TWO

How Borrowing Magnifies Risk

Loans and debts make worry and frets.

Proverb

BANKS MAKE LOANS to individuals, businesses, and governments. Banks borrow from individuals and from firms, including other banks. Understanding banks requires an understanding of borrowing. In this chapter and the next, we discuss how borrowing works and how borrowing affects risk. Our discussion applies to any private borrowing, not just to borrowing by banks.1

Individuals borrow to buy such things as a car or a house so they can own and enjoy these things earlier than they could if they had to pay for them on their own.2 Individuals and businesses also borrow to make investments. For example, individuals may use borrowed money to pay for their education, and businesses ...

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