Student Loans – A Legally Unfounded Business?

Student “loans“ are not loans in the legal sense. According to the legal concept of loan, the essential characteristic of a loan lies in entrusting capital for a specified period in return for payment of interest so the other party can use it for its own ends. It is thus an unconditional prerequisite of the granting of a loan that the party granting the loan (creditor) makes certain assets (capital) available to the party receiving the loan (debtor), thus renouncing the right to dispose of the relevant assets for the specified timeframe. With student “loans“, the situation is quite different. To be sure, the bank grants the student something that the student can dispose of within the defined period; but what the student can dispose of is not an asset which has been transferred by the bank because – and this is crucial to understand – what the student disposes of did not exist prior to the “loan“ agreement with the bank. What the “borrower“ is granted by the bank is not money in terms of something with legal tender status (notes, coins) – it is so-called book or fiat money. In and of itself, book money is not legal tender, it is a claim for legal tender in the form of deposits in a bank account. Ultimately, those deposits are created by a mere booking process within the bank’s computer system whereby the bank books the “loan“ amount as debt twice in its balance sheet: once as a claim against the client on the asset side of the balance sheet, once as a liability towards the client on the liabilities side of the balance sheet.

Contrary to what is commonly believed in business and politics to this day, the granting of “loans“ through commercial banks does not transpire based on its clients‘ savings. “Loans“ are granted by the bank crediting the “loan“ sum as so-called “demand deposit“ to the client’s current account after the client has agreed to the transaction by signing the contract. Thus, the creation of the “loan“ sum takes its origin solely from the client’s willingness to enter into a “loan“ agreement and therefore, to pay interest on something that did not even exist prior to the contractual agreement. The notion that banks proceed in the manner described when granting “loans“ is not – as many polemically state – an unfounded theory, as is not least revealed in a recent study by economics professor Richard Werner (“Can banks individually create money out of nothing? – The theories and the empirical evidence“, 2014), that provides empirical evidence for the above-described booking process through banks, i.e. the creation of money “out of thin air“.

Student “loans“ do not qualify as loans because when a bank grants a “loan“, it does not transfer any capital to the client; it merely credits an amount to the client’s account. If student “loans“ were genuine loans, the bank would book the “loan“ sum as debt only once, as a claim against the client on the assets side of the balance sheet. This, however, is not the case. As money that is created out of thin air, i.e. that comes into being as a result of a “loan“ agreement, there is no legal foundation for student “loans“ whatsoever. For, what happens when a bank grants a “loan“ is merely an exchange between the student’s debt towards the bank (the signed “loan“ agreement in terms of a security paper) and the bank’s debt towards the student (the book money credited after signing the “loan“ agreement). The debt claims, then, balance each other out. Since students seeking a “loan“ do not receive anything from the bank in the strict sense of the word, there is nothing to owe to the bank either. It follows that, legally speaking, there is de facto no legal basis for banks to claim either “repayment“ of the “loan“ amount nor payment of any interest that go with it. It is nothing more than a tacitly accepted convention.