What is the concept of “moral hazard” in financial markets?

Moral hazard refers to a situation where a party takes on excessive risk because they do not bear the full consequences of their actions. In financial markets, moral hazard often occurs when institutions or individuals assume more risk because they believe they will be bailed out if things go wrong. For example, banks that are considered “too big to fail” may take on more risk than smaller banks, knowing the government will intervene if necessary. This creates inefficiencies in the market and can lead to financial instability, as the party taking on the risk does not fully face the negative consequences of their decisions.