Moral Hazard in Banking Essay -- essays papers

Moral Hazard in Banking Moral hazard is an asymmetric information problem that occurs after a transaction. In essence, a lender runs the risk that a borrower will engage in activities that are undesirable from the lender's point of view, making it less likely that the loan will be paid back. Gary H. Stern's article, "Managing Moral Hazard with Market Signals: How Regulation Should Change with Banking", addresses the moral hazard problem inherent to the financial safety net provided by the government protection of depositors. Interest rates do not reflect the risk associated with bank activity, which in turn causes banks to finance higher-risk projects with price tags that are not parallel to the risk level. A solution to the moral hazard problem lies within government supervision and regulation. In the article, Stern challenges the assertion that proposals that rely exclusively on government regulation will satisfy the problem of moral hazard, especially for TBTFs (Too Big to Fail banks). Stern states several factors to support such assertions:  The ability of regulators to contain moral hazard directly is limited, due to the exploitable tactics of regulatory reform.  Limited confidence that regulation and supervision will lead to bank closures before institutions become insolvent.  The limited ability of regulators to asses bank risk due to asymmetric information and reliance of internal bank models that may be inaccurate. &...