When the average default rate increases, the interest rate paid by all borrowers goes up. This is related to the risk premium on interest rates. There are 10,000 borrowers in an economy each of whom borrows $100 for a 1 year loan.
The lender could always choose to put all of her money in US T-Bills instead of lending. If the 1 year US T-Bill is paying 0.03 (3%), then what is the minimum interest rate that the lender will charge to borrow money in this economy?