Expected interest rate charged by a bank which cant distinguish between two types of borrowers.
Suppose a bank is faced withtwo of borrowers - a high risk borrower that should be charged an intrest rate of 9% and a low risk borrower that should be charged an interst rate of 4%. There is a 30% chance of getting a hogh risk borrower and a 70% chance of getting a low risk one. What is the expected interst rate that will charged by a bank that cannot exactly distinguish among the two types but knows the probablities of every type. What would be the result in this market for loans.