Credit Expansion

Anna’s bank is not the only source of finance. A company can also borrow by issuing a bond, a promise to make payments to its holders. The Bank for International Settlements (BIS) therefore distinguishes domestic bank credit to the private non-financial sector from finance supplied by all the sources it covers. It separately identifies households, non-financial firms and government. A report that credit is growing does not yet tell us whether families are borrowing for homes, firms for equipment or the state for its spending. First we need to know what the figure includes. [1]

The Bank of England explains that a bank loan normally creates a matching deposit. For simplicity, suppose the bank credits Anna with 100 monetary units. She has a deposit of 100 and a debt of 100. The bank has a claim on Anna and a liability represented by her deposit. This is not a gift: she gains the ability to pay now in exchange for an obligation to repay later. The bank need not merely transfer another saver’s existing deposit. [2]

While Anna draws her loan, other customers may repay older debts. As the Bank of England explains, repaying bank-loan principal, the amount borrowed excluding interest, destroys deposit money. In our example, new loans of 100 and principal repayments of 80 produce a net increase of 20 if nothing else changes. Paying the machine’s supplier is a different event: the money moves to the recipient, but Anna’s debt remains. New contracts and payment counts alone are therefore insufficient; the amount of debt still outstanding matters too. [2]

If an accounting entry were all it took, a bank could approve every idea. Instead, it must consider the risk of borrowers not repaying, payments leaving for another bank and the cost of funding. The Bank of England highlights profitability, risk management, rules to keep banks financially sound and monetary policy. Borrowing must also make sense to the customer. The ability to create a deposit is therefore not an unlimited source of funds without costs or consequences. [2]

Ludwig von Mises examines additional circulation credit reaching the lending market first. In his theory, projects may then appear more affordable even though the necessary equipment and materials have not increased. Return to the printing business: more approved loans may mean more orders competing for the same machines and technicians. Delivery becomes dearer or slower, and original budgets no longer work. This illustrates the mismatch of plans being described; it does not prove that every new loan is a bad investment. [3]

Anna may previously have been turned down because the bank considered her project too risky. Later, she may obtain a loan even though the advertised percentage is unchanged. Mises explicitly allows for this form of expansion: credit reaches borrowers who would not previously have received it at the same nominal rate. Here, the nominal rate means the percentage stated in the contract. Compare access to credit and risk assessment as well as the movement of a single rate. [3]

The BIS also reports debt relative to gross domestic product (GDP), the value of final goods and services produced in an economy over a period. In our example, debt is 100 and annual GDP is 200, giving a ratio of 50%. If annual GDP falls to 160 while debt stays unchanged, the ratio rises to 62.5%. Nobody necessarily borrowed anything extra. The difference is 12.5 percentage points, not an amount of new credit. Comparisons require matching units, periods, sectors and debt valuations. [1]

Satoshi Nakamoto designed a network that verifies transfers and prevents the same coins being spent twice. It is not an accounting system for every credit contract. If Anna borrows 100 US dollars (USD) and provides bitcoin (BTC) as collateral, she incurs dollar debt; no new Bitcoin units are created. Collateral is an asset backing the lender’s claim in case of non-payment, not the currency of the debt. Likewise, a claim against a service is not automatically the same as coins in self-custody, where the person directly controls the private keys needed to spend them. Counting network transfers alone therefore does not measure the scale of lending. [4] [1]