Borrowers, obviously, would have superior information than lenders about their own past actions and future intentions although it is the lender who bears the negative consequences of the risk. Moreover, borrowers have incentive to misrepresent their risk profile. In any case, lenders cannot rely solely on the information provided by the applicant but must evaluate borrowers’ claims even when borrowers are truthful.
This entails significant cost and time. Such information asymmetry has consequences for lending as it results in misallocation of credit. Let me explain. Before the advent of credit information models, traditional neoclassical economics assumed that markets were “informationally efficient”. This implied that one cannot consistently achieve returns in excess of the average market returns on a risk adjusted basis, given the information available.