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And yet you want him to turn to a bank to help secure Paypal's position so that would indicate that the costs of the risk are not wrapped into Paypal's processes (i.e. the transactions between the two parties).

For Credit Risk banks and other financial institutions use interest rates.

For Operational Risk they use fees. The freezing of accounts comes only when the activity of the merchant approaches a threshold not covered by the fees not prior.

As a base coverage all banks are required to keep a reserve just in case their losses start to mount and then they kick in the extreme measures. Paypal has no such standard to meet in the US (not sure what being a Bank in EU/UK would do).

Truly the Merchant should cover the risk directly with Paypal and the fee structure if they are legitimate. But that is not your solution... a third party must enter the equation to cover where Paypal is deficient in their risk assessment.

Who would have thought that a merchant should have to cover the risk entailed by its choice of business model?

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