Question

1. Why is moral hazard a problem in the banking sector?

   	a.	Lack of competition in the banking industry mean that consumers have few alternatives, and so bank executives are able to make decisions without considering the preferences of their customers.
   	b.	Regulations are difficult to impose on international banks because they operate in multiple jurisdictions and use foreign currencies.
   	c.	Government bailouts of banks create a moral dilemma because they involve a transfer of money from regular taxpayers to rich bank executives.
   	d.	Government policies such as deposit insurance, bailouts, and lender of last resort liquidity have created a situation where bankers and bank customers do not face the full consequences of their risks, which can lead to poor risk-taking decisions.
   	e.	Government policies such as reserve requirement and capital-asset requirements make banks less profitable, causing them to take on extra unnecessary risk.

Answer 1

Answer- Government policies such as deposit insurance, bailouts, and lender of last resort liquidity have created a situation where bankers and bank customers do not face the full consequences of their risks, which can lead to poor risk-taking decisions.

reason- Moral Hazard occurs when people take risky actions knowing that the unfavourable consequences will be borne by someone else.

In the case of banking, banks take part in risky investments knowing that they will be protected by policies like deposit insurance, bailout etc.

So it leads to moral Hazard.