Risk-based deposit insurance premiums help control moral hazard by:

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BlackTom AI · Accepted Answer

Topic: Risk-based deposit insurance premiums and moral hazard. The question asks how risk-based premiums help control moral hazard, and presents four options to evaluate.
Option 1: 'All of the above.' This option suggests that every listed mechanism contributes to reducing moral hazard. To evaluate it properly, we should assess each of the other options and see if they are valid mechanisms. If all of the individual mechanisms are valid, then 'All of the above' is supported.
Option 2: 'Providing incentives for banks to maintain higher capital ratios and engage in less risky activities.' Risk-based premiums align the cost of insurance with risk, creating a financial incentive for banks to hold stronger capital positions and avoid highly risky assets, since riskier banks would face higher premiums. This helps mitigate moral hazard by making excessive risk-taking more costly to the insurer (and indirectly to the bank).
Option 3: 'Making deposit insurance more actuarially fair by aligning premiums with expected losses.' If premiums reflect the expected losses from a bank’s risk profile, then banks contributing more to the expected loss pay higher premiums. This makes the pricing of insurance more fair and accurate, reducing cross-subsidization and moral hazard where safe banks subsidize risky ones.
Option 4: 'Charging higher premiums to riskier banks, thereby internalizing some of the cost of risk-taking.' Directly pricing the risk in premiums internalizes the externality of risk-taking: riskier banks bear more of the expected cost, which discourages excessive risk and aligns incentives with prudent behavior.
Synthesis: Each of Options 2, 3, and 4 describes a mechanism by which risk-based premiums create incentives to reduce risk-taking and align incentives between banks and the deposit insurer. The common thread is that premium levels reflect risk, altering expected costs for banks that undertake riskier activities.
Edge considerations: In some frameworks, there could be additional design features (e.g., dynamic premium adjustments, countercyclical components), but the core idea remains that risk-based pricing discourages moral hazard by making risk more costly for the bank.
Overall takeaway: The mechanisms described in Options 2, 3, and 4 are consistent with the purpose of risk-based deposit insurance premiums to control moral hazard, and collectively they support the notion captured by 'All of the above.'

BU.231.710.51.FA25 The Final Exam

Risk-based deposit insurance premiums help control moral hazard by:

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BU.231.710.51.FA25 The Final Exam

Risk-based deposit insurance premiums help control moral hazard by:

View Explanation

Log in for full answers

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