Ending Bank Interest Capitalisation to End Inflation and Reduce Housing Costs

Listen to this “podcast” generated by Google’s Notebooklm. (about a 12 minute listen) Notebooklm also generated the Frequently Asked Questions at the end of the article. If you are unfamiliar with capitalisation, please read the FAQ.

This article proposes a government intervention to reduce housing costs and inflation by addressing bank interest capitalisation practices that remained unchanged after Nixon made the US dollar a fiat currency. The core argument is that banks’ capitalisation of interest and fees with a fiat currency injects excess money into the economy, fueling inflation. The solution involves legislation requiring bank shareholders to sell shares equivalent to the capitalised amount when the borrower pays their interest and fees or for a bank to stop capitalising.

Either action will lower borrowing costs for homeowners and remove the need for the Reserve Bank to aim for a 2% to 3% target inflation to remove the excess capital currently introduced into the economy. There may be potential resistance from banks, but the scale of the share purchases will not destabilise the stock market. It will stop the distortion in the financial system caused by unnecessary excess money creation going to bank shareholders.

Most borrowers, except a few privileged clients, pay bank interest and other fees twice. This happens when banks capitalise interest and fees and put the money created into bank capital, increasing the value of shares. The unnecessary increase in the value of bank shares has caused an extraordinary increase in Australian Bank share values since the CBA was privatised.

The banks give nothing to the borrowers for the capitalised interest and fees, but they could provide the funds to a third party to buy bank shares on the stock market and provide them to the borrowers or give the interest back to the borrowers. The important step is not to increase the money supply by selling existing shares instead of creating new shares or increasing the value of existing shares.

Capitalisation became unnecessary after the link between gold and a currency was broken. Banks are meant to provide their depositors with money on demand, meaning they need liquid assets. The US government promised to supply gold if a US bank could not supply US dollars. The oil crisis and the movement of vast amounts of money to the oil states showed that the US banks could not supply gold if asked, and Nixon removed that unnecessary promise. However, banks had protected themselves by capitalising interest just in case large borrowers — particularly countries decided not to repay loans. The solution was allowing the banks to continue to capitalise interest and fees if they felt it necessary.

Banks don’t feel it necessary if they have collateral they can seize if the borrower does not repay. This led to the perverse situation today where wealthy borrowers do not suffer from capitalisation, but the less wealthy and governments do. Solutions are:

1. Stop capitalisation or
2. Allow capitalisation and return the borrower capital in the bank when they pay the interest and fees. This can be done by requiring existing shareholders to sell a small proportion of their shareholdings to borrowers when the borrowers pay their interest. Another way is for the borrowers to use the capitalised money to buy shares on the open market.

Banks could give the money back to borrowers willingly, or the government could legislate for it to happen. Banks that do not capitalise interest and fees would not have to provide shares to borrowers.

The capitalisation of interest and fees is why the Reserve Bank cannot control inflation with changes to the interest rate. Capitalisation is estimated to put 90 billion extra unearned capital into the Australian economy annually. The GDP of Australia is about 1,800 billion dollars, and it is estimated that the banks collected about $90 billion in unearned capitalisation money, which is about 5% of GDP. This accounts for the 3% inflation and shows that the economy grew by 2%. It will also release $90 billion for investment — not spending.

The government should immediately propose legislation, and the banks should change before any bill is passed. Banking systems would not change except for the automatic purchase of shares with periodic transfers to borrowers or a bank treating all borrowers the same and stopping all capitalisation.

Home borrowers who sell their shares would save about 30% each year. Those who keep their shares would likely halve the cost of their homes. Capitalisation with shares increases share liquidity. Inflation would be controlled as $90 billion of unnecessary money would be removed from the economy.

Banks need not buy the shares on behalf of the borrowers; they could find a third party to do so. Over $300 billion in bank shares were traded last year, so the $90 billion in capitalisation can be absorbed. Banks that did not want to capitalise do not have to, and it is expected that most banks would choose not to.

If governments do not legislate, borrowers will launch legal actions to force the banks to stop capitalisation and provide compensation.

Frequently Asked Questions

Generated by Google Notebooklm from the article.

FAQ: Bank Interest Capitalization and its Impact on the Economy

1. What is bank interest capitalisation, and how does it work?

Bank interest capitalisation occurs when banks add unpaid interest and fees to the principal balance of a loan. The bank does it by debiting your loan account and crediting their account — not the borrower’s account. This increases the loan amount, leading to higher interest charges over time. Essentially, borrowers pay interest twice as well as interest on interest. The practice increases the value of bank shares without providing any tangible benefit to the borrower.

2. How does bank interest capitalisation contribute to inflation?

When banks capitalise interest and fees, they effectively inject new money into the economy. This increases the money supply without a corresponding increase in goods and services, leading to inflation. This practice adds around $90 billion annually to the Australian economy, contributing significantly to the country’s inflation rate.

3. Why is bank interest capitalisation unnecessary in a fiat currency system?

Before fiat currency, banks needed to hold gold reserves to back their lending. Capitalising interest provided a buffer if borrowers (particularly other governments) defaulted. However, with fiat currency, governments guarantee the value of money, eliminating the need for gold reserves. Capitalisation is now an unnecessary practice that primarily benefits bank shareholders.

4. How does interest capitalisation disproportionately impact different borrowers?

Wealthy borrowers often avoid interest capitalisation because they can provide collateral that minimises the bank’s risk. Less wealthy borrowers and governments, who may lack substantial collateral, are more likely to have interest capitalised, increasing their borrowing costs.

5. What are the proposed solutions to address the issue of bank interest capitalisation?

The article proposes two solutions:

• Stop capitalisation entirely: This would require legislation prohibiting banks from capitalising interest and fees.
• Return capitalised funds to borrowers: If the capitalised funds are returned by existing shareholders selling shares to borrowers equivalent to the capitalised amount, the money supply would not increase, and the borrowers would get paid for the capitalisation.

6. How would the proposed solutions impact the economy and borrowers?

Eliminating or offsetting interest capitalisation is expected to have several benefits:

• Lower borrowing costs for homeowners: Borrowers would save approximately 30% annually on their mortgage payments or potentially halve the cost of their homes.
• Reduced inflation: Removing $90 billion from the Australian economy annually would help control inflation without relying solely on the Reserve Bank’s interest rate adjustments.
• Increased investment: The money saved by borrowers and removed from inflationary pressures could be redirected towards productive investments.

7. Would the proposed solutions negatively impact the banking system or stock market?

The scale of share purchases in the proposed solutions would not destabilise the stock market. The $90 billion in capitalised funds represents a manageable portion of the over $300 billion in bank shares traded annually. Furthermore, banks not wishing to capitalise could choose not to, avoiding the need for share transactions.

8. What actions are recommended to implement these solutions?

The government should propose legislation addressing bank interest capitalisation. However, banks can proactively change their practices before legislation is passed to demonstrate goodwill and avoid potential legal action from borrowers.