A fundamental problem in financial markets is when the parties involved have different, or asymmetric, information in a transaction. Akerlof described the problem of information asymmetry as early as 1970 in "The market for lemons". Akerlof described a market for a product where the seller has an information advantage over the buyer regarding the quality of the product. A classic example is used cars - so-called "lemons" where the seller has much better knowledge of the product than the buyer. Akerlof showed that information asymmetry can hypothetically collapse the entire market or shrink it to a negative selection of low-quality products. This is the case, for example, when a bank issuing a security has more information about the risk of the security than an investor. Since the investor lacks full knowledge of the risk, they cannot fully differentiate between the prices of securities issued by banks that take a low risk and those issued by banks that take a high risk. If investors do not have sufficient information on the nature of the risk, a high-risk bank will not be "penalised" with a higher funding cost. However, a lack of transparency does not necessarily mean too little information. Information that is not material may also make it more difficult to accurately assess banks’ risks. The information provided must therefore be clear, relevant and understandable to the counterparty, which also requires it to be harmonised and comparable. Without sufficient transparency, it is also not possible for investors to obtain information on the underlying risks of a company's operations, making it more expensive for financially strong companies, relative to their risk profile, to obtain funding. This can then contribute to lower investment and growth than would otherwise have been possible and to greater risk in the financial system, which in turn increases the likelihood of financial stress in the banking system.
Deficiencies in the availability of accurate information can also spread and exacerbate financial stress already present in the system. Without sufficient transparency about individual banks' risk exposure and links to different sectors and companies, it becomes difficult for investors to assess whether problems arising in an individual bank can be confined to that bank, or whether there is reason to believe that other banks also have similar problems. There is then a risk that even the strong banks will be affected. Through this spill-over effect, inadequate transparency can contribute to problems for the financial system as a whole. During the global financial crisis of 2008, this insight became very clear when it was discovered that banks' risks could not be observed and measured well enough.