4.4.2 Market failure in the financial sector Flashcards
Asymmetric information
When a party has more information than the other party.
E.g. A potential borrower has better information on the likelihood that they will be able to repay a loan than a lender.
Externalities
An externality is a benefit/cost to a third-party as a result of an economic transaction.
E.g. Negative externalities of the Global Financial Crisis 2007-2009
-Taxpayers (taxpayers bear the cost of the bank-bail-out costs and the impact of fiscal austerity measures).
-Depositors (risk of lost savings if a bank collapses).
-Shareholders (lost equity from falling share prices).
-Government (increased fiscal deficit worsening national debt).
Moral hazard
When people take risky decisions because they know that someone else will pay the consequence.
E.g. Moral hazard during the Global Financial Crisis 2007-2009
-The UK government bailed out Northern Rock, RBS and Loyds. This created moral hazard because banks and other financial institutions would know that, in times of financial difficulty, the government would step in to prevent them from going bankrupt.
Speculation and market bubbles
E.g.
Market rigging
Companies in a market act together to stop a market from working freely in order to gain an unfair advantage.
E.g. In 2017, Deustche Bank, Germnay’s largest bank, was fined a record$2.5 billion for rigging Libor and was ordered to sack 7 employees.
