A Congresswoman introduces a bill to outlaw credit rationing by banks. The bill would require that every applicant be granted a loan, no matter how high the risk that the applicant will not pay back the loan. She defends the bill by arguing:
There is nothing in this bill that precludes banks from charging whatever interest rate they would like on their loans; they simply have to give a loan to everyone who applies. If the banks are smart, they will set their interest rates so that the expected return on each loan—after taking into account the probability that the applicant will default on the loan—is the same. Evaluate the Congresswoman’s argument and describe the likely effects of the bill on the banking system.