What is the concept of moral hazard in finance?

Moral hazard in finance refers to a situation where one party takes on excessive risk because they do not have to bear the full consequences of their actions. In financial markets, moral hazard often arises when institutions or individuals engage in risky behavior, knowing that they will be protected or bailed out if things go wrong. For example, banks that are “too big to fail” may take on more risk than smaller institutions because they believe the government will intervene to prevent their collapse. Moral hazard can lead to inefficient behavior and contribute to financial instability, as parties may act without regard for the potential negative consequences.