Mention two specific cases of moral hazard problems in the banking industry that may occur due to regulation and government action

ANSWER

Moral Hazard is the concept that individuals have incentives to alter their behaviour when their risk or bad-decision making is borne by others.

Two specific cases of health hazards in banking industry include:

• Comprehensive insurance policies decrease the incentive to take care of your possessions
• Governments promising to bail out loss-making banks can encourage banks to take greater risks.

conditions necessary

1. There is information asymmetry. Where one party holds more information than another. For example, a firm selling sub-prime loans may know that the people taking out the loan are liable to default. But, the bank purchasing the mortgage bundle has less information and assumes that the mortgage will be good.
2. A contract affects the behaviour of two different agents. In some cases, two parties face different incentives. If you are insured, then you may have less incentive to take care against risks. For example, if a country knows it will receive a bailout from the IMF, then it may feel less incentive to reduce debt. Moral hazard is particularly a problem in the insurance market because when insured, people may be more liable to lose things.