In banking, moral hazard is perceived as a type of risk that arises when both the parties to a banking transaction (the bank and customer, whether as a provider of funds or as borrower, etc.) have incomplete information about each other. From a bank’s perspective, this involves a situation where it has incomplete or misleading information about its customer with regards to a certain transaction or relationship.
In turn, this flawed information has the potential of negatively impacting or jeopardizing the interest of the bank, principally due to financial recklessness or leniency of the customer in the measures that may be taken in terms of proper disclosures or responsible actions as to the best interest of all parties involved.
Moral hazard may also reflect the tendency for banks and financial institutions operating in a banking system to assume greater risk taking advantage of protection from the adverse consequences of their actions (at the expense of the broader system). In this respect, it is commonplace in relation to safety nets– i.e., government guarantees provided to depositors and sometimes to all bank creditors.
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