Interest rates and information

In a lending relationship, a bank learns information on its borrowers.\r\nAdverse selection makes the usefulness and value of this information\r\ndepend on the interest rates the bank charges in the different periods. The\r\noptimal intertemporal screening of borrowers calls for a monopolistic\r\nbank to smooth interest rates. In a repeated relationship, interest rates\r\nare lower than in a one-period setting; furthermore, they are less volatile\r\nand the quality of the loans is higher than under competition (with symmetric\r\ninformation). Information sharing may reduce both the probability\r\nthat a debt will be paid and the sum of banks’ and borrowers’ profits.