Adverse Selection, Moral Hazard, and Credit Information Systems: Theory and Experimental Evidence

This paper demonstrates the positive effects of credit information systems. It presents a theoretical model that predicts the effects of credit information systems and divides them into three separate effects: a screening effect that mitigates adverse selection, an incentive effect that mitigates moral hazard, and a credit expansion effect that causes higher default rates from larger loans. The paper demonstrates that the positive effects overwhelm the negative effect and that the overall effect of information sharing is positive. The study uses a combined natural and field experiment to support the hypotheses generated by the model. Findings reveal that:

• Lenders are quick to expand credit to borrowers who pass the screening test posed by a credit bureau;
• Screening effects reduce portfolio delinquency and default rates;
• Increase of credit to good borrowers increases problems with repayment;
• Above effect does not overwhelm the improvement in overall repayment that arises from improved borrower screening.

The paper suggests that broadcasting credible statements about the future implementation of information sharing systems may be an inexpensive and quick way to bring stability to markets plagued by information asymmetries.