What is the Federal Deposit Insurance Corporation and the inherent role of Moral Hazard?

Student
Professor
Class
Date
Federal Deposit Insurance Corporation and the Inherited Role of “Moral Hazard”
The banking system is important in the economy of a country. The most critical aspect of the banking system is the presence of public confidence. However, in the United States, Federal Deposit Insurance Corporation (FDIC), is an independent agency established by the national government to promote and preserve the public confidence in the financial structure (Gorton, and Metrick, n.p.). Headquartered in Washington D.C, this agency performs its duty by collecting and managing the deposit insurance fund. This paper, therefore, discusses FDIC and the inherited role of “moral hazard.”
Established in 1933, the Federal Deposit Insurance Corporation (FDIC) was a response to many bank failures that had been witnessed in the years of 1920s and in the wake of 1930s across the nation. Since the FDIC insurance activities on 1st January 1934, there is no depositor reported to have lost their money among the insured funds because of a bank failure. The deposit insurance submitted to the FDIC has also reduced the chances that a bank will run out or fail. However, if not managed well, the deposit insurance could fuel financial system crisis by giving banks undesired incentive to invest in additional risky investments (Salter, Veetil, and White, 156). This case is the inherited role of “moral hazard” by the FDIC.
The creation of FDIC was accompanied by a problem, referred to as the “moral hazard” risk on the side the agency. The “moral hazard” risk comes about when one person, in our case the banks takes more risks because someone of, the FDIC bears the cost of the risks.  This risk has been elevated by the urge for the agencies, not only in the US provide relief to depositors and therefore the agencies like FDIC commonly offer depositors some financial safety. However, before 1933, explicit deposit insurance was no part of the financial safety net in the US. Instead, the country’s financial system relied on other means of safety nets, such as implicit deposit guarantees.
In the United States, the then President Franklin Roosevelt saw the possibility of the rise of “moral hazard” when the explicit deposit insurance was to be adopted in 1933. He went on to oppose and warn the adoption of the safety net but did not work for him. Not for long did the same issue came to hit the banking system when the largest bank crisis since 1930 took place, just five years after the adoption of the new system. In the United States, the ‘moral hazard’ faced by FDIC comes in two different ways. First, the banks get the incentive to go for added risks under the expense of the agency and second, the shareholders and depositors lose profits (Salter, Veetil and White, 156) in the incentive to monitor the banks under the new system.
In the era before the introduction of the deposit insurance, the banks were making risky loans and had to pay the depositors more for taking the risk on their deposits. The risk would be covered by asking for a risk premium or even not making the loans at all in the case the risk becomes huge. After the introduction of depo...