Rate of interest

Interest is payment from a borrower or deposit-taking financial institution to a lender or depositor of an amount above repayment of the principal sum (i.e. the amount borrowed). It is distinct from a fee which the borrower may pay the lender or some third party.

For example, a customer would usually pay interest to borrow from a bank, so they pay the bank an amount which is more than the amount they borrowed; or a customer may earn interest on their savings, and so they may withdraw more than they originally deposited. In the case of savings, the customer is the lender, and the bank plays the role of the borrower.

Interest differs from profit, in that interest is received by a lender, whereas profit is received by the owner of an asset, investment or enterprise. (Interest may be part or the whole of the profit on an investment, but the two concepts are distinct from one another from an accounting perspective.)

The rate of interest is equal to the interest amount paid or received over a particular period divided by the principal sum borrowed or lent.

Compound interest means that interest is earned on prior interest in addition to the principal. Due to compounding, the total amount of debt grows exponentially, and its mathematical study led to the discovery of the number e. In practice, interest is most often calculated on a daily, monthly, or yearly basis, and its impact is influenced greatly by its compounding rate.

According to historian Paul Johnson, the lending of "food money" was commonplace in Middle Eastern civilizations as early as 5000 BC. The argument that acquired seeds and animals could "reproduce themselves" was used to justify interest, but ancient Jewish religious prohibitions against usury (נשך NeSheKh) represented a "different view". While the traditional Middle Eastern views on interest was the result of the urbanized, economically developed character of the societies that produced them, the new Jewish prohibition on interest showed a pastoral, tribal influence. In the early 2nd millennium BC, since silver used in exchange for livestock or grain could not multiply of its own, the Laws of Eshnunna instituted a legal interest rate, specifically on deposits of dowry. Early Muslims called this riba, translated today as the charging of interest.

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