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Moral Hazards: The Financial Institution Concept

What is the meaning of moral hazard, and why is it an important concept for financial institutions?

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What is the meaning of moral hazard, and why is it an important concept for financial institutions?

A moral hazard is when one party assumes, or takes on, additional/excessive risk despite the fact that other parties are involved. Often, the moral hazard is engaged because of some potential short-term gain by the party assuming the new, greater risk.

How about some examples?

According to Dowding (2011), "...the very act of taking out property insurance means that the insured party will not act as carefully with regard to one's property as one otherwise would have...". Dowding elaborates that when one has "...no home insurance, one might buy extra strong locks for windows and doors; once the contents are insured against burglary, one might save money on the lock." Or, if someone has NO health insurance, they are likely more apt to be extra careful with the way they conduct their everyday life. If the acquire insurance, they might be inclined to act a little more recklessly.

In a financial or banking situation, a moral hazard might be a situation where a bank or lending institution publicly shares gains made in their loans and investments, while at the same time hiding any losses from discovery. Greed might be a factor; the ...

Solution Summary

How did the concept of moral hazards impact banks and other financial institutions, and eventually lead to the U.S. financial collapse? Can something be put into place to persuade banks to avoid moral hazards and hopefully avoid another financial crisis?

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