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 would 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 the likely effects of the bill on the banking system.