Money Creation Process: An Interpretation of Credit Inequality with an Emphasis on Relationship Lending

According to the Austrian School of Economics, money creation as the new purchasing power causes a boost in inequality because it is not simultaneously available to consumers. Therefore, imposing restrictions on money creation prevents the increase in inequality. Although assessing moral hazard and creditworthiness is an essential factor in credit supply, "Money Multiplier Theory" also considers it a function of the inflow of reserves and their supply by the central bank. In contrast, according to "Money Creation Theory," reserves are not a prerequisite for creating money. Banks' lack of need for reserves results in passive money creation, which is inelastic to the supply of reserves, and a large amount of it is made up of loans paid to related individuals and close to the bank. Although this kind of lending reduces the cost of evaluating creditworthiness, it provides new purchasing power to a small part of society who have access to new money earlier than others and are not limited to prudential rules such as the loan-to-value ratio. Analyzing the performance of the banking system in the Iranian economy shows that the amount of loans provided to people with a long-term relationship with the bank is beyond the limits specified in the prudential regulations.