Why do Banks Innovate Around Regulations by "Loophole Mining”

Financial Institution
Name
Institution
Financial Institution
Question 1
Loophole mining is a term that is used by banks to find their way around regulations set by the government. In most cases, the government might come up with regulations that make it hard for banks to make profits. To guarantee their survival, banks look for ways through which they can defeat these regulations without necessarily breaking the law. This is important for banks as the failure to innovate may make it hard for a bank to stay competitive. An example of loophole mining is derived from the Great Inflation where banks were forbidden by the law to pay any interest on checking deposits or on amounts exceeding percent on time deposits something that was far less than the existing market rates at that time. Banks tried to lure depositors by offering them incentives, but this did not work leading to a high rate of disintermediation. To circumvent this law, banks came up with the money market mutual funds (MMMFs). This fund was a sort of a checking account that paid interest at the existing market rates. The growth of this fund led to the blossoming of the commercial paper markets while this period also saw the growth of nonbank financial institutions. These defacto branches could only accept deposits or give loans thus beating the definition given by the law that a bank is an institution that can “can accept deposits and make loans” (Mishkin, & Eakins, 2012).
Question 2
In the world of an economist, the ideal kind of insurance transfers money from the fortunate and gives it to the unfortunate. In the insurance industry, moral hazard takes place when the expected loss from an adverse event rises as insurance coverage increases. On its part, adverse selection is the tendency for individuals with higher-risk to get insurance coverage to a higher extent than individuals with lesser-risk since it is hard for insurers to tell who is at a higher risk and who is not. Ideally, moral hazard and adverse selection are only limited for insurance products since this is the only economic area where an individual can invest and expect to get a higher return after some time. This high return is gotten in the form of the settlement of claims by the insurance company. Ideally, moral hazard and adverse selection can only be applied in the insurance sector as it is the only area of investment that guarantees protection from financial risk. In the world today, it is rare to find an area of investment that offers anything above the worth of what it costs but this is possible in medical care as an ...