Gross Interest and Net Interest

Gross Interest and Net Interest

In common language, interest is a payment made by a borrower of the lender for the use of money and is expressed as a rate per cent per year. But the economics,  interest is defined  differently by different economist. According to Carver, ” interest is the income which goes to the owner of capital.”

Marshall defines interest as “” the price paid for the use of capital in any market.” For Wicksell, interest is ” a payment made by the borrower of capital by virtue of its productivity, as a reward for his ( the capitalist’s ) abstinence.” Keyanes regards interest as a purely monetary phenomenon and defines it as the  ” premium which has to be offered to induce people to hold their wealth in some form of other than hoarded money.”

 

Gross Interest:

The whole of amount paid by a borrower to the lender for the use of borrowings is called gross interest.The payment made exclusively for the use of capital is called net or pure interest. Grooss interest is a broader concept while net interest is a narrow concept. Besides net interest, gross interest also includes many other payments, such as those made for inconveniences and risks involved in the lending activities. Thus , according to Chapman, ” Gross interest includes payment for the loan of capital, payment to cover the risk of loss which may be ((a) personal risk or (b) business risk, payment for inconveniences of the invest and the payment of work and worry involved in watching invest.” Similarly, in the words of Chapman,” Gross interest includes payment for the loan of capital, payment to cover the risk of loss which may be (a) personal risk or (b) business risk, payment for  inconveniences of the investment and the payment of work and worry involved in watching investment.” Similarly, in the words of Chapman, ” Net interest is a payment for the loan of capital, when no risk, no inconvenience ( apart from that involved in saving) and no work is entailed on the lender”

 

Constituents of Gross Interest

Gross interest includes the following five elements:

1. Net Interest

2. Reward for Risk

3. Reward for Inconvenience

4. Reward for Management

5. Reward for Changing value of money

 

1. Net Interest : Net Interest is the payment made purely for the use of capital.

2. Reward for Risk: The act of lending involves risk a part of the interest received by the lender is a reward for this risk.Greater the risk involved in a loan, higher will be rate of interest and vice versa. Risk can be of two types:

    a) Personal Risk:

         The borrower may refuse to pay back the borrowed money.

b) Business Risk:

The borrower may experience losses in the business and thus may not be able to repay    the loan.

3) Reward for Inconvenience: A lender lends money for a period of time and cannot demand repayment during the period. Thus, he faces inconvenience because he is not able to get his money back as and when he needs it for his own use.Even  at the time of recovery, the money lender has to pursue the borrower and remind him and again to get the money back. Thus, the money lender includes the compensation for such inconveniences in the rate of interest and vice versa.

4) Reward for Management :   The lender has to spend money and energy on the management of the loan. He has to maintain a separate account for every borrower and may have to employ clerical staff for this purpose. Hence, gross interest must include some compensation for all such management expenses.

5) Reward for Changing value of money: During the period of rising prices, the purchasing power of money falls and the lender loses. To compensate for such a loss, high rate of interest may be demanded by the lender.

To Sum Up:

Net Interest = Payment for the use of capital

Gross Interest = Net Interest + reward for risk + reward for inconvenience + reward for management + reward for changing value of money.

Gross Interest and Net Interest

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Gross Interest and Net Interest

Gross Interest and Net Interest