A number of writers on monetary reform have argued for the banning of charging of interest. They see the use of interest as a major contributor to inequality and destruction of the environment. It’s well worth reading some of these arguments, such as those of Margit Kennedy – Interest and Inflation Free Money or Money & Sustainability: The Missing Link by Bernard Lietaer, and there’s further research to be done there.
However, Positive Money isn’t campaigning against the charging of interest, and the system of money that we propose in Modernising Money still involves people receiving interest on their savings, and borrowers paying interest on their loans. There are a number of reasons why we’re not campaigning against the use or charging of interest. There is further detail on each point below, but here’s a brief summary:
1. There would be less interest to pay in the system proposed by Positive Money, because money would not be created through bank lending, and because there would be less debt overall. So the transfer of income through interest would be much less than in the current system.
2. Interest has a useful role to play: it provides a fair return for taking risk with your money and giving up access to your funds for a period of time. It can help to cover losses on a portfolio of loans or mortgages, so that no saver actually loses more than they initially invested.
3. Even where “interest-free” models of lending are proposed, the administration fees often add up to amounts that are equivalent to a standard rate of interest. In other words, there are costs to borrowing money and these have to be covered in one way or another.
4. Loans at interest can be a cheaper deal overall for many businesses than raising money by selling equity (i.e. shares in the business).
So interest can have a useful role, and if it’s not charged on all money at the point that it’s created, it doesn’t necessarily have such an impact on inequality.
This is why we focus on reforming the way that money is created in the first place.
In More Detail
1. The scale of the problem is less in a reformed monetary system
In the current monetary system, almost all money – in the form of the numbers that you see in your bank account – is created at the point when a bank makes a loan. As the Bank of England describes:
“In the modern economy, most money takes the form of bank deposits. But how those bank deposits are created is often misunderstood: the principal way is through commercial banks making loans. Whenever a bank makes a loan, it simultaneously creates a matching deposit in the borrower’s bank account, thereby creating new money.”
What this means is that for every pound in your bank account, there is someone somewhere else in the economy who has a pound of debt. This is the debt that was taken on when the money was created in the first place.
In effect, this means that interest is being charged on all of the money that banks create. In effect, the money we use to run our economy has to be rented from the banks.
The payment of interest on all this money represents a significant transfer of income to the banking sector. Some of that comes back to people through interest on savings and deposits, but when we’ve crunched the numbers, overall the bottom 90% of the population by wealth pay more interest than they ever receive, whilst the top 10% receive more.
But in the system that Positive Money proposes, money is not created by banks making loans. Instead, new money would be created by the Bank of England, and transferred to the government, who would then spend it into the economy (or use it to cut taxes).
In this system, money is not created as a debt, and no-one has to pay interest on the new money that is created. Instead of the money that we use being created by – and rented from – banks, it would be created free of debt. Interest would only be charged/paid when savers choose to make their money available to borrowers. Instead of interest being paid on 100% of the money that is created, it will only be paid on the lower proportion of money that is owed by borrowers to savers.
In addition, over time the Positive Money reforms would make it possible for the overall levels of debt to fall significantly, so there is less interest to be paid there too.
In short, the transfer of income through the payment of interest should be significantly less in a system where money is not created by banks making loans.
2. The return for taking risk
Interest is often justified as a reward for a) taking the risk that you won’t be repaid, and b) giving up access to your money for a period of time.
But in the current system, savers earn interest on their bank deposits, whilst taking absolutely no risk, thanks to the government’s guarantee on the first £85,000 of a person’s bank account. There are serious problems with this guarantee: it provides a safety net to banks that encourages them to take higher risks; it acts as a subsidy to the largest “too big to fail” banks; and it means that savers have no interest in whether the bank is well run or reckless. But significantly, it means that savers can earn interest, whilst taking no risk by passing the risk off onto a third party – the taxpayer.
In addition, savers do not have to give up access to their money. They can withdraw it at any time. Whereas investors in startup business know they won’t get their money back for a number of years – if at all – a saver with a bank account can reclaim the funds at any time (unless they agreed to a notice period, but even these are usually flexible).
Under a Positive Money system, savers would need to make a conscious decision to provide their funds to the bank for investment. They would give up access to the funds for a period of time (eg. at least 1 month, but usually longer). And crucially, they would be accepting a degree of risk, since the government would no longer be providing a safety net for banks through deposit insurance (the £85,000 guarantee).
In this situation, where a saver has taken some risk and given up access to their money for a period of time, it seems entirely fair that they should be rewarded with interest.
3. Interest can protect savers from losses
Out of 100 loans made by a bank, one or two of them may go bad when the borrowers are unable to repay. In this case, the interest paid by 98 of the borrowers can cover the losses when the other 2 of them default, meaning that no-one actually loses their investment – they just get slightly less interest overall. So interest in this way provides a way of covering risk and spreading losses.
4. “Interest-free” lending is still not free
Even the ‘interest free’ forms of lending that are often proposed still require fees for the adminstration of the loan (assessing whether the borrower can repay, collecting repayments etc.). When these fees are added up, they work out to cost pretty much the same amount as interest. Even some forms of Islamic Shariah-compliant lending charge a range of fees that work out at a similar cost to conventional bank loans. The reality is that there are real costs to borrowing money, and these can either be paid through an interest arrangement or some other arrangement, but no-one should expect to be able to borrow money for free.
5. For many businesses, loans with interest can be cheaper than equity
Some people argue that all investments should be done through equity (i.e. direct investments where the investor ends up owning a share of the business). Yet borrowing through selling equity, particularly in the early days of a business, can turn out to be incredibly expensive for a business in the long term. If a startup business takes £100k of equity investment for 25% share of the business, and ends up being worth £10 million in 5 years, that would be equivalent to a loan with an interest rate at around 190% a year. (These are back-of-a-fag-packet figures but the point should be clear).
So decreeing that interest should be banned and requiring all investments to be made through equity can actually be a worse deal for entrepreneurs and businesses in the long-run.
6. Interest is central to the modern economy
The charging and paying of interest is so central to the current economic system that it’s here to stay. Changing the structure of banking only affects banks, whereas trying to change the nature of interest affects every aspect of the economy.