Private banks do not charge interest in respect of the money they issue.

There is a popular myth to the effect that the above is the case. The myth is promoted by among others, Positive Money, an organisation I actually support because PM gets many things right. Also Bryan Gould (former member of the UK Labour Party shadow cabinet) seems to lend credence to the myth.

The idea that private banks DO CHARGE interest in respect of the money they issue stems from the “loans create deposits” phenomenon: that is, when a bank makes a loan, it does not need to get the relevant money from depositors or from anywhere else. It can simply open an account for the borrower and credit $X to the account – the money comes from thin air. The bank then charges interest on the loan.

Thus banks do two things there: first, create money, and second, charge interest. Ergo, so it might seem, they charge interest on the money they have created.

The flaw in that argument is that banks either charge for the loan or for the money. They cannot charge for both. I.e. if a bank charges 5% interest, is that for the loan or is it the lucky recipient of the money who is charged?

Take the case of a loan for $X which is granted to Y, who then spends the money, which ends up in the bank account of Z. There is no doubt that Y pays interest to the bank. But Z, the recipient of the money doesn’t.!! If anything, Z charges his or her bank interest (or put another way, Z’s bank will pay interest to Z, particularly if the money is put into a term account.)

 
Double checking the argument.

By way of double checking the above points, consider an economy where there was no borrowing or lending, but people did (understandably) want a form of money. And let’s say that money is supplied by, or at least supplied almost exclusively by private banks.

Those banks would open their doors for business. Customers would ask to open accounts and would ask for some specific sum of money to be credited to those accounts to enable day to day transactions to be done. Banks would demand collateral as appropriate.

Certainly banks would charge for ADMINISTRATION  costs there (e.g. the cost of checking up on the value of collateral). But there would at that stage be no reason to charge INTEREST because no real resources would at that stage have been transferred by banks to customers.

Moreover, even after customers started spending their money, there would still be no very good reason for banks IN THE AGGREGATE to charge customers in the aggregate for interest. Reason is that money leaving one account must arrive in some other account. (To keep things simple, I’ll assume there is no physical cash – a not totally unrealistic assumption, given that it looks like physical cash will disappear in the near future.)

Of course where specific customers ran down their bank balances, and left them in a “run down” state for extended periods, banks would charge interest to those customers. But in that case, real resources would have been transferred to those customers for an extended period. That is, the only way for that “extended run down” to occur is for relevant customers to buy stuff off other customers and leave it at that. I.e. the latter “buyers” would in effect be borrowing from the latter sellers with banks acting as intermediary. Sellers, would understandably want interest, and that interest would be passed on to buyers.

 
Conclusion.

Banks charge interest on loans. They also charge for administration costs when supplying customers with day to day transaction money. But it would not make any sense for banks to charge interest simply for supplying all and sundry with day to day transaction money.