The world’s financial system supplies the world with money to invest. It does it by creating debt in the form of loans through banks. The banks lend the money and receive back the money plus interest. Interest covers the risk of the money not being repaid and gives investors a return on investment. For example, for an investment of $1,000,000 at 5% the financial system charges $50,000 per year. If the borrower repays $50,000 off the Capital, the borrower pays a total of $100,000 back to the bank. The next year the financial system charges 5% on $950,000 or $47,500 plus $52,500 off the Capital or $100,000. After 20 years the debt is repaid at an interest cost of $500,000.
There is another way of financing without using the finance system. If we remove the finance system as an intermediary, the lender and borrower share the risk of the money not being repaid and the borrower gives the return on investment directly to the lender. Doing this saves the cost of finance or in the case of the $1,000,000 above it saves $500,000 in interest costs spread over 20 years. Instead of banks creating extra money as debt lenders use existing money they have saved.
Instead of going to a bank, let the business borrow money directly from a customer investor. Let us assume the borrower makes $100,000 profit on sales of $200,000 from using the loan of $1,000,000. With the financial system, the borrower pays back $1,500,000 to the financial intermediary over the 20 years.
Instead of the customer investor getting back extra money, let the investor get goods and services of value $200,000 for a price of $125,000. For the next 20 years, each year, the investor receives a return on investment of $75,000, and the business has an extra profit of $25,000.
If the lender and the borrower are members of the same business cooperative, the cooperative is $50,000 better off on sales of $200,000. It means the business has created a 25% productivity improvement by removing the cost of the financial system. As the operating cost remains the same at $100,000 the profit has increased from $50,000 to $100,000 or a 100% increase in profitability.
Productivity improvements reduce the risk of failure. As buyers are members, the risk of losing customers reduces as customers share in the extra profits.
The approach works particularly well when the underlying asset being purchased is a dwelling. Dwellings and the land on which they reside rarely depreciate in value except when there is a financial crisis caused by dwelling price inflation. To find out more read Community Funding for Home Ownership.
