Risky loans are the result of deposit insurance. This is because when a bank benefits from deposit insurance the customers (depositors) of the bank and not concerned about the viability of the loans being made by the bank. The bank has little disincentive not to make excessive loans.
But what about the risk of non-repayment, to the bank? This is not such a great risk when all other banks are inflating the money supply simultaneously; the borrower can either refinance or the loans are easy to pay back due to the inflation.
Even if the bank is eventually made bankrupt, after a credit contraction, they will have made considerable (non-refundable, retained by the owners of the bank) profits in the interim. If there are no guarantees from the Government, the bank will be more cautious because it would be a breach of contract to make loans without the consent of (deposit account) customers.
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