1)Are bank regulations able to eliminate moral hazard problems completely?

2)A colleague tells you that he can get a business loan from the bank, but the rates seem very high for what your colleague considers a low-risk loan.

a. Give an adverse selection explanation for this, and offer advice to your friend on how to solve the problem.

b. Give a moral hazard explanation for this, and offer advice to your friend on how to solve the problem.

1)No, banks cannot eliminate moral hazard problems completely but can reduce the moral hazard problems and effects within a given period. To completely eliminate moral hazard problems may require a lot of work than just regulations. Efficiency, effectiveness, commitment, thorough supervision, and strict strategies can be a great start though it may take ages to eliminate them entirely. Most bank regulations mostly aim at reducing the effects the moral hazards may cause to a business.

2)

A:

The bank is charging such a high rate of interest because they don't know much about you and you ability to repay the loan. They don't have enough information to distinguish you from someone who is unlikely to pay the loan back and thus this high degree of uncertainty is why the interest is so high. To solve this you can provide the bank with more information on you such as financial history and the more details on what the funds will be used for to bridge this information gap.

B:

The bank is concerned that you will not have a large incentive to be responsible with the funds as the bank is the one taking most of the risk. To solve this problem, you can put an asset up as collateral that you may own to greater share the burden of risk.