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IAI Actuarial Core Principles · Business Economics · Role, structure and stability of the financial system

Which of the following best describes how a well-functioning financial system helps reduce the problem of asymmetric information between lenders and borrowers?

Intermediaries specialise in screening and monitoring borrowers, which spreads the cost of gathering information across many savers. This lowers the adverse selection and moral hazard problems from asymmetric information, whereas uniform lending, fixed rates or perfect knowledge are not how the system operates.

  1. ALenders are legally required to lend equal amounts to all borrowers
  2. BBorrowers are prohibited from borrowing more than once
  3. CIntermediaries specialise in screening and monitoring borrowers, lowering the cost of information for individual saversCorrect
  4. DInterest rates are fixed by the government at a uniform level
  5. Savers are given complete knowledge of each borrower's future profits

Explanation

Banks and other intermediaries gain economies of scale in assessing creditworthiness and monitoring, so individual savers need not do this themselves. The other options are not mechanisms the financial system uses and none removes the information gap.

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