Loans

Loans

BIBLIOGRAPHY

A loan is a type of debt. In general, a loan refers to anything given on the condition of its return or the repayment of its equivalent. All material things can be lent, but the most common type of loan is the monetary loan. Like all debt instruments, a loan implies the redistribution of financial assets over time between the lender and the borrower.

In a monetary loan, the borrower initially receives an amount of money from the lender, which he pays back, usually in regular installments. This service is generally provided at a cost, referred to as interest on the debt. The provision of loans is one of the principal tasks of financial institutions. A loan also may be acknowledged by a bond, a promissory note, or a mere oral promise to repay.

The concept of loans dates back to the very old ages of the agricultural era, when people had started living in organized societies. However, it developed and became widespread with the use of money. Because of biblical injunctions against usury, the early Christian church forbade the taking of interest. In feudal European society, loans were little needed by the great mass of relatively self-sufficient and noncommercial farmers and serfs, but kings, nobles, and members of the church community borrowed heavily for personal expenditures. The role of the moneylender was undertaken back then by merchants and other townsmen, especially the Jews, while various devices were found for circumventing the prohibition of usury.

The development of money lending among the Jews as their almost exclusive occupation began in the twelfth century, and it was probably the consequence of the persecutions during the First Crusade; Jews at this time could not own land or vineyards, so money lending was one of the few occupations open to the Jews as a means of livelihood. In addition, the Catholic Church’s prohibition against money lending for Christians provided Jews with a unique opportunity to step into this void in establishing themselves as bankers. The laws regarding pawn-broking also became increasingly more detailed. During the Middle Ages, local rulers prohibited Jews from occupying most professions, so they were pushed into marginal occupations that were considered socially inferior, such as money lending.

Historically, attacks on usury have often been connected with anti-Semitism. Moreover, Judaism has been a more lenient religion with respect to lending than other religions. The Torah and later sections of the Hebrew Bible criticize the taking of interest, but interpretations of the biblical prohibition vary. One common interpretation is that Jews are forbidden to charge interest upon loans made to other Jews but allowed to charge interest on transactions with non-Jews. However, the Hebrew Bible itself gives numerous examples where this prohibition was evaded. Moreover, legislation concerning the Jews recognized the rabbinical law. According to the latter, for instance, a Jew who had advanced money on a stolen article was entitled to recover the amount he had loaned for it, including interest, if he could swear that he did not know it had been stolen.

By contrast, many religions prohibit the charge of interest. The most prominent example is that of Islam. Sharia, the Islamic law, does not allow the collection and payment of interest (riba ). However, as Maxime Robinson demonstrates in his book Islam and Capitalism (1974), even the Islamic prohibition of usury and other kinds of transactions was no barrier to the continuation and elaboration of pre-Islamic capitalistic practices. The Koranic revelation, therefore, did not bring into being an exemplary moral economic system that was fundamentally different from any other existing economic system. Thus, Islamic prohibitions on usury were circumvented with the establishment of Islamic banks. Islamic banks have the same purpose as conventional banks but are believed to obey the rules of Sharia. Islamic banking is based on the sharing of profit and loss and the prohibition of interest. According to a common practice used to lend money for a purchase, a bank might buy the item itself from the seller and resell it to the buyer at a profit while allowing the buyer to pay for it in installments. To protect themselves against default, Islamic banks retain ownership of the item until the loan is paid.

The United States has an old tradition of lending. Americans have long relied on credit, which, for day-to- day matters, typically took the form of charge accounts with local retailers. In the early years of the United States, when it was primarily an agrarian society, income for many people rested upon when the crops were harvested and sold. Credit and charge accounts, rather than the more structured repayment of an installment purchase, were more individual in nature, relying heavily on the personal relationship between the consumer and the retailer. Credit cards and other more modern and impersonal means of credit and charge-account purchasing became a fixture in the consumer-retailer relationship in the 1950s. However, even today the traditional, more personal and informal types of charge accounts do exist. Without extending some sort of credit to customers, many businesses in the past simply would not have been able to operate. Today’s modern means, the credit card, has greatly reduced the degree to which individual retailers personally extend credit to consumers. However, credit itself remains as essential to the retail economy as it has ever been.

The history of formal lending in the United States is also deeply related to the rise of homeownership in the lower socioeconomic classes. Formal lending, in terms of institutional lending, has long been the means by which many have been able to buy their own home. Before institutionalized lending that was accessible to those who were not wealthy, people relied on private loans or small, regional networks serving a particular ethnic or professional group. These types of lending situations, however, did not nurture and support homeownership in the same ways, or for as great a percentage of people, as does formal or institutional lending today.

The early types of formal mortgages were extended by insurance companies. The terms of these mortgages, however, were often quite risky for the borrower, with the balance of power distinctly tipped toward the lender in ways that would be deemed unfair and even predatory by today’s standards. Savings and loan associations also evolved, although they remained separate from traditional banks, which could offer checking accounts and other services, until the 1970s, when banking regulations changed. Once those regulations changed, savings and loan associations became almost indistinguishable from the typical bank of today, but their loan practices became the universal standard among many of today’s financial institutions. The practices have been revised continuously through the years by regulations meant to ensure that minorities and women were able to have equal access to fair lending.

Today, banks and finance companies usually extend loans against collateral, such as stocks, personal effects, and mortgages on land and other property. Credit activity is considered to be strongly correlated with consumption, and it is expanding due to the gradually decreasing savings rates of typical households. Financial institutions are the ones responsible for extending loans, and they make a large share of their profits out of this activity. The low penetration of loans to an economy, as is the case in the developing countries of central and southeastern Europe, attracts many foreign direct investments in those countries.

Bank loans and credit are considered to be one way to increase the money supply. Policymakers, such as many central bankers, take into account credit growth developments in their decisions about interest-rate movements. Another aspect of the internationalization of loans is the ability of the participants of economic activity—governments, companies, and households—to borrow from abroad under better terms and conditions.

Apart from those who have access to financial markets, the establishment of organizations such as the International Monetary Fund and the World Bank allow the provision of loans to countries experiencing economic problems. This financial assistance enables countries to encounter economic difficulties, reconstruct, and restore conditions for economic growth. Moreover, Muhammad Yunus of Bangladesh, who was awarded the Nobel Peace Prize for providing, through his Grameen Bank, small loans known as micro-credit to poor people without any collateral showed that loans can be accessible and provide support even to those who have no financial security.

SEE ALSO Banking; Banking Industry; Discounted Present Value; Equity Markets; Financial Instability Hypothesis; Financial Markets; Hedging; Leverage; Liquidity Premium; Microfinance; National Debt; ROSCAs

BIBLIOGRAPHY

International Monetary Fund. 2006. IMF Lending. International Monetary Fund, September. http://www.imf.org/external/np/exr/facts/howlend.htm.

Robinson, Maxime. 1974. Islam and Capitalism. Trans. Brian Pearce. New York: Pantheon Books.

Secor, Sharon. 2004–2006a. A Brief History of Formal Lending in the United States. Direct Lending Solutions. http://www.directlendingsolutions.com/history_of_lending.htm.

Secor, Sharon. 2004–2006b. Credit History: Before There Was Plastic … The Earliest Charge Accounts. Direct Lending Solutions. http://www.directlendingsolutions.com/history_of_credit.htm.

Tran, Mark. 2006. Pioneering Economist Wins Nobel Prize. Guardian Unlimited, October 13. http://business.guardian.co.uk/story/0,,1921726,00.html.

Eleni Simintzi