When I began working in the financial services industry, I was shocked to learn that banks actually like to make loans. All of the imagery I had seen in movies and television depicted hard-bitten credit officers who delighted in turning borrowers down. They sought to be so intimidating, in fact, that applicants thought twice about even asking for a loan.
As I have come to appreciate, arranging financing is one of the ways that companies like ours earn money. Banks actively solicit lending and underwriting business, subject to standards for credit quality. The intermediation is not only important for the firm, but also for the economy in general.
The Federal Reserve has complained recently that the conditions under which this financing is occurring have gotten too easy. The concern is not bad credit decisions, but rather that accommodative credit terms are working at cross purposes with efforts to tame inflation. But a close look at financial conditions suggests that this concern may be misplaced.
Monetary policy works by modulating the level of reserves in a financial system. Once created, reserves cascade through the economy through strings of transactions. Credit is one of the binders that sustains the string: new liquidity created by a central bank is lent, spent, deposited and then lent again. The more willing that creditors are to provide financing, the greater the length of the economic chain.
In traditional models, banks are the main financial intermediaries. In many parts of the world, they still are: in Europe, for example, banks still account for almost 60% of the credit received by businesses and households. In the United States, capital is more often raised in the bond and stock markets, where investors and borrowers meet more directly. Market-based sources account for more than 60% of the financing used by American businesses and households.