Credit: An Introduction
Fredcric S．Mishkin The Economics of Money—Banking and Financial Markets
Commercial banks extend credit to different types of borrowers for many different purposes. For most customers, bank credit is the primary source of available debt financing. For banks, good loans are the most profitable assets. As with any investment, extending loans to businesses and individuals involves taking risks to earn high returns. Returns come in the form of loan interest, fee income, and investment income from new deposits. The most prominent assumed risk is credit risk. Many factors can lead to loan defaults. An entire industry, such as energy and agriculture, can decline because of general economic events. Firm-specific problems may arise from changing technology, labor strikes, or bad management. Individual borrowers find that their ability to repay closely follows the business cycle as personal income rises and falls. Loans as a group thus exhibit the highest charge-offs among bank assets, so banks regularly set aside substantial reserves against anticipated losses.
