Accordingly, the value of collateral and thus owners’ assets continued to grow, as expected. Against this background, banks for their part were more optimistic about credit risks as the number of loan defaults remained low thanks to rising property prices and favourable credit conditions. As both credit volume and real estate prices rose higher, economic agents felt vindicated in their optimism. But if such a period of excessive optimism is followed by a downturn, the impact on these highly indebted agents is huge. The trend on the real estate market in Switzerland reversed in 1989 (cf. slide 14). Systemic risks materialised and considerable losses were registered. As investments were largely debt-financed, there was a flurry of loan defaults. Ultimately this led to banks in Switzerland having to write off more than 40 billion francs. 18 To cut a long story short, the Swiss economy slid into recession at the beginning of the 1990s, unemployment rose sharply to 5% and the economy subsequently recovered only very slowly (cf. slide 15). Ladies and gentlemen, having shown you in the first part of my speech that loans are an essential basis for economic growth, I have now explained how excessive lending can seriously damage the economy. I have also outlined how a combination of rational behaviour and distorted expectations of borrowers and lenders can lead to harmful excesses in the credit market. What role do central banks play in the credit cycle?
My main focus thereby will be on what central banks can and should do. Why are loans useful from an economic perspective? Lending is one of the cornerstones of a successful economy based on the division of labour. This fact has been recognised since ancient times (cf. slide 5). As much as 5,000 years ago in Mesopotamia, seeds for crops were made available on loan, with repayment including interest due after harvest. Loans were also commonly used in ancient Greece and Rome. 1 Lending in its present form dates back to the emergence of the ‘modern’ banking system in Europe in the late Middle Ages. 2 To this day, banks fulfil key functions in brokering loans. Without them, efficient large-scale lending as we know it would not be possible. 3 Most recently, alternative methods of credit provision have emerged thanks to digitalisation – P2P or crowd lending for example. Nevertheless, banks remain the mainstay of an effective credit system. I will now explain why growth and prosperity would be significantly lower without an efficient credit system. To do so, I need to clarify the two basic functions of loans (cf. slide 6). First, loans enable borrowers to have future income at their disposal now. And second, loans allow creditors to make optimal use of their available capital. Loans enable borrowers to have future income at their disposal now  Let me explain this in greater detail. Regarding function number one: Without loans, expenditure at any given time is limited to one’s savings and one’s current income.