An Empirical Analysis of Adverse Selection in Consumer Lending

The study employs Principal Component Analysis, Cluster Analysis and Multinomial Logistic Regression Analysis to investigate adverse selection in consumer lending using a randomly-drawn sample of 250 individualbank customers in Ghana and finds that they are not homogenous in terms of propensity to cause adverse selection in lending. Among the three clusters of latent orientation to borrow (undisclosed orientation); negative orientation to borrow (more likelihood of causing adverse selection in lending) and positive orientation to borrow (little or no likelihood of causing adverse selection in lending) identified in the study, gender, marital status, level of education and the number of years of saving with a bank are not discriminators. Only age as a demographic factor has been found to be a positive and significant discriminator between latent orientation to borrow and positive orientation to borrow. The paper, therefore, contends that as an individual bank customer grows his or her propensity to cause adverse selection reduces and that individual bank customers who are older are less likely to cause adverse selection than individual bank customers who are younger. The recommendation of the paper is that banks and other lending institutions that seek to mitigate their credit risk should lend more to individual customers who are older.