To reduce moral hazard problems,banks include restrictive covenants in loan contracts. In order for these restrictive covenants to be effective,banks must also
A)monitor and enforce them.
B)be willing to rewrite the contract if the borrower cannot comply with the restrictions.
C)trust the borrower to do the right thing.
D)be prepared to extend the deadline when the borrower needs more time to comply.

Question

Quizplus · Accepted Answer

Restrictive covenants alone cannot prevent moral hazard problems unless the banks monitor and enforce them. Without monitoring and enforcing, the borrower may break the covenant with impunity, leading to moral hazard issues. Banks need to ensure that the borrower complies with the restrictions imposed in the contract.

To Reduce Moral Hazard Problems,banks Include Restrictive Covenants in Loan