The latest round of bank failures has not been met by protests on the street, with the question of who ultimately pays for bank bailouts a thorny one.
In recent weeks financial markets have been deeply shaken by a further round of bank failures, a pattern of history that many had thought behind us.
The collapse of SVB and Credit Suisse has provoked questions about who really bears the cost of guaranteeing the banking system.If this is the brave new world of never-too-small-to-fail banking, what might this hold for the risks that banks take? Or the costs for society? And the implications for investors tasked with navigating these changes?To examine this, we first need to understand that moral hazard, at its most basic level, is an adverse incentives problem.
If the net result of rising regulation is lowered risks, then all else being equal, the likely return on banks and the financial sector can be expected to decrease. Lower returns on banking over the long term essentially means falling profitability. This would be felt by investors as lower returns across the sector.
If the end result is lowered risk-taking among banks, and higher costs incurred by society, what might this mean for investors going forward? One aspect relevant to this outcome is that moral hazard does not stop with the banking sector itself, but rather, like most financial risks, simply gets passed from one set of hands to another.
Where then might this end? Governments typically behave in ways that maximise their prospects for re-election and minimise voter backlash, in keeping with the representative nature of governments in the advanced economies.
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