Interest rate controls
One of the oldest forms of bank regulation consists of laws restricting the rates of interest bankers are allowed to charge on loans or to pay on deposits. Ancient and medieval Christians held it to be immoral for a lender to earn interest from a venture that did not involve substantial risk of loss. However, this injunction was relatively easy to circumvent: interest could be excused if the lender could demonstrate that the loan was risky or that it entailed a sacrifice of some profitable investment opportunity. Interest also could be built into currency-exchange charges, with money lent in one currency and repaid (at an artificially enhanced exchange rate) in another. Finally, the taint of usury could be removed by recasting loans as investment-share sale and repurchase agreements—not unlike contemporary overnight repurchase agreements. Over time, as church doctrines were reinterpreted to accommodate the needs of business, such devices became irrelevant, and the term usury came to refer only to excessive interest charges.
Islamic law also prohibits the collection of interest. Consequently, in most Muslim countries financial intermediation is based not on debt contracts involving explicit interest payments but on profit-and-loss-sharing arrangements, in which banks and their depositors assume a share of ownership of their creditors’ enterprises. (This was the case in some medieval Christian arrangements as well.) Despite the complexity of the Islamic approach, especially with regard to contracts, effective banking systems developed as alternatives to their Western counterparts. Yet during the 1960s and early ’70s, when nominal market rates of interest exceeded 20 percent in much of the world, Islamic-style banks risked being eclipsed by Western-style banks that could more readily adjust their lending terms to reflect changing market conditions. Oil revenues eventually improved the demand for Islamic banking, and by the early 21st century hundreds of Islamic-style financial institutions existed around the world, handling hundreds of billions of dollars in annual transactions. Consequently, some larger multinational banks in the West began to offer banking services consistent with Islamic law.
The strict regulation of lending rates—that is, the setting of maximum rates, or the outright prohibition of interest-taking—has been less common outside Muslim countries. Markets are far more effective than regulations at influencing interest rates, and the wide variety of loans, all of which involve differing degrees of risk, make the design and enforcement of such regulations difficult. By the 21st century most countries had stopped regulating the rate of interest paid on deposits.