Q.Distinguish between gross interest and net interest.

Net interest (pure interest) is the payment made solely for the use of capital - the reward for lending money by itself. It is gross interest minus the charges for risk, management and inconvenience of lending. Gross interest = net interest + reward for risk + reward for management + reward for inconvenience.

Meaning

Gross interest is the total payment that a lender actually receives from the borrower. It is made up of several elements. Net interest (also called pure interest) is only that part of gross interest which is paid for the use of capital alone, excluding all other charges.

Gross interest and its components

Gross interest includes:

• Net (pure) interest - payment for the mere use of capital.
• Reward for risk-bearing - compensation for the risk that the loan may not be repaid.
• Reward for management/trouble - compensation for the work and inconvenience of lending and recovering the loan.
• Reward for inconvenience - compensation for parting with liquid money for a period. …

Net interest (pure interest) is the part of gross interest that is paid solely for the use of borrowed capital, leaving out the charges for bearing risk, for inconvenience and for the trouble of managing the loan. It is the pure reward of capital as a factor of production.

Meaning

When money is lent, the total payment received by the lender is called gross interest. Gross interest is made up of several elements:

• payment for the use of capital itself (pure or net interest),
• reward for the risk of possible loss of the loan,
• payment for the inconvenience of parting with money, and
• payment for the work of managing and recovering the loan.

Net interest is only the first of these: the payment made purely for the use of capital, after all the other elements are deducted. Thus:

Net Interest = Gross Interest minus (reward for risk + reward for inconvenience + reward for management).

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