Critical Analysis of Arguments in Favor of Interest


Salman Ahmed Shaikh

In this article, we briefly analyze the logical arguments that are usually presented in the defense of interest as a price of money capital in loans.

Interest is the price of risk

It is not correct to say that lending money involves risk. Because the lender gets interest in any condition, whereas businesses after taking entrepreneurial risk either earn profit or incur a loss. In any entrepreneurial investment, the investment has to go through the entire process of a business activity that involves risk taking at each stage and any compensation on investment is strictly dependent upon the outcome of the entrepreneurial activity. Time value of money is the problem for the investor to avoid keeping his money idle and to avoid forgoing the use of money that may bring positive value to his investment. However, it does not mean that the investor can demand an arbitrary increase (or is given as the case may be) as the cost of using money without taking the entrepreneurial risk.

Share in the profit of the borrower

Interest is not a share in the profit of the borrower because if money is borrowed for fulfilling needs rather than  for  conducting  business,  then,  there  is  no  question  of  a profit.  But,  even  if  money  is  lent  for commercial purposes, then, how one can determine that the enterprise will be profitable let alone determining the level of profits. Businesses earn profits and incur losses, but why the investor does not share in the losses and what sort of an effort he has put in to demand a share in profits that is fixed and confirmed irrespective of the profitability of the business.

Interest is a rent on money

Those things on which rent is charged are used and given back in the same existing condition like homes and cars, while money and other consumption goods are consumed.  When we borrow money, we consume it and regenerate it. When the money is consumed, the borrower has to regenerate it and the lender without taking any risk is entitled to receive the consumed money with interest. Can we borrow apples or mangoes on rent? We can borrow hammer, but not the nails based on the above classification.

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About Salman Ahmed Shaikh

PhD Economics, National University of Malaysia. Assistant Professor of Economics and Finance. Author, Researcher, Teacher and Consultant. He can be contacted at: salman@siswa.ukm.edu.my
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One Response to Critical Analysis of Arguments in Favor of Interest

  1. Thanks a lot for a useful feedback. Some observations are shared.

    Entrepreneurial risk is the dividing line between trade and lending for interest. A trader takes the risk that market price may turn out to be less than the cost or that he may remain unable to sell at all. Lending for interest avoid both these things. Plus, the subject of trade is fiat money that has no intrinsic value, so it cannot be traded at different face values across time periods. Reason why we discount present values is based on an implicit assumption that a parallel interest based system is operating and its legal basis is justified. In an interest free economy, time will become irrelevant for value. Even if things change in value overtime, it will not be a deterministic exponential function of time (as in compound interest), but based on changes in fundamental values of the assets because of real disturbances.

    For the second point, it is not necessary that all consumption goods have same features. Some are eatables while some are not. What is common feature among consumption goods is that their use require their destruction/consumption or non-usability after they are used. For example, eatables or money. Money has to be spent and parted away with to be of use. Then, it is regenerated by the borrower to repay the loan.

    Money is a means of payment. If means of payments are given exponential increase via interest, then they will be hoarded. Then, we are encouraging hoarding than spending. We are also creating a perpetual source of wealth concentration and by allowing interest on money, we are establishing a systematic source of rising income inequality.

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