Consider the two-period model with asymmetric information. Households deposit, D, in financial intermediaries (banks) and are paid the risk-free rate, r. Households take loans, L, from banks and pay...

Extracted text: Consider the two-period model with asymmetric information. Households deposit, D, in financial intermediaries (banks) and are paid the risk-free rate, r. Households take loans, L, from banks and pay the lending rate, rl. A fraction of households, p, pay back their debt, and a fraction, 1-p, default completely on their loans. Ex-ante banks know the fraction that repay, p, but cannot identify the individual households. Banks lend out all deposits. However, banks do not make zero profits but maintain positive profits such that profits = q*D where 0