Federal deposit insurance, for example, has protected small depositors but led many banks and thrifts in prior decades to take on greater risk because, for most of the FDIC's history, insurance premiums were the same for all depository institutions, resulting in riskier depository institutions being subsidized by safer institutions.

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Quizplus · Accepted Answer

This phenomenon is known as moral hazard, where the presence of insurance, in this case, federal deposit insurance, leads institutions to take on greater risks because they know that their deposits are protected. Since the insurance premiums were historically not adjusted based on the risk level of the institution, riskier banks were effectively subsidized by the safer ones, encouraging riskier financial behaviors.

Federal Deposit Insurance, for Example, Has Protected Small Depositors but Led