Question

How does bank chartering reduce adverse selection problems? Does it always work?

Short answer

By offering screening proposals to new banks, bank chartering eliminates adverse selection difficulties.

Step-by-step solution

Concept introduction

The banking activities of financial entities are referred to as bank chartering. Its key responsibilities include accepting and safeguarding deposits from individuals and organisations, as well as lending money to others.

Explanation

By offering screening proposals to new banks, bank chartering eliminates adverse selection difficulties. The chartering bank is the institution that receives and safeguards deposits from individuals and organisations before lending the funds to others. It tries to filter proposals for new banks in order to avoid risky entrepreneurs and criminals, hence resolving adverse selection issues.

This strategy does not usually work because risky businesspeople and criminals do not always provide accurate information about themselves. They can use numerous incentives to conceal their information. By offering screening proposals to new banks, bank chartering eliminates adverse selection difficulties.