The extrajudicial liquidation of Banco Master, which the central bank ordered this month, illustrates a classic economic problem: moral hazard. This incident prompted the Credit Guarantee Fund (FGC) to provide the largest compensation in its history, with guarantees estimated at R$41 billion, potentially reaching R$49 billion, and 1.6 million creditors affected. We will all pay part of the loss.
Before the collapse, the bank was offering above-average interest rates to its development banks, in some cases 180% of the value of the secured credit, while competitors offered interest rates of 100% to 110%, premiums that in any market usually indicate trouble. The marketing came at the invitation of the “Chinese Development Bank covered by FGM up to R$250,000”, turning the mechanism created to protect savers into a key part of the strategy to push credit risk higher.
To understand why this moral hazard is created, it is helpful to go back to the basics of insurance. In car insurance, the driver knows that an accident could cause large losses, but he does not know the probability of this happening, so he pays a small amount to transfer to the insurance company the task of measuring risks and concentrating losses, avoiding exposure alone to a large and uncertain loss.
However, when there is information hidden before the contract, adverse selection arises. The driver knows they are riskier than average, but the insurance company can’t tell the difference, and by charging an “average” rate, they end up attracting the worst risks. When information is in post-contractual proceedings, moral hazard arises. After all, once insured, the individual may decide to be less careful because he or she is not bearing the cost alone.
If the insured influences the probability of loss and effort is invisible, offering full coverage distorts incentives, tipping the scales to include deductibles and insurance so that the driver remains interested in avoiding the accident. Too much coverage reduces care, and too little coverage leaves people vulnerable to shocks. In other words, design needs to find a compromise between protection and liability.
In the banking system, FGM is the institutional version of this logic. It is a private association, financed by the financial institutions themselves, and acts as deposit insurance for account holders and small investors: it guarantees investments such as CDB, savings, LCI and LCA up to R$250,000 per CPF or CNPJ per institution to protect those who cannot monitor the risks of each bank and, essentially, avoid withdrawals and the domino effect of a collapse on the rest of the system.
By reducing the fear of total loss in the event of intervention, FGM reduces the chance of mass panic withdrawals, which can drag in institutions that can pay alongside those in trouble. But this safety net, combined with lax supervision, distorts incentives: banks feel more comfortable taking risks, knowing that some of the losses will be shared back to society, and investors begin to look almost solely at the price, trusting that the fund will step in if something goes wrong. Guarantee design specifically attempts to walk this narrow line between containing financial contagion and not fueling moral hazard.
The Masters case brings together both sides of the dilemma. For retail investors, FGM became a shield: it was enough not to exceed R$250,000 per CPF for any price to seem acceptable, supported by the marketing itself. For the bank, the combination of strong collateral and customer focus on the FGC acronym has enabled strong financing at well above market interest rates.
When the music stops, the bill doesn’t just go to the “reckless”. Those within this limit must be compensated, but they face bureaucracy and a lack of liquidity, while female genital mutilation burns tens of billions in one case and needs to restore itself with larger contributions from other institutions. Small investors lose peace of mind, some lose their money, the fund loses its margin of protection, and the system becomes more expensive and suspicious.
Insurance served the role of avoiding races and infections, but it redistributed the cost of decisions over time based on the search for easy prices and the use of FGM as a means of selling. In the books, moral hazard is when someone relaxes because they know they won’t be left alone with a loss; In Masters, the relief was on both the investor and the bank, and when moral hazard was achieved, everyone who relied on an efficient banking system shared the bill.
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