Interest

Interest, payment made for the use of another person’s money; in economics it is regarded more specifically as a payment made for capital. Economists also consider interest as the reward for thrift; that is, payment offered to people to encourage them to save and to make their savings available to others.

Interest paid only on the principal, that is, on the sum of money loaned, is called simple interest. Interest paid not only on the principal but also on the cumulative total of past interest payments is called compound interest. The rate of interest is expressed as a percentage of the principal paid for its use for a given time, usually a year. The current, or market, rate of interest is determined primarily by the relation between the supply of money and the demands of borrowers. When the supply of money available for investment increases faster than the requirements of borrowers, interest rates tend to fall. Conversely, interest rates generally rise when the demand for investment funds grows faster than the available supply of funds to meet those demands. Business executives will not borrow money at an interest rate that exceeds the return they expect the use of the money to yield.

In medieval Christendom and before, the payment and receiving of interest was questioned on moral grounds, as usury was considered a sin. The position of the Christian Church, as defined by St Thomas Aquinas, condoned interest on loans for business purposes, because the money was used to produce new wealth, but adjudged it sinful to pay or receive interest on loans made for purchase of consumer goods. Under modern capitalism, the payment of interest for all types of loans is considered proper and even desirable because interest charges serve as a means to allocate the limited funds available for loan to projects in which they will be most profitable and most productive. Islamic Shari’ah law, however, still regards interest as, strictly speaking, sinful, and in some Islamic countries legal provisions are made to replace interest with other rewards for thrift or investment such as shares in profits.