Adverse selection in credit analysis of the community credit bank (CCB)

Abstract

Asymmetric information in credit market arises when the bank is not able to identify borrower based on the probability of repayment. This situation can cause credit defaults. The high of nonperforming loan in CCB credit market refers to the high of credit defaults which indicate the existence of asymmetric information in CCB credit analysis. One of manifestation of asymmetric information problem is adverse selection. Adverse selection arises when borrower has hidden characteristics that are unknown by the bank. As screening device, high interest rate may only attract borrower with low probability of repayment, so adverse selection arises because bank refuses borrower whom cannot afford the high interest rate. This research identifies adverse selection problem in CCB credit analysis. The objective of this research is examining the relationship of credit interest rate to quality of borrower credit collectability and the hypothesis is that credit interest rate has negative relationship with the quality of borrower credit collectability.