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Answer: Providing a certain amount of protection to a depositor against losses arising from a potential bank failure.
**Providing deposit insurance protection** creates moral hazard because it reduces the incentive for depositors to monitor bank risk-taking. When depositors know their funds are insured, they are less concerned about the bank's risk profile and may not demand higher interest rates for riskier banks. This can encourage banks to take on more risk than they otherwise would, knowing that depositors won't withdraw funds due to risk concerns.
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To maintain confidence in the banking system, many countries have introduced deposit insurance. However, a serious consideration in deposit insurance that can make the insurance contract riskier is the so-called moral hazard problem. Which of the following actions is most likely causing the moral hazard problem in the deposit insurance scenario?
A
Enforcing strict limitations on borrowing.
B
Setting the risk-based deposit insurance premium.
C
Implement regulatory measures that ensure banks maintain sufficient capital reserves in proportion to the risks they undertake.
D
Providing a certain amount of protection to a depositor against losses arising from a potential bank failure.