banks will default on them or not; banks cannot perfectly observe what borrowers do with their loans so that they cannot tell whether these loans will be fully repaid; when one bank lends to another bank, the lender bank cannot precisely tell the borrow bank’s risk... such information asymmetry often leads to credit risks that borrowers may default on lenders, and ...
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