Why Should Banks Get Paid Interest On Money They Couldn't Create On Their Own?

Mensa emblem

PROPOSAL - banks shouldn't be allowed to charge interest, only - at best - a creation fee.

From Bill Kruse

It's not so nice paying off the mortgage, is it?

Paying off the original sum you borrowed, the principal, that's not so bad.

It's all that interest takes some paying!

"Fair's fair," you think, "The banks are the ones with all the money so they can charge whatever they want for it".

Now if that really were the case, then it might be fair, but it isn't fair because that isn't the case at all.

The case is, unlikely as it may seem, the banks aren't the ones with the money.

The banks are the ones allowed to make money up.

The money they lend you isn't money they already have, getting dusty in the vaults or as bytes on their computers.

No, it's money that, under a longstanding cultural prerogative, they're allowed to make up.

From nowhere.

On the spot.

You're paying them interest, then, on money they never had.

Which begs the question, why?

Well, to give us some background, here are perspectives from people widely regarded as authorities on banking;

  1. Former Bank of England Governor (now) Lord Mervyn King who said When banks extend loans to their customers, they create money by crediting their customers accounts. in an a speech to the South Wales Chamber of Commerce at The Millennium Centre, Cardiff on the 23rd October 2012.
  2. His former deputy (now) Sir Paul Tucker who said "banks extend credit by simply increasing the borrowing customer's current account... That is, banks extend credit by creating money." in a speech from the BofE and included in the Bank's Quarterly Bulletin for 2008 Q1".
  3. The Bank of England itself who informed us that Commercial [i.e. high-street] banks create money, in the form of bank deposits, by making new loans. When a bank makes a loan, for example to someone taking out a mortgage to buy a house, it does not typically do so by giving them thousands of pounds worth of banknotes. Instead, it credits their bank account with a bank deposit of the size of the mortgage. At that moment, new money is created" in March 2014 in a report called Money Creation in the Modern Economy.
  4. We could have learned this even earlier from former Coalition Chancellor The Right Honourable Reginald McKenna who noted the banks like to keep quiet on the subject; "I am afraid the ordinary citizen will not like to be told that the banks or the Bank of England can create or destroy money. We are in the habit of thinking of money as wealth, as indeed it is in the hands of the individual who owns it, wealth in the most liquid form, and we do not like to hear that some private institution can create it at pleasure. It conjures up a picture of an autocratic and irresponsible body which by some black art of its own contriving can increase or diminish wealth, and presumably make a great deal of profit in the process." from his book 'Post-War Banking Policy'.


We know then from the authorities quoted above that banks don't actually lend you existing money, money they already had handy, lying around in their vaults. No, instead they create brand new money from nowhere when they, ah, 'lend' it.


Why are we paying them all that interest then? The prospect of profit in the form of interest is almost invariably the reason commercial loans are made, as well as compensation for the temporary loss of the use of money while it's loaned to a third party. The money banks 'lend' though, isn't existing money the banks will lose the use of if they lend it out; it's actually money they've just created (out of nothing!!) in response to specific input from a potential borrower in the form of their signature on a 'loan' agreement. I stress again, this is not money the banks had laying around in their accounts that they'll be denied the use of if they lend it out, it's brand new money they've only been allowed to call into existence in response to a specific request from a potential borrower.
So how come they can charge interest on it then?

I agree they should be allowed to charge a fee for their money creation service but charging interest on money they never had is, frankly, a scam. There's no way this fraudulent practice can be justified. It should never have been introduced and should certainly not be allowed to continue.

What effect could finally understanding this have upon the public? I'm not the only one to wonder... here's David Graeber, author of 'Debt; The First 5,000 Years' speaking; "Just consider what might happen if mortgage holders realised the money the bank lent them is not, really, the life savings of some thrifty pensioner, but something the bank just whisked into existence through its possession of a magic wand which we, the public, handed over to it".

There will be those who argue instances of bank speciality 'lending' (which I haven't covered here as I don't claim knowledge of all of them) shouldn't be subject to this stricture, It may well be that in some cases I've not considered, they could be correct. I'd say as a rule of thumb, if the money in question didn't exist before the proposed borrower came in and signed it into existence then the 'lending bank' shouldn't get interest on it. Period.


Bill Kruse - http://www.economania.co.uk/various-authors/various-authors.htm - Permission granted to freely distribute this article for non-commercial purposes if attributed to Bill Kruse, unedited and copied in full, including this notice.

Members can discuss this and other articles on the economics forum at International Mensa.

About Us

Economania is the website of Mensa's internationally recognised Special Interest Group dedicated to economics, trade and finance.