A home loan borrower has an agreement with a bank for a $500,000 loan at a 6% interest rate to be repaid over 20 years. A regular bank requires the borrower to pay interest twice. An ethical bank asks the borrower to pay the interest once.
Banks call the first interest payment capitalisation of interest. Here is how it is done. When a loan account is debited with interest in double-entry bookkeeping, there is a matching credit where new money the bank can create is deposited in a bank account. This should be a bank account that the borrower controls — such as their trading account. However, the banks deposit it in their capital account as an unearned gain. This is unethical and is only made legal by government regulations.
The following shows the calculations for regular and ethical loans over the first three months.
The regular loan doubles the interest unnecessarily by claiming that the first payment debiting a loan account with interest is a capital gain. The bank does this because it has done it since banking was invented. There is no justification for doing it with old money, and it should be considered stealing from the community when it is done with new money.
They don’t have to because the banking rules in Australia changed in the early 1980s when Australia, along with the rest of the world, fell into line with the USA on banking rules. The Federal Reserve, a consortium of bankers, sets the US banking rules. The Australian rules are set by the Reserve Bank, an independent instrument of government, and they went along with the USA bankers of double interest payments.
Forty years later, this decision has proved to be wrong. The Reserve Bank could change it tomorrow and stop banks from charging interest twice. However, they are unlikely to do so as they haven’t done so for the past forty years and are probably terrified of the possible repercussions from the USA. We know they can give ethical loans because they give loans to each other and pay the difference once using a low interbank rate. They provide commercial in-confidence loans using mutual credit with borrowers with large deposits or securities.
Change will only come if the public demands it. Individual borrowers, including governments and government instrumentalities, can request that banks change their loans into ethical loans. Sooner or later, one of the banks will change, or the Reserve Bank will give the go-ahead, and all banks will have to change to compete.
You can read more about my unsuccessful individual attempts to halve the interest on my credit card debt at “How to Halve your Interest Payments”
