Conventional wisdom has it that banks exist in order to intermediate financial risk. They safeguard the money of depositors, provide the mechanisms for transacting payments reliably and safely, and enable economic growth by lending depositors’ funds to creditworthy borrowers to buy homes, start businesses and create jobs. At least that is the theory. Fundamental to all this activity is the basic assumption that banks know how to manage and minimize the risks that are always involved in financial transactions: borrowers may not pay back, transactions may be fraudulent, markets may swing the wrong way, and human or technological error may otherwise cause losses. Banks are supposed to understand risk, and to have developed sophisticated tools and techniques to protect themselves and their customers from its worst effects. Legislators and regulators issue laws intended to force banks to operate within the confines of “safe and sound” banking practices.
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