A loop associates an ordinary file (opposed to special files: block or character) to a device.
As an example, if you want to use linux soft links on fat system, you create a file called "something.txt" (with dd), you create an ext2/3 filesystem in it (with mkfs) and then you tell the Virtual File System to see this file as a device (using mount -o loop).
But for the system to be able to mount the file, the underlying fs (contained in the file) has to be known by the system (cat /proc/filesystems).
modprobe ext2
mount something.txt /mnt/loop0 -o loop