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What is moral hazard?

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Quick answer

Moral hazard is when someone takes bigger risks because they don't bear the full consequences. If a safety net catches their losses, people and companies tend to behave more recklessly than they otherwise would. It arises when one party is shielded from the cost of their risks.

Key things to understand

  1. It arises when one party is shielded from the cost of their risks.
  2. Being protected encourages riskier behavior.
  3. Example: a bank may gamble more if it expects a bailout.
  4. Insurance can cause it, so insurers use deductibles to curb it.
  5. It's a central issue in finance, insurance, and policy.

People also ask

What is an example of moral hazard?
A driver with full insurance may park less carefully, since the insurer — not them — pays for a dent or theft.
Why is moral hazard a problem in banking?
If banks expect governments to bail them out, they may take reckless risks, knowing the downside falls on taxpayers.
How do you reduce moral hazard?
By making people share in the risk — deductibles, co-pays, or letting failing firms bear real consequences.