Counting on interest is good, thinking ahead is better

Interest is an integral part of a modern financial system. How is it used to overcome crises?

The way interest affects economic conditions depends on individual decisions and social conditions. Usually, the higher the risk, the higher the interest rate.

Take farming as an example: in good times with good harvests, farmers can obtain capital for the purchase of new machines at low interest rates. But if the risk increases, investors are no longer willing to provide money because they might lose part of their capital. If, however, a higher interest rate is offered, investors will make a loan.

Worsen crises? Encourage more growth?

The worse a company situation becomes, the more it has to pay for loans. This applies not only to individual companies, but also to entire states. After the financial crisis of 2008, the interest paid by Greece – a country in deep crisis – to finance its state debts rose sharply. This placed the country under even greater pressure.

Such an interest rate mechanism has a reinforcing effect on the respective economic situation: crises are intensified, prosperous conditions are further improved. This is understandable since investors are not interested in taking higher risks for the same returns. 

Does it have to be so? Of course, it cannot be a matter of keeping every company and every initiative artificially alive through concessions. On the other hand, there are crises that are there to be overcome and so lead to new developments. Would it not be more appropriate in such cases to support, rather than to complicate? Is this at all conceivable?

To escape the fray and counter the mainstream.

It can be different

In a time when people need to make their own choices, to demand a certain type of behaviour is wrong and to do so will not therefore lead to the goal. But what happens when people become interested in the motives and ideas of an initiative and when they combine their financial commitment with their own further development?

The experience of the Free Community Bank shows that there is a different tendency in such cases. In crisis situations, such people frequently grant interest rate reductions and risk premiums are rarely called for. But they do want to know how the crisis is to be overcome. Without such a perspective, they reclaim their money.

Follow the market or act autonomously

When a business is successful, borrowers are able to pay a higher interest rate to their sponsors, enabling them to participate in its success. The same is true for market interest rates: in high interest rates, creditors are often ready to give up some of their interest, since they not only take into account the situation of the market, but also the individual situation of the initiative they are funding. But it is also often the case that, in times of low market rates, loans advanced by interested parties enjoy interest above the market price.

Overall, this results in both more stable interest rates and more stable initiatives. This benefits everyone.

What does it take for interest rates to develop in this way? 

1. Transparency: Lenders need the opportunity to perceive the project they are funding and its initiators in order to come into a relationship.

2. Value and importance: The social value and the importance of the funded project must be tangible and comprehensible to the lender.

3. Scope: Both creditor and debtor need to be able to shape the terms of money use on their own responsibility.

What seems unrealistic in large contexts is manageable in more direct circumstances – namely, to take individual circumstances into account and to consider the possibilities the concerned parties have to affect economic decision-making.

 

Max Ruhri 

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