Question

Banks are more willing to lend money to those who have a sizable amount of their own money at risk because

a) They like lending to individuals who usually don’t need the money

b) Those with their own money at risk are more likely to only propose viable projects to the bank

c) Borrowers with their own capital invested are more likely to make payments on any loan that is made

d) Both b and c

Key word for the answer is Moral Hazard. Please give a detailed explanation to your answer

Answer 1

Option D.

Explanation: People tend to take more risks knowing that they are insured against the risk i.e. someone else is going to compensate in case of an unfavorable event. This phenomenon is called moral hazard. When a person faces the costs, he/she takes fewer risks and behave more responsibly.

When a borrower has a sizable amount of his/her own money at risk, he/she acts more responsibly in the business. This ensures that the money lent by the bank is relatively safe and the bank can reasonably expect to get the loan returned. This is why banks feel safer to lend such borrowers.