Part of the idea of college is that the student can be open and take risks and the consequences are not too severe, even if the student fails. Giving feedback to the student about the student's performance makes sense, even in this type of hermetic environment. One of the basic questions anyone asks when they are learning is "how am I doing?" It is useful to give some gauge on that question and to provide some direction for where the student should place his efforts.
I give that type of feedback all the time, to colleagues and staff. And I get feedback of that sort as well on my own work. But there is nothing akin to a letter grade. The letter grade conveys some benchmarking across individuals (unless every student gets an A). Presumably there is some value in using competition to promote learning. I can sort of get the argument, but it definitely has Darwinian undertone and while the species may thrive individual members may do miserably. Certainly most colleges I know don't explictly want to take a Darwinian approach, their Engineering schools notwithstanding.
Beyond this, the letter grades can be made known to outsiders (graduate schools, potential employers) and presumably GPA conveys some information in this context. What information it conveys, I'm not sure. If we said something like the following, then one could see the information in the GPA. (Hypothetical: The student took courses 1, 2, and 3. Course 1 had the following grade distribution. Course 2 had the...). While the NCAA requires publication of 5 and 6 year graduation rates, I don't think anyone publishes grade distributions. So what does a particular GPA mean? And that is not even getting into the issue of the student's course selection.
Nonetheless the perception by the students, no doubt, is that grades matter. Hence an instuctor can leverage that to motivate sutdents. That is a plus. But students in certain circumstances become highly instrumental about the grades and block out other things. That is a minus. We need to talk about that minus and provide other incentives for students than the indirect incentive via grades.