What is meant by the term "moral hazard" in ethical finance?

The term "moral hazard" refers specifically to a situation in ethical finance where one party is incentivized to take risks because the negative consequences of those risks are borne by a different party. This arises typically in situations where there is an imbalance of information or power between parties involved in a financial transaction, such as insurance agreements or financial institutions engaging in high-risk lending.

In such scenarios, the party taking the risk may act more recklessly than they otherwise would if they fully understood that they would face the consequences of their actions. For instance, if a bank lends money to a business and the business has little personal liability, it might be encouraged to take risks that could potentially lead to significant losses, while the bank absorbs the impact of those risks if the business fails.

Understanding moral hazard is crucial for ethical finance as it highlights the responsibilities and incentives created by financial agreements and encourages the design of contracts and regulations that align the interests of all involved parties, ensuring that risks are understood and managed appropriately.