Implementing a software banking system is easy. Commerce is defined by transactions: a buyer and a seller, a creditor and a debtor. Money moves from one account to another, and it adds and subtracts a corresponding quantity from the account totals. So, what’s this whole thing with loans?
The idea with loans is that you have to work with physical currency. The flexibility of a “paper-based” banking system allows account balances to freely float positive or negative. By the “tip of a pen,” you can insert a negative sign in front of a bank account balance number. However, the primary concept behind loans is that of the constraints that physical money imposes. You can’t own “negative” physical possessions: either you have them or you don’t. If you don’t have the physical money, you can’t trade it complete a commercial transaction; therefore, you simply can’t do commerce.
Hence, when working with physical money, the concept of a loan is absolutely required. It is the only way to “virtually” allow bank balances to float negative when working with physical money. The requirement, of course, is that all bank balances eventually become positive.
So, this is exactly how a loan is precisely defined. Someone has a pool of physical money, of spare cash, that they know they will not need to use immediately. Another person does not have any money available, but they still want to complete a commercial transaction. A lender gives money to a borrower, with the expectation that all money will be returned before the lender needs to spend it. Therefore, they make a note of the lended money so they can keep track of their total effective assets that they should have available under ideal circumstances. Namely, this note just needs to include, at minimum, the name of who they lended money to and how much money is currently lended out. The note value is updated when money is paid back specifically in reference to that loan note. The idea is that once this note goes to zero, they finalize the status of the loan as completed and no longer need to keep track of that note.
As a practical matter, loans are typically defined with deadlines and payment schedules to make the whole matter easier for both parties to understand. This usually works well with the assumption that the lender has a relatively fixed income and will thereefore have the funds available to pay back on a regular schedule. But, this is not a strict requirement for the primary definition of a loan.
Substantially speaking, this is the difference between “money” and “currency.” Currency is, principally, the number that is written down in an accounting balance book. In a double-ledger accounting system, the total of all balance statements is always equal to zero any any given time, and the absolute values can float freely. “Currency is debt” is a common short explanatory phrase. Money, however, is a physical substance, it has a defined mass and weight, and mass is never negative. Therefore, if you must use physical money in a commercial transaction, you can never complete any such commercial transaction with debt. Loans must be used if the virtual effect of negative money is desired.
There is, however, one significant problem with physical money. Where does physical money come from? With the case of gold, it’s “finders-keepers.” The gold is just sitting around in nature, in a relatively or completely pure form. Whoever finds the gold owns the gold, and once it becomes an object of human position, it can enter the commerce system proper. But, the problem here is that this method for bringing money into the commerce system allows people to gain money without doing any commerce, heck, without doing any commercially valuable work. In fact, the only way for money to enter the system is for someone to get it without doing any commercial work. This is the main criticism with gold in the modern era: gold doesn’t correspond directly to work. Why should we consider people rich if they didn’t do any commercially valuable work for anyone else?
Currency is very different in this respect. The idea with currency is that it’s primary form is the “virtual” form: what is written in the books, traditionally paper books. The physical money form, in cash, is provided under very strict and tightly regulated terms. Only a centralized, regulated issuer, like a central bank, especially one owned by the government, may produce the physical form of the currency. The physical form may then be issued to account holders who have a positive balance.
But, since this is still a balance book, who has the negative balance? The issuing bank, or especially the government, takes the negative balance. The centralized, regulated party takes all the hit for determining the most rational way to distribute the initial money, i.e. the money coming to people without commercial transactions, into the system so that the account holders can have a positive balance suitable for doing regular commerce.
Here’s the problem. What if the physical money form of currency gets destroyed? The problem to the commerce system here is very real: that causes the total bank balance to go negative. However, to the central bank, it simply appears that the money is still being stored somewhere in cash form. They can only hypothesize that a certain quantity of the cash form of money has been destroyed and make a corresponding correction by assuming that debt into government ownership and re-issuing the positive balance out to the people.