Moral hazard

The effect on a creditor’s or an economic actor’s behaviour when they are covered against a given risk. They will be more likely to take risks. Thus, for example, rescuing banks without placing any conditions enhances their moral hazard.

An argument often used by opponents of debt-cancellation. It is based on the liberal theory which considers a situation where there is a borrower and a lender as a case of asymmetrical information. Only the borrower knows whether he really intends to repay the lender. By cancelling the debt today, there would be a risk that the same facility might be extended to other debtors in future, which would increase the reticence of creditors to commit capital. They would have no other solution than to demand a higher interest Interest An amount paid in remuneration of an investment or received by a lender. Interest is calculated on the amount of the capital invested or borrowed, the duration of the operation and the rate that has been set. rate including a risk premium Risk premium When loans are granted, the creditors take account of the economic situation of the debtor country in fixing the interest rate. If there seems to be a risk that the debtor country may not be able to honour its repayments then that will lead to an increase in the rates it will be charged. Thus the creditors receive more interest, which is supposed to compensate for the risk taken in granting the loan. This means that the cost to the borrower country is much higher, accentuating the financial pressure it has to bear. For example, in 2002, Argentina was faced with risk premiums of more than 4,000 points, meaning that for a hypothetical market interest rate of 5%, Argentina would have to borrow at a rate of 45%. This cuts it off de facto from access to credit, forcing it even deeper into crisis. For Brazil in August 2002, the risk premium was at 2,500 points. . Clearly the term “moral”, here, is applied only to the creditors and the debtors are automatically suspected of “amorality”. Yet it is easily demonstrated that this “moral hazard” is a direct result of the total liberty of capital flows. It is proportionate to the opening of financial markets, as this is what multiplies the potentiality of the market contracts that are supposed to increase the welfare of humankind but actually bring an increase in risky contracts. So financiers would like to multiply the opportunities to make money without risk in a society which, we are unceasingly told, is and has to be a high-risk society… A fine contradiction.

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