Non-price restriction of loans. This takes place when lenders will not make loans to all applicants willing to pay the interest rate demanded, even though they have enough funds for lending. This is likely to occur when the lenders cannot perfectly distinguish between risky and safe borrowers, and when the borrowers have limited liability on defaulted loans. The lenders may prefer ration credit rather than raise interest rates to clear the market for loans cause adverse selection: a higher interest rate would attract borrowers with riskier projects, thus leading to a worse incidence of bad debts and less profitability than a lower interest rate which produces excess demand for loans.
|Reference: Oxford Press Dictonary of Economics, 5th edt.|