Credit Creation
Credit creation is the process by which banks generate new loans, thereby expanding the money supply within the economy.
Meaning in Practice
In practice, banks create credit when they issue loans by simultaneously recording a loan asset and a deposit liability on their balance sheet. This process increases the overall money supply beyond existing reserves. Credit creation is influenced by capital requirements, liquidity constraints, and borrower demand.
Why It Matters
Credit creation supports economic growth by financing consumption, investment, and business expansion. It is a key transmission channel of monetary policy into the real economy. Excessive credit growth, however, can contribute to asset bubbles and financial instability.
Market Impact
Strong credit growth typically supports equity markets and economic expansion. Rapid or uncontrolled credit creation may increase inflation risks and financial imbalances. Weak credit growth can signal tightening financial conditions and slower economic momentum.
Example
When a bank grants a €200,000 mortgage, it creates a new deposit in the borrower’s account, effectively increasing the money supply while adding a loan asset to its balance sheet.