Banking has been around in one form or another throughout recorded history, as issuers of currency and as stores of wealth. Even before currency emerged, starting with the first minted coins, and then adding what were known as banknotes, paper currency, banks still were around to manage the accumulation of assets.
In order to manage an empire for instance, even the earliest ones, some form of banking was required to manage trade and keep the flow of goods and services moving both within the empire and to other empires.
Once currency emerged, this made this exchange of value much easier and efficient, and now one could simply trade things like coins or gold for other goods. You can’t have any form of currency without banking to manage it, and even the mere issuing of it requires management by banks of some sort.
So the earliest incarnations of banks were central banks, operated by governments, to help manage their economies, although when most people think of banks they usually think retail banks, the places where they deposit their money and borrow money from. Central banks though are at the top of the banking hierarchy in an economy and provide management and oversight of the entire economy, so that individual banks can operate efficiently and prosper.
As banking evolved, the need arose for the populace to be served by banks at the retail level. As people accumulated wealth, in the form of currency, this money had to be stored somewhere, and one’s home wasn’t really the ideal place to do this at, especially if one had accumulated a significant amount.
In ancient times, temples typically performed this function, and in addition to storing money for others, and providing security to depositors, there is evidence to suggest that these temples also lent out money, although their function was primarily to store assets. We now had the makings of the first retail banking system, from which banks as we know today evolved from.
Most of the money lending during these times was performed by individuals, known as money lenders, which would be similar to what we could call loan sharking today, although this was typically the only commercial lending available.
Banks Become Institutionalized Under the Roman Empire
The Romans were the first culture to institutionalize banking, taking it from the temples to formal banks, backed by the full power of the law. The law was certainly on the side of the bankers in the early days, with non payment of debts a crime, as well as debts being passed along to one’s descendants, sometimes for several generations.
The money lenders still did a good business back then, but the retail banking of the Romans did provide some serious competition to them, although these banks tended to cater to commercial interests and others of more significant means, leaving the money lenders to deal with the common folk more.
This is a segmentation that we still see even today, with those of higher income and higher reputation having access to superior banking services, while those of lesser means and reputation being relegated to dealing with financial institutions with less friendly terms and a greater risk tolerance to match.
Money lending terms have always been all about risk, and the more risk that is involved or is perceived, the less favorable the terms, including higher interest rates to compensate for higher default rates.
While the organized banking developed by the Romans did fall along with their empire, the idea did persist though, especially the one where the power of law was used liberally to protect banking institutions. Banks could seize land upon non payment of debts, and while this isn’t always seen as a good thing by creditors, this and other powers were fundamental to allowing banks as institutions to become both secure and profitable, two necessary conditions for an effective banking system.
There is no other business that even comes close to being as much of a concern as potential bank failure, and even today people worry about that, in our very highly regulated banking environment. The regulations do help, but what’s even more important is a bank’s ability to preserve its assets in a reasonable manner, where potential losses are kept to an acceptable level, allowing the bank to at the very least remain solvent.
Few care about a bank’s liabilities, but the bank’s assets are their liabilities, and in essence when we have assets held on deposit at a bank, we are lending them money, and want to collect on this debt just like the bank wants to collect on their debts to others. So in protecting a bank’s ability to collect on their debts, we are protected in collecting their debts to us, and this is why affording legal power to banks is so necessary.
Banks Become Formidable Institutions
Over time, as banking really matured, and in particular became more efficient in managing both their assets and their risks, the rather harsh conditions of days of yore become lessened, and one no longer is subject to criminal prosecution for non payment of debts, nor are they passed on to one’s children, and one now has the ability to declare bankruptcy and invoke the protection of the law on their side.
The creditor debtor relationship of the Romans did serve the banking industry well though for many centuries. In subsequent times, institutional money lending was taken up by the Catholic Church, as we moved from the Roman Empire to the Holy Roman Empire. Money lenders still flourished, but were cast into disrepute by the Church for charging excessive interest rates, the sin of usury, rates which were generally much higher than the Catholic Church charged.
Banks as institutions grew in power and scope over the years, to the point where they grew to be large enough to lend money to entire kingdoms. Many of these kingdoms borrowed very heavily, even to the point of bankruptcy, as was the case with Spain in the 16th Century. Sometimes a bank would lend to both sides in a war, for example with the Rothschilds during the Napoleonic War between France and England.
Needless to say though, when countries such as this are indebted to you, and very heavily at that, this does convey quite a bit of power to the banks, although this can often be overstated, and even lead to conspiracy theories where the bankers are calling all the shots. This may have been the case at one time, but public debt no longer is held in the hands of a few anymore, being instead held by the public for the most part.
The Free Market and Modern Banking
Modern banking as we know it today had its roots in the laissez-faire philosophy of British economist Adam Smith, who advocated for a much more free market approach to banking, being ruled more by the “invisible hand” of market forces.
This was around the time of the American Revolution, and the young country was eager to adopt this more market centric approach to banking, in spite of it leading to an alarming number of bank failures in the early years.
The American government came to the rescue, as it was clear that banks did need a helping hand at times to be able to meet business demands. At the time, the banks themselves issued all of the currency, and one simply lost all their money if the bank they had money at went under, not only their deposits but their currency as well.
The national bank permitted people to exchange their banknotes from member banks though, and this provided a lot of extra security and confidence, and back then this was the biggest issue, because a run on a bank when depositors get alarmed could itself spell the death of a bank.
Eventually, bank issued banknotes were replaced by the national currency entirely, which is the case today, where the American Dollar is the only legal currency in the country, as well as the most predominant currency in the world.
Banking lacked proper regulation though in those days, and the successful banks that grew very large would often become heavily involved in other industries, such as J.P Morgan’s involvement in several very large businesses. This led to anti-trust law being created to protect against the restraint of trade that often emerges with these relationships, where markets become restricted and normal market forces are not permitted to flourish.
In 1907, a financial crisis was averted by the actions of Morgan, who wielded such enormous power that he was able to successfully do so single handedly. This disturbed some people, which led to the creation of the Federal Reserve in 1913 as an overseer of banks as well as the economy.
Contrary to popular belief, the Federal Reserve is not purely a government institution, it is a more like an association of bankers, operating under the power granted to them by Congress, and it is subject to their oversight at least somewhat. Member banks own the Federal Reserve though, not the government, and even collect dividends from their shares in it.
The main Federal Reserve and its 12 regional Federal Reserve banks do serve to provide a lot more stability to the economy and the banking system that would be otherwise possible if this were just left up to the market. A major goal of economic management is to blunt normal business cycles, and in particular, to ease downward forces, and the Fed does do a pretty good job of this, although cycles do happen in the economy of course.
Other countries have central banks as well, and while the market does operate at least somewhat efficiently, it is often necessary to actively manage the economy and the money supply, to keep both the banks and the people happy.
Banking has come a long way from the days of agricultural goods as deposits in ancient times, and is now very tightly regulated and organized, inspiring a lot of confidence, something that is absolutely necessary where banks are concerned.