Question

Why does domestic lending increase the money supply?

Answer 1

Domestic lending moves capital out of reserves and into capital available for purchases (i.e. money supply).

Explanation:

The term "money supply" is normally used to mean capital available to purchase goods and services.

Banks and other financial institutes hold back capital as "reserves".

When a bank (et al.) makes a domestic loan, that money comes out of the "reserves" and becomes available within the domestic market.
That is, within the domestic market, the supply of money available for he acquisition of goods and services has been increased.