Question

Suppose you are applying for a mortgage loan. The loan officer tells you that if you get the loan, the bank will keep the house title until you pay back the loan. Which problem of asymmetric information is the bank trying to solve?

Short answer

Adverse selection is the asymmetric information problem that the bank is attempting to address.

Step-by-step solution

Introduction

A mortgage loan is a loan secured by an asset.

Asymmetric information refers to information that is not identical, hence there will be inconsistency if the information presented to individuals differs from the genuine information.

Explanation

Asituationinwhichthebuyerhasmoreinformationthanthesellerorthesellerhasmoreinformationthanthebuyerisknownasadverseselection.

Adverseselectionistheasymmetricinformationproblemthatthebankisattemptingtoaddress.

It implies that the house is mortgaged against the loan amount; as a result, both the borrower and the lender are aware of the loan's repercussions and terms.

The bank solves the asymmetric information problem in this way.