In such cases, borrowers will of course do all they can to avoid a default and first of all try to lower other expenses. This may mean cutting back on non-essential consumer spending or postponing maintenance work or investments. A default, after all, has far-reaching 7 8  In this simplified example, no mention is made of the risk/return considerations that naturally need to be made in such a case. This is also what the empirical literature suggests. An advanced financial system and access to efficient credit provision are closely linked to growth and a high level of prosperity (cf. Beck (2011) and Levine (2005)). It should be kept in mind that a modern financial system comprises further key elements besides the credit mechanism, in particular payment systems, market places for trading shares and bonds, and insurance business. Page 5/16  consequences. In the case of the start-up, it could possibly lead to insolvency. The Miller family for their part might be forced to sell the house in an emergency sale. When borrowers face payment difficulties or default on their loan, this also causes problems for creditors. They will have to write off anticipated interest income and may even lose the money lent if the loan isn’t secured by collateral. And even if the loan is secured – for instance by real estate – getting a good price for the collateral could prove difficult, depending on the circumstances.
Friedman (1957) as well as Modigliani and Brumberg (1954)). In other words, their consumption level would remain more or less steady throughout. In reality, income at certain stages of life does not suffice to cover this hypothetical consumption level. This is true mostly in younger years and in old age. Taking out a loan enables a household to overcome financial bottlenecks in certain phases of life and to make use of their income at a time when they derive the greatest benefit from it. Page 4/16  diversification of investment risk. For society as a whole, it means that accrued savings are made widely available and thus put to better use. Let me give you an example. An entrepreneur is faced with the question of what use to make of his assets. There is no major purchase to be made at the moment. Neither is there a profitable project at his own company in the pipeline. Do you remember our university graduate with her brilliant idea for a product? The entrepreneur could lend her some of his assets against interest and so generate a return. 7 By extending a loan to the young graduate, he is also diversifying his investments. As the proverb has it, he is not putting all his eggs in one basket. Overall, we can conclude that an effective credit system represents an essential basis for a thriving economy. It allows borrowers to put their income to the best-possible use over time.