Credit is a hard concept in the Bitcoin economy. That being said, lending isn't that terrible. Go back to the basics -
If a bank uses only Bitcoin, then this is how it will make money: through a spread between savers and lenders. That's how traditional banks are supposed to make money too. People deposit their Bitcoins in the bank for safekeeping and they get some rate of interest. If you're borrowing Bitcoin from the bank to start a business, say, then you need to pay back a higher number of Bitcoins. The bank keeps the difference for taking that risk. Same concept as traditional economy.
Remember currency is just the medium of exchange. The total wealth of the world can keep increasing irrespective of the currency.
You did not understand the problem. If deflation is 20% a year you cannot lend from bank for anything under 20% in real terms. Such high interest would cause demand for credit to be very small and without demand there is now way bank can profit from lending.
It was a good answer to the original poster's question: 'How do banks pay their lenders?' The OP seemed to be under the mistaken impression that a specific business (a bank) needs to increase the stock of money to to pay the interest off loans. The truth is that profit can pay the interest.
Also, if the currency is increasing in value 20% per year, think about why that is.
It's because of economic growth. If you can't have economic growth with the currency appreciating that much, then the growth slows, and the currency increases in value at a lower rate.