The Real Effects of the Bank’s Function as a Creator of Liquidity Through Lending and Factitious Rollover of Non-Performing Loans Channels (DSGE Approach)

Experimental evidence and research on accounting show that the banking system does not create money based on the money multiplier theory but rather employs the credit creation theory of banking, ruling out the need for a monetary base. Critics argue that while proponents of this type of banking claim that it promotes economic growth and development, the restrictions and behavior of banks may actually lead to the creation of unproductive liquidity from multiple channels, provided that they are given more freedom to implement independent policies. In addition to lending, the transfer of non-performing loans to performing loans heading with its factitious rollover and identification of fictitious profits for banks have been two of these channels in the Iranian banking system. Accordingly, this paper analyzes the dynamic stochastic general equilibrium of these monetary arrangements, a topic rarely discussed in modeling. The results show that a negative productivity shock can lead to a more significant and rapid reduction in investment, production, consumption, and welfare in this model compared to the money multiplier model. Factitious rollover of non-performing loans also increases the firm's debt to the bank as well as debt default, credit risk, and credit crunch for the firm, and hampers the destruction of liquidity and the creation of credit with the ability to accumulate on time deposits, which, in turn, can have negative consequences through circulation. This further causes the profitability of firms and banks to decline and the inflation rate to increase, leading to increased interest rates, contrary to the money multiplier model; Thus, accurate control over the behavior of banks is essential. It is suggested that macroprudential policies and dynamic provisioning strategies should be implemented along with the accounting system reformation.