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Economic Theory of Bank Credit$
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L. Albert Hahn

Print publication date: 2015

Print ISBN-13: 9780198723073

Published to Oxford Scholarship Online: November 2015

DOI: 10.1093/acprof:oso/9780198723073.001.0001

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The Extent of Credit Activities of Banks

The Extent of Credit Activities of Banks

(p.42) (p.43) [1.]B. The Extent of Credit Activities of Banks
Economic Theory of Bank Credit

L. Albert Hahn

Oxford University Press

Credit is the source of deposits and the primary business activity of banks. Whether or not a bank grants a credit (assuming creditworthiness) is driven by liquidity considerations; in particular, credit creation decreases and credit closure increases the liquidity of the bank. There are two types of liquidity in an economy with cash: money (the ability to supply cash) and economic liquidity (the ability to settle credits). The central bank acts as a lender of last resort and supplies money liquidity. The case of economic illiquidity (a credit crisis) is more severe and can result in the collapse of the economy. Bankers' liquidity perceptions are highly subjective and mainly determined by their trust in the future of the bank. Credit is a promise, and the interest rate can therefore be seen as the price for trust capturing the risk of default, and is a pure risk premium.

Keywords:   credit creation, interest rate, trust, liquidity, solvency, financial liquidity, economic liquidity

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