Question

What are some examples of moral hazard problems in bank lending? How do regulators act to prevent these problems?

Answer 1

Moral hazard in the financial markets or lending of banks is that there is a risk that a party has not entered into a contract in good faith or the borrower may be engaged in undesirable activities from lenders point of view.Some of the example of moral hazards are as follows:

• borrower provide misleading information about its assets,liabilities, or credit capacity to obtain good amount of loan.
• when a property owner obtains insurance on a property the contract is based on the idea that the property owner is saving his property from damage but moral hazard arises when the aim of owner is to take advantage of the insurance company money through damage of property.
• not using the amount of loan taken for the purpose for which it is taken
• giving fake documentation to obtain the bank loans etc.

To prevent moral hazard in banking sector regulators has set up several measures these are:

• setting up of different departments in order to verify the documents and other paper work
• going to the borrowers place and checking wether the funds are used for the purpose taken
• proper contract work is there among parties
• collateral is adeqaute and present etc.