Screening and monitoring are costly activities. Why is it a bad idea t

Screening and monitoring are costly activities. Why is it a bad idea to impose these costs on borrowers?

What will be an ideal response?

ANSWER

Imposing extra costs on borrowers exacerbates the adverse selection problem, because “good” borrowers are most likely to feel that the costs are excessive and punitive, while “bad” borrowers — whose intention to repay is questionable — are relatively unaffected. Monitoring that is inconvenient and/or intrusive penalizes good borrowers and undermines their cooperation, while bad borrowers may continue to thwart the monitoring system.