Reciprocal Loans

Kevin Cox
10 min readJun 19, 2023
Figure 1 — All interest goes to lender

The financial system distributes investment money through society. We call it Capital. It is a form of money, or derivative, to which we give properties. The main derivative is called a Loan, where a lender gives Capital (money) to a borrower, and the borrower promises to give back the Capital plus interest in periodic repayments. Today all the interest goes to the lender. In the Reciprocal Loans described here, the lender shares the interest, after it is paid, with the borrower in proportion to each party's costs of earning the interest. The borrower pays interest and repays some Capital, and the lender gives back some of the interest by reducing the amount of Capital owing. It results in lower-cost loans and a fairer distribution of interest.

Figure 1 illustrates an existing loan with no sharing of interest. It is called a Negative Reciprocal Loan, as the Bank keeps all the interest the borrower earns and does not share. Over the life of the loan, the lender gives the borrower $1,000 as a loan, and the borrower gives back the $1000 plus interest of $625.50 and receives nothing for their effort in earning the interest even though they typically contribute the most of the effort.

However, the interest payment can become a Balanced Reciprocal Loan if the interest payments are reciprocated by reducing the loan balance by a share of the interest. The above shows the result of reducing the Balance by 50% of the interest.

The following shows the full spreadsheet of Negative Reciprocal Loans on the left and Balanced Reciprocal Loans on the right.

The government licenses Banks to create new government money by issuing debt. The Bank puts an amount of new money into the borrower’s account, and the borrower works to earn the money to repay the debt plus the interest. The Bank keeps all the interest even though the borrower did all the work for the government in creating both the Capital and the interest. The Bank takes the risk of the Capital not being repaid and the interest it has to pay on deposits. However, the Bank does not supply the money to pay the interest. The borrower earns it, and the lender takes it all, including the interest on the interest.

This is unfair. Some of the interest value should go to the borrower. Otherwise, the borrower will feel aggrieved and do the same thing with their investments, taking all the profits and not sharing them with their customers.

Banks can share the interest with the borrower to make a fairer society. The following outlines sharing interest by adjusting the risks and rewards with each monthly or yearly loan repayment. The approach is a Balanced Reciprocal Loan that increases the productivity of the Financial System so both lenders and borrowers can be better off.

Bank Loans Create New Capital

When a Bank gives a loan, it creates New Capital. The following expands on the above.

Capital is money provided by one party to another for the purpose of creating more money. Banks are licensed to create loans without using existing money. When it does this, it creates new money mainly for investment.

Negative Reciprocal Loans are where the lender keeps ALL the interest and does not share the interest with borrowers, even if the borrower takes the larger risk and expends more effort to pay the interest than the Bank.

Balanced Reciprocal Loans address this misbalance between the Bank and the borrower by allowing for continual adjustment with each repayment depending on the interest and costs on each repayment. The result is Balanced Reciprocal Loans, lower-cost and equitable Capital transactions. Without it, lenders collect unearned income, meaning they collect money from borrowers or customers that, in a fair transaction, should have gone to the borrower. This distorts the financial system and is the main reason for the drop in productivity as a society gets wealthier and for the gross disparities in wealth in societies ever since the invention of money.

When an individual or a group amasses wealth, it remains stagnant as it is not re-invested to generate further wealth. It is stored until it is sold. For example, the increased value of already owned properties does not increase society's wealth. Rather, it stores wealth and limits the availability of the wealth for investment. This leads to a paradoxical situation where wealth accumulation leads to a decline in productivity.

Balanced Reciprocal Loans operate so that interest payments made by the borrower are a new transfer of value from the borrower to the lender. The borrower should receive a return to cover the difference between projected and actual operating and opportunity costs. Before the interest payment, there was risk payment and opportunity cost. Both have been satisfied by the interest payment. The money transfer in the interest payment is a new transfer of value and should be reciprocated. The sharing might be money. Alternatively, it can reduce the balance of money owed. The approach curbs asset and money inflation and boosts the funds for investment.

With interest on Bank Loans, a first approximation to sharing is to assume 50% of the interest charge covers the probability that the borrower will not repay the money, and the other 50% is the cost of administering the loan and the lost opportunity costs. When the borrower pays interest, the Balanced Reciprocal Loans remove 50% of the interest from the Capital owing to make the adjustment. In practice, the 50% will vary depending on the financial environment and actual costs, including changes to the Reserve Bank Interest Rates.

Sharing Interest on Loans

Assume a Bank gives a loan to a buyer of an existing home. The money is almost certain to be paid back because the Bank has a mortgage on the house. The Bank only needs a fraction of the interest to cover the costs of a house mortgage. The following assumes 25% of the interest goes to the Bank, and the remainder goes to the borrower. The percentage can be recalculated at each payment. Importantly the total interest is collected and given to the Bank. The sharing happens because the interest payment has reduced the risk and costs to the lender. It means the loan is repaid in a shorter time or the repayments are lower over a longer time. This is a productivity improvement.

Savings to the borrower of sharing interest.

Banks don't have to retain all the interest as the Bank has few costs on each mortgage. It is no wonder that Banks in Australia give loans for existing housing instead of loans for new products because the extra money paid by the borrower without sharing is unearned income to the Bank.

Increasing Interest Rates without punishing Households

Reducing the payback time by ten years

The Reserve Bank could require regulated Banks to share the interest on existing mortgaged houses. This would reduce inflation and direct loan funds to investments in new production — particularly new houses. The Banks would still get the same interest but not get unearned interest on a given loan.

If the Reserve Bank needed to increase interest rates to reduce inflation, they could require borrowers to reinvest their share of the increased profits in productive investments like infrastructure. The Reserve Bank has the power to do this because it is the government’s money the Banks are lending under license from the government. Sharing interest will make the Reserve Bank more productive and set an example for others in the financial system.

Sharing the interest rates makes a dramatic difference in the productivity of Capital. Banks loans with sharing for existing houses will transfer existing assets for less cost. The next section describes how everyone in the Community can own their home, and we can shift Capital from overpriced houses to new houses and other productive investments such as renewables.

If the Reserve Bank does not change the current unfair system, any Bank can do it unilaterally. The Bank will gain customers and increase its loans as borrowers pay less. The Bank will make the same profit but must make more loans (be more productive).

Community Capital and Affordable Housing

Self Regulating Community Capital is a financial arrangement where a group of households combine their homes into a single structure and distribute shares to each homeowner and investor based on the value they contribute to the entity. Shares are attached to any dwelling an investor occupies.

Rather than the shares earning dividends, the entity creates and distributes new shares as the entity assets increase. The assets remain in the entity when the holders buy and sell shares. The Capital self-regulates as it always matches the value of the assets in the entity and changes the number of shares continually and incrementally rather than changing the share value.

To create a fixed price market for shares, each year occupiers buy shares of value 12.5% of their yearly disposable income or an upper limit based on the value of their property, whichever is the least. The shares are in the home occupied. The occupier also pays the same amount to cover the operating costs of the enterprise, like bookkeeping, maintenance, insurance and other costs the enterprise specifies.

To create the other side of the market each year, all existing shareholders agree to sell 5% of their shares. The shares are at a fixed price. If there are no buyers, the shares remain for sale. If the shares are in the house they occupy, an arrangement can be made for the shares to be automatically repurchased by the same occupier. As there are no charges for buying and selling shares, and the shares are at the same price, there are no tax implications or charges. It accommodates the changes in income of many households. It allows occupiers to incrementally sell the dwelling where they live and adjust their payments to accommodate other financial changes.

The entity itself can buy and sell shares, and any increase in asset values results in the entity acquiring shares. In contrast, a decrease may result in the entity having a negative balance that the shareholders will resolve at the earliest opportunity.

Each month the value of homes on the open market is estimated. This is added to the net balance of other assets and liabilities, and each occupier and investor's total number of shares in the entity is adjusted. Profits are not distributed as cash but are distributed as additional shares for which there is a ready market. Importantly, the number and value of shares always equal the value of assets held by the enterprise and its members.

The rules for each group of houses can change. The ones outlined above ensure there is a market for shares, a fixed price, a return on investment as shares that have a ready market, and no speculative return on financial assets like Capital gains without a corresponding increase in assets.

The financial benefits are many. There are zero financial costs of interest and no charges for buying and selling, as there is no change in asset ownership. Homes can combine and work on maintenance, insurance, and other bank or other loans. The liquid market for shares and normally a high return of extra shares means Community Capital is a convenient place to put spare cash. The shareholders and the entity can work together on projects like moving to renewable energy, garbage collection, and other community facilities.

The approach is expected to halve the cost of housing while leaving the prices about the same.

Self-Regulating Capital for an Efficient Economy

Most Capital Markets, such as Bank Loans, the Housing Market, and the Share Market, suffer from the inefficiency of unearned income. It comes about because of the duration of the relationship between the buyer and seller of Capital. The buyer of Capital may not repay it. The debt solution is accumulating a wealth buffer in case the buyer defaults. This approach proved advantageous for the seller, who held the initial Capital, and sellers continue to follow this practice. They ensured the laws and regulations favoured their interests by making society accept the unfair practice as normal.

The solution proposed here uses modern computing and communications technology to adjust the repayments to match the relative risks in the case of loans and to eliminate loans altogether in the case of housing and other long-lasting infrastructure like Community Batteries and the electricity system. With regular companies, we can replace stock markets by sharing profits with customers, described in A Self-Regulating Efficient Monopoly.

The approach increases Capital Productivity, and the resulting savings are distributed amongst investors, consumers, and government regulators, allowing everyone to reap the benefits. Speculators and predatory capitalists will experience a gradual decrease in their static wealth but not their income. With the government's example of regulating Banks to share interest, many local communities will adopt the approach and release existing Capital to combat humankind's existential threats.

What Can Australians Do to Increase Productivity?

We have been told repeatedly that to increase our standard of living and address existential threats, we must become more productive, and we are told untruths on why productivity is dropping.

The reasons why wages are going down and prices are going up are NONE of the following.

  • the war in Ukraine,
  • the lack of innovation,
  • the decrease in worker productivity,
  • the excesses of bureaucracies,
  • the waste of resources through excessive regulation,
  • or that other people in the world work for lower wages.

Productivity is low because the system moves Capital to people who accumulate it by taking other people’s efforts and give nothing in return. The system allows some to claim someone else’s earned income as their own.

One place to start is to protest the Reserve Bank’s interest increase without giving borrowers their share of the increase. The Reserve Bank could require Bank home loans on existing houses to share 75% of interest charges with borrowers. The other change is to support people working together to get collective loans, keep Capital within local communities, and reduce the number of absentee landlords who extract money from communities.

By sharing Capital, the cost of buying a home in Australia will drop by half and home investors will get an annuity stream of income that will last twice as long as Super Funds allocated pensions. These productivity improvements come from making the financial system more efficient and eliminating “unearned income”.

By sharing Capital, Australians can “rewire their buildings” from the released funds from lower-cost housing, and governments can accelerate the change to a zero-emissions society.

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Kevin Cox

Kevin works on empowering individuals within local communities to rid the economy of unearned income.