Answer to Question #170174 in Economics for pp

Question

Question 1

Generally, deposit-insurance system is believed to help increased deposit taking in the financial services industry. It also levels the playing field between state owned banks and privately owned banks.

Explain how the deposit insurance scheme would be of economic benefit to financial intermediation in Zambian.

Explain why you believe the implementation of deposit insurance in Zambia would bring about moral hazard in commercial banks. (20 Marks)

Answer 1

Deposit insurance systems are designed to minimise or eliminate the risk that depositors placing funds with a bank will suffer a loss.

In the case of deposit insurance, moral hazard refers to the incentive for increased risk taking by insured institutions that can result when depositors and other creditors are—or believe they are—protected from losses, or when they believe that an insured institution will not be allowed to fail and thus do not monitor.