The Bankers’ New Clothes: What’s Wrong With Banking and What to Do About It by Anat Admati

The Bankers’ New Clothes: What’s Wrong With Banking and What to Do About It by Anat Admati

PART ONE
Borrowing, Banking, and Risk

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.
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.
Individuals
and businesses also borrow to make investments. For
example, individuals may use borrowed money to pay for
their education, and businesses may invest in new factories
or in new product developments. Borrowers hope to pay
their debts from money they will earn later, for example, as
their investments pay off.
Borrowing creates leverage: by borrowing, individuals
and businesses can make investments that are larger than
they can afford on their own right away. This leverage
creates opportunities for the borrower, but it also magnifies
the borrower’s risks. The borrower makes promises to pay

The Bankers’ New Clothes: What’s Wrong With Banking and What to Do About It by Anat Admati