Loan commitments may be effective in mitigating moral hazard because

Question

Quizplus · Accepted Answer

Options (b) and (c) both contribute to mitigating moral hazard. Option (b) by offering a lower interest rate to encourage borrowers to take on less risky projects and to compensate the bank with a commitment fee, and option (c) by making the commitment fee a sunk cost which incentivizes borrowers to select projects carefully as they would not have a chance to recover that cost if they abandon the project. Option (a) is not entirely effective because not all projects have collateral, and some borrowers may post collateral valued lower than the loan amount. Therefore, options (a) and (c) alone are not enough to mitigate moral hazard.

Loan Commitments May Be Effective in Mitigating Moral Hazard Because