A moral hazard situation arises in the lender of last resort function because:
A) a central bank finds it difficult to distinguish illiquid from insolvent banks.
B) a central bank usually will only make a loan to a bank after it becomes insolvent.
C) a central bank usually undervalues the assets of a bank in a crisis.
D) the central bank is the first place a bank facing a crisis will turn.

Question

Quizplus · Accepted Answer

Moral hazard in the context of the lender of last resort function arises because a central bank may find it challenging to differentiate between banks that are merely facing temporary liquidity issues (illiquid) and those that are fundamentally unable to meet their obligations (insolvent). This uncertainty can lead to the central bank potentially supporting banks that are not viable in the long term, encouraging risky behavior.

A Moral Hazard Situation Arises in the Lender of Last