From our archives: why interest-free banking matters

Does it matter whether a bank charges interest or not? After all, every bank has to charge for its services or it won’t stay in business. Interest is simply the way that banks calculate the charge they make for the service they render when they approve a loan and for the risk they take on by doing so. Why shouldn’t the charge be based on the amount of money involved, the time for which it’s being lent and the demand for money at the time? Doesn’t that method of calculation seem fair?

As Ana Carrie shows in her article, even the JAK Bank charges an arrangement fee for approving a loan and then an annual fee every year for as long as that loan is on its books. If these charges were expressed as an interest rate, they would work out at about 3%. That seems cheap until you realize that JAK requires its borrowers to lend it the sum that they borrow for an equivalent length of time. This means that, while they are lending to the bank, customers lose roughly the same amount of interest that they would have paid, net of the 3% service charge, if the JAK had been an ordinary bank and had charged them interest when they were borrowing.

So if the JAK system merely involves people losing on the swings what they gain on the roundabouts, why are the bank’s members so enthusiastic about it? One reason is that some believe that the charging of interest sets up a growth compulsion in the economy and that, as perpetual economic growth is unsustainable, the development of a no-interest banking system is a key step towards building a sustainable economy.

The roots of this type of thinking run back to the time when gold was used as currency. Since gold did not increase itself, and very little was being mined, where, people asked, was the extra bullion to come from to pay the interest when both principal and interest had to be handed over at the end of the year? Obviously, the borrower could only obtain more gold if someone else had less, so lending money at interest meant that either the borrower impoverished himself when he paid over the extra or he impoverished someone else. And, as neither outcome was socially desirable, usury, as all forms of moneylending were called no matter how low the interest rate, stood morally condemned by both the Roman Catholic Church and by Islam.

Even though we now use paper currencies, this source-of-interest problem has not gone away. Since almost all money in circulation is issued on loan, the money to cover interest payments can only be obtained by borrowers if other borrowers have borrowed sufficiently more. Moreover, the necessity to pay interest on these additional borrowings means that the economy needs to expand if the proportion of world income which is paid over in interest to the lenders is not to increase.

But let’s look at this argument a little more closely. How much is ‘sufficiently more’? Not all the interest paid over to the banks gets withdrawn from the stock of money in circulation. Some of it is returned to the stock right away by being paid as interest to the people from whom the banks themselves are borrowing money. Some returns by being paid to cover the banks’ operating costs, such as their wages bill. And the amount paid in dividends to the banks’ shareholders goes back into the stock too. So only the fraction of the interest paid that ends up as the banks’ retained earnings has to be borrowed back into the system. This is not a serious problem. If inflation was allowed to run at about 2.5% a year, that would be enough to allow the ratio between the level of outstanding loans and national income to be held constant. So, if one has a fairly relaxed attitude to inflation, the charging of interest is not a serious component of the growth compulsion. If the JAK bank made a surplus one year and increased its reserves, it would be just as much a part of the problem as its commercial, interestcharging, competitors.

Other members of JAK have more sophisticated reasons for giving the bank their support. Oscar Kjellberg, the development director, is opposed to charging interest because it transfers wealth from the poor to the rich and from declining areas – often rural ones – to more prosperous parts. “That sort of transfer doesn’t happen with JAK,” he says. “People save with us because they either want to borrow interest-free themselves or because they want to assign the right to an interest-free loan to a relative, a son or daughter, perhaps or to an organization they support. This means that most money is lent out in the same area that it was collected, and, if it’s not, it’s only loaned in a place and for a purpose which the original saver has approved.”

In other words, perhaps the most important reason for backing JAK-style interest-free banking is that it limits a dangerous, destabilising positive feedback built into the present economic system. The feedback occurs because prosperous parts of the world get more investment because better returns can be had from projects there, which makes them still more prosperous, while poorer areas have what capital they possess taken away because no good projects can be found. As a result, the poorer areas fall further behind and people living in them are forced to leave to seek work wherever investment is going on. They take up residence in the expanding areas and add their spending to its rising income flow, generating further investment possibilities. And so the cycle goes on. A major cause of the emigration of young people from rural Ireland used to be that their parents had allowed their savings to be invested away from home. A JAK bank would help prevent a recurrence of that situation.

The JAK bank is a good example of a flourishing cooperative – the lenders and the borrowers and the owners of the bank are all the same people ­engaged together in an independent enterprise which serves them all and accords with their beliefs. Although the services provided and the purposes for which loans are made are still fairly limited, these are expanding as Ana Carrie mentions at the end of her article. JAK is one of thousands of small cooperative banks around the world that confound the myth that financial services are best provided by the large capitalist institutions which dominate the mainstream financial services industry.

Note: This article first appeared in 2004 in the second Feasta Review. It was written by Richard Douthwaite and John Jopling.

Featured image: money. Author: Konto Studenta. Source:

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