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Loans Can Come In Many Different Sizes

Loans are an essential part of macro and micro economics. They allow a nation’s economy to expand and allow for increased opportunity. Among other things, loans enable people to set up new businesses, to attend higher education institutions and for companies to invest in new capital equipment.

Not all loans are made by financial institutions or exist on such a large scale. Personal loans made between friends or family members are an important economic mechanism. Usually interest is not paid on the loan and often there is no formal agreement. Although this type of loan opens opportunities for the borrower, the risk to the lender can be greater.

The majority of cases dealt with in small claims courts are to do with this kind of loan. Frequently the borrower does not agree that money given was a loan. The lending of money in these cases has a further and significant economic impact because money goes into the justice system. The lender’s risk was more than just the money however: the friendship or family relationship could be threatened.

Risk is an aspect of lending that has to be managed at every level. When a lender makes a loan, they risk the borrower not repaying it. Defaulting on loan repayments can have serious consequences for individuals, corporations or governments.

Loans for capital equipment become part of a company’s liabilities. The lender and the borrower must be sure that the expenditure will produce enough extra income to be able to pay back the loan plus interest. The period of the loan must offset depreciation of the equipment.

An example of this on a small scale would be a taxi company that takes out a loan to buy a new car through Both the loan and the taxi company must be confident that the additional car will bring in enough new customers to pay back the loan over the loan period. During that period of time, the car will depreciate in value. If the loan period is too long, the economic value of the car may be lower than the outstanding debt. In this case, the taxi company may decide to default if it is experiencing other difficulties. A lender would be aware of this possibility and manage the risk by setting a higher interest rate for a longer loan repayment time.

There are economies of scale available to governments and very large corporations that are not available to the person on the street. The size of loan at risk makes it impossible for the lender to call in the debt without catastrophic consequences to both lender and borrower.