The fact that the U.S. government provides deposit insurance to banks creates a form of ________, which is at least partially offset by requiring banks to hold more capital if they are riskier.

Question

Quizplus · Accepted Answer

Deposit insurance creates moral hazard because it incentivizes banks to take on more risk knowing that they will not bear the full cost of potential losses. Requiring riskier banks to hold more capital is one way to partially offset this moral hazard by making them face higher costs for taking on risky investments. Adverse selection is not directly related to deposit insurance, risk aversion is a different concept related to an individual's preference for risk, and interest rate risk is the risk that interest rate changes will affect the value of a bank's assets or liabilities.

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