Interest – the cost of borrowing money or the return earned on an investment – is deeply woven into the fabric of the world’s financial system. It regulates (or controls) spending and saving behaviours, influences the money supply, and incentivizes lenders to provide loans. The thought of a world economy without interest raises intriguing, complex questions. Although hypothetical, it’s worth investigating how such a scenario might play out.
The Role of Interest Today
Interest plays an essential role in today’s global economy. Globally, the interest rate market was valued at $1.67 quadrillion in 2020. This value takes into account not just the lending between banks and consumers but also interbank lending and interest rate derivatives, which form the backbone of the global financial system.
Interest: An Essential Incentive
Interest rates incentivize lenders. Banks, for instance, earn billions in interest annually. In 2020, the four biggest banks in the U.S. collectively earned over $56 billion in net interest income. Without this income, the institutions would need to devise other forms of compensation to justify the risks associated with lending.
Risk Management and Interest
Interest rates serve to price risk. Consider credit card interest rates, which average around 20%. These rates are higher than those for secured loans, such as mortgages, because of the greater risk associated with unsecured lending. Without interest, an alternative mechanism to compensate for such risk would be essential.
Interest Rates as Economic Regulators
Central banks use interest rates to manage inflation and stabilize economies. For instance, in response to the 2008 financial crisis, the U.S. Federal Reserve slashed rates to near zero, injecting liquidity into the economy. Without this tool, regulators would need to devise alternative strategies to control economic health.
Real-World Alternatives: The Case of Islamic Finance
While the notion of a world without interest might seem radical, examples do exist. Islamic finance, operating under religious laws that prohibit ‘riba’ (usury or interest), provides an alternative framework. This system, valued at over $2.4 trillion in 2019, uses profit-sharing, leasing, and other contract-based methods for financial transactions. However, even this model presents unique challenges and complexities, highlighting the difficulty of operating outside the conventional interest-based framework.
Conclusion: A Future Without Interest?
The idea of a global economy functioning without interest presents a monumental challenge. It would necessitate significant overhauls of current financial systems, requiring innovative approaches to incentivizing lending, managing risk, and controlling economic stability.
Although a world without interest seems implausible in the current economic climate, exploring these alternatives encourages us to think critically about our existing systems and their potential for transformation.