The government is involved in every part of the financial system.

a. Government officials may intervene in the financial system in order to:

i. Protect small depositors.

ii. Protect bank customers from exploitation.

iii. Safeguard the stability of the financial system.

b. Most financial regulations apply to depository institutions, while shadow banks usually face less regulation.

c. Intermediaries that are less prone to runs, such as pension funds and most insurers, face less intrusive government oversight than the banking industry.

d. The U.S. government has established a two-part safety net to protect the nation’s financial system.

i. The Federal Reserve acts as the lender of last resort, providing liquidity to solvent institutions in order to prevent the failure of a single intermediary from becoming a systemwide panic.

ii. The Federal Deposit Insurance Corporation (FDIC) insures individual depositors, helping prevent bank runs by reducing depositors’ incentive to flee at the first whiff of trouble.

e. The government’s safety net encourages bank managers to take more risk than they would otherwise, increasing the problem of moral hazard.