Banking regulation

Depositors lack information about the quality of these private loans.Unable to learn if bank managers were taking too much risk or were outright crooks, depositors would be reluctant to put money in the bank, thus making banking institutions less viable.

A government safety net for depositors can short-circuit runs on banks and bank panics, and by providing protection fro the depositors, it can overcome reluctance to put funds ion the banking system. One form is deposit insurance.

The most serious drawback of the government safe net stems from moral hazard, the incentives of one party to a transaction to engage in activities detrimental to the other party. Depositor won't monitor the bank. Banks may have more risky investment.

One problem with the too-big-too-fail policy is that it increases the moral hazard incentives for big banks. The result of the too-big-to-fail policy is that big banks might take on even greater risks, thereby making bank failures more likely.