Interest

The concepts credit and interest have been around at least as long as currency and banking and it is not too difficult to trace their development.

The Sumerians, who lived in the middle-east, have provided historians the first systematic records reflecting the accumulation of interest. And the concept of returning something more than exactly what was lent was observed by livestock owners who lent possession of some of their stock for extended periods.  The herd of livestock would naturally increase in population through their husbandry so that some gain from the loan of that property was expected by these ancient tribal herders.

So you can see the idea of interest was around at a time long before there was banking and financial institutions. But money matters were handled differently in those days, often by religious edict and royal decree.  At first it was against the law to receive anything more than the original sum when money was lent.  But as commerce grew and sums became greater there was more to be gained, and lost, so that the value of money in relation to time was discovered. Ancient merchants quickly learned the impact risks associated with loss of capital could have on profitability and pushed for changes in the rules that would allow them to protect themselves against loss and to take advantage of healthy economic conditions. And changes did come about.

During the rein of King Hammurabi, 18^th century BC, the first regulations of interest, debt and extension of credit were developed. Payments through a local banker by drafts written against deposit (early checks) were frequent, bonds owed were treated as negotiable and merchants began to make business loans bearing stated interest in precious metal or grain. So far, so good; this all makes sense- or does it?

In the cases where the seller himself does not wish to get involved in the financing of the sale there is a business opportunity for a third party lender.  Think of the car salesman we talked about before.  If the car salesman cannot afford to, or will not elect to, extend the buyer the $20,000 for five years then there is the opportunity for another lender, a bank, for instance, to step in to lend the buyer the needed capital. But why would a lender want to do this?  Pretend you have a lot of money; so much that you have more than you need and can lend to others if you wished to.

A borrower comes up to you and asks you for $20,000 today for a car and sincerely assures you he can pay it all back completely in five years.  The borrower has a good job and is an honest, reliable person. Would you lend them the money?  Of course not!  Absent some political reason for doing this you’d never take the future risk of the inability of the borrower to pay you everything back when all you’ll get is what you already have securely right now.

You need something extra, a reason to take the risk of parting with your wealth or else you will not be inclined to do it.  That extra ingredient is called interest.