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Banks as entrepreneurs of credit

Reading the comments on Larry White's testimony, it occurred to me that a single word might make a difference in the perennial debate about whether banks are creators of credit. The word is "entrepreneurs." Often, economists who are discussing banking call banks "intermediaries of credit." I have used the phrase myself. It fails to capture an important aspect of what is involved, because it gives the impression that banks always act as pure intermediaries, connecting lenders to borrowers with few mistakes. If banks are pure intermediaries, though, why do they so often make huge, costly errors?

It is more accurate to call banks "entrepreneurs of credit." When a bank grants a loan, it is testing whether demand exists to hold the credit it has granted. That is an act of credit entrepreneurship. If the public in the aggregate wishes to hold the funds rather than spend them, it desires to engage in more saving than before, and the bank can expand its liabilities without losing reserves. To that extent the bank is acting as an intermediary, fulfilling a previously unsatisfied demand by the public to extend credit. In contrast, if demand to hold the credit does not exist, the bank loses reserves. To that extent it is acting as a creator of undesired credit in the interval until losses of reserves restrain it. The undesired credit, by the way, is not fraudulent. It is simply a product that failed, as happens frequently in every other line of business.