Anyone who is for some reason confused about this I have a suggestion that makes the question less academic.

Get on Prosper.com, fund your account with a few thousand dollars of your own money and start looking for borrowers. When it's your own money you're lending, you figure out pretty darned quick who's fault a bad loan is. Even if the borrower is not telling the truth. When you're lending your own money, it's still your job to figure out if the borrower is being truthful or not. Maybe they are lying to themselves. Doesn't matter. At the end of the day, after you make a loan, he or she has got your money.

Same is true of banks, except the banker is not lending his own money. If he screws up and lends a lot of other people's money (OMP) to people who can never pay it back because the interest rates he can charge are so high, who is supposed to save him when they inevitably default?