Adverse Selection, Moral Hazard, and Credit Information Systems

Abstract: We develop a model that derives “screening ” and “incentive ” effects of credit information systems that mitigate problems of adverse selection and moral hazard in credit markets. We also derive a “credit expansion ” effect in which borrowers with clean credit records receive larger and more favorable equilibrium loan contracts. The credit expansion effect increases default rates, but does not overwhelm the reduction in portfolio default from screening and incentive effects. We create a simulation model which allows us to examine the relative magnitudes of these effects in relation to the order in which they occur. Our results indicate that a substantial portion of the positive effects of a bureau can be realized through the publicity of a bureau prior to its implementation. We then use loan-level data from the rollout of a credit information system used by a Guatemalan microfinance lender to show that this credit expansion effect partly, but not fully, counteracts the positive screening and incentive effects from the system