Why when credit expands does the risk of default increase

When a bank extends credit, it issues debt in the form of a claim against the borrower It might be a mortgage on a house, a car loan, a credit card, or some other kind of debt instrument The important thing about the debt is not so much its type as its size relative to the borrower’s balance sheet If the bank makes a loan of $100,000, for example, and the borrower’s balance sheet is $1,000,000, then the loan is a relatively small percentage of the borrower’s assets If the balance sheet is $10,000,000, then the bank loan is a much smaller percentage of the borrower’s assets When banks extend credit, they also extend bank deposits The borrower puts the loan proceeds in an account at the bank This deposit is just an accounting entry, but to the bank, it is a liability In a fractional reserve banking system, the bank can hold only a fraction of its deposits in reserves In the United States, the Federal Reserve requires banks to hold reserves equal to only 10% of their deposits The other 90% can be lent out When banks make loans, they create both loans and deposits The loans are on the asset side of the bank’s balance sheet, and the deposits are on the liability side The loans are new claims against the borrower’s assets. The loan can be used as a deposit by the person with the loan to spend