Banking Origin and Development

While the true origins of banking are obscured by a lack of written records, many banking functions, especially moneylending and money changing, are as old as the earliest known civilizations. Five thousand years ago Sumerian priests were accepting deposits and making loans. Over the course of history, wherever trade developed, money changing became necessary and so became the business of specialists. In Rome during the republic and early empire eras, banks accepted deposits, made loans, and transferred funds on the basis of oral contracts. It was not until the 18th century that "modern" banking that is, banking as it is known today emerged fully.

MoneyLending and Money Changing

With the decline in trade that followed the fall of Rome, banking practically disappeared from the Western world. It remained very much alive, however, in the Arabic countries and in China, where paper money and checks were already being used in the 9th century. By the 10th century, funds were transferred through letters of credit over long distances, and bankers in Baghdad made loans to caliphs on the security of anticipated revenues. When European trade again began to thrive in the 11th century, banking, aided by the knowledge reimported from the Middle and Far East, reawakened. Like capitalism, the modern commercial bank developed in the Italian city-states of the Middle Ages and the Renaissance. It originated in the twin occupations of money lending and money changing. The religious orders and the Jews first made moneylending a thriving business. As early as the 10th century, monasteries that had accumulated a treasure from donations and rents were making loans to peasants, landowners, and the local nobility. Because these were consumption loans at very high interest rates (30% and often higher), they violated the church's rule against usury. This opened opportunities for the Jews who were not bound by the Christian prohibition against interest-bearing loans. Aided by a knowledge of banking and some capital brought from the Middle East, the Jews by the 11th century were handling most of this business.

Meanwhile, events in the monetary sphere brought back the ancient profession of money changing. During most of its history the medieval world suffered from a shortage of gold and silver and an oversupply of mints. Every major lord and some minor lords in Europe had the right to coin money. In an effort to increase their revenue, these masters of the mints kept reducing the silver content of their coins, and by the 11 th century, Europe was overrun by a multiplicity of debased coins. Because average citizens did not know the exact value of these moneys, they turned to the initiated for guidance. Soon money changers were going from fair to fair changing new coins for old, and domestic coins for foreign. In a short time they extended their operations to include moneylending and the solicitation of interest-bearing deposits.

Broadening of Services

By the middle of the 12th century the Jews, who were leading money changers and moneylenders, had begun to make business loans. Because the business appeared to be lucrative, powerful rivals soon ended the Jewish hegemony. By the middle of the 13th century the Italians from Lombardy had taken over the leadership. They sometimes had the privilege of minting coins. They could solicit deposits, which the Jews were often prohibited from doing. They also managed to get around the church's edict against interest. They did not make loans and charge interest but bought and sold bills of exchange payable in foreign currency. They were, therefore, merchants in banking who hoped by the difference in exchange to make a profit equal to the interest rate they would have charged for a loan. The bill of exchange was very old; it may have been used in Babylon, and a variant of it was used in Rome. The Genoese either developed it independently or brought it back from the East at about 1150, but it was not widely used until after 1350.

The Italians had another immense advantage: they were ideally situated to act as bankers to the church the most important bank customer ot the day The church's Curia collected revenues all over the Christian world. At first the complications of collecting and changing money and converting payments in kind were handled by ecclesiastical officers. But by the early 13th century bankers from Siena were lending to German church members, and in 1233 they became fiscal agents for the papacy. This was a great windfall, for the deposits that were credited to Rome often remained with the same banker for many years.

Hazards for Banking Families

Banking was immensely profitable in the short run, but it was also a hazardous occupation, with ultimate disaster an odds-on chance. In 1298 the Bonsignori, the largest Siena banking house, failed and carried the whole city with it, but Florence was already waiting to pick up the pieces. By 1338 Florence had 80 important banking firms, of which the Bardi, the Peruzzi, and the Acciaiuoli were the most important. The Bardi, the largest, had 15 partners, and employed at least 100 clerks in branches that stretched from Cyprus to London. All three houses extended large credits to European sovereigns. In the 1340s the "big three collapsed when they could not collect the debts owed by Edward III of England and by Robert of Naples.

Once again there were families eager and ready to fill the void left by wholesale bankruptcy. Of these, the Medici (1397-1494) were the most famous, although they were never as big as the Bardi or the Peruzzi.

By the time of the Medici, rivals were beginning to appear in other countries. In France the fabulous Jacques Coeur (1395-1456) is said to have amassed a fortune before he went broke because his royal debtors defaulted. In the Low Countries the Louchart and Cresping families did well. But the most successful of all the medieval bankers was the Fugger family of south Germany. They were the money power behind the house of Habsburg as well as the successors to the Medici as fiscal agents for the Curia. At one time the family is reputed to have been worth at least $50 million but with the fall of the Holy Roman Empire, which they had done so much to maintain, the house disappeared from the business world.

Peculiarly enough, none ot the great medieval banking families contributed any major innovations to finance, although Jakob Fugger was an extraordinary innovator in general business administration. Checks, which are bills of exchange payable on demand, appeared as early as 1374, but they were not used on any broad scale until much later. Similarly, endorsements were used occasionally, but not commonly until after 1600. The innovations in banking during the time of the Medici came through the formation of the first public banks, the so-called exchange banks or transfer banks, the first of which was the Bank of Barcelona (1401). Similar to modern clearinghouses, these banks were created to eliminate abuses that had developed in money changing. Theoretically, an exchange bank could not make loans, but this edict was often violated. The Casa di San Giorgio in Genoa (1407) made short-term loans to the government. The Banco della Piazza di Rialto in Venice (1587) was very similar to a private bank. The Amsterdam Wisselbank (1609) made loans to the East India Company. The Bank of Hamburg (1619) had a twin that made loans on merchandise collateral.

Advances in the 17th and 18th Centuries

By the end of the 16th century and during the 17th, the traditional banking functions of accepting deposits, moneylending, money changing, and transferring funds were combined with the issuance of bank debt that served as a substitute for gold and silver coins. These new banking practices promoted commercial and industrial growth by providing a safe and convenient means of payment and a money supply more responsive to commercial needs, as well as by "discounting" business debt. The new practices also served to accommodate the exploding financial requirements of Europe's relatively new and combative nation-states. By the end of the 17th century, banking had taken on a public importance that made government legislation necessary, and which planted the seeds for government-affiliated central banks.

Many of the significant changes in banking techniques occurred in the early 1600s in the thriving money markets of Antwerp and Amsterdam. They developed a little later in London, with a permanent success that influenced banking development elsewhere in Europe and the United States.

The principle elements emerged in the operations of London goldsmiths in the latter half of the 17th century. The activities of these artisans had been confined mostly to buying, selling, and working with silver and gold plate, under the auspices of a guild with the corporate title of the Wardens and Commonalty of the Mystery of Goldsmiths of the City of London.

Contemporary accounts indicate that merchants ceased to keep their cash in the Royal Mint when, in 1640, King Charles I appropriated £200,000 of private money from the mint. Merchants subsequently found that they could not trust their own clerks to hold their money, and they therefore turned to the goldsmiths as a safe depository.

The goldsmiths soon found themselves with money for which they had no immediate use, and they began to lend the money out at interest to both the merchants and the government. Finding substantial profit in this business, they began to solicit deposits and pay interest on them. The goldsmiths eventually discovered that the deposit receipts they provided were being passed on from one person to another in lieu of payment in coin, which prompted them to begin lending paper receipts rather than coins. By promoting acceptance of the receipts as a means of payment, the goldsmiths discovered they could lend more than the gold and silver coin they had on hand, a practice that became known as holding fractional reserves. The new "mystery" of the goldsmiths, as a contemporary pamphleteer noted, was banking.

These novel commercial practices created a new kind of "money" that was actually debt, that is, goldsmiths' debt rather than silver or gold coin — a commodity that had been regulated and controlled by the monarchy. This development required the acceptance in trade of the goldsmiths' promissory notes, payable on demand. Acceptance in turn required a general belief that coin would be available; and a fractional reserve normally served this purpose. Acceptance also required that the holders of debt be able legally to enforce an unconditional right to payment; it required that the notes (as well as drafts) be negotiable instruments. The concept of negotiability had emerged in fits and starts in European money markets, but it was well developed by the 17th century. Nevertheless, an act of Parliament was required in the early 18th century (1704) to overrule court decisions holding that the gold smiths notes, despite the "customs of "merchants, were not negotiable.

Meanwhile, the credit of the British Crown had been diminished by default in 1672. The monarchy s urgent need for funds at rates lower than those charged by the goldsmiths, and the example of the public Bank of Amsterdam, which had been able to make an ample supply of credit available at low interest rates, led in 1694 to the establishment of the Bank of England. The Bank of England succeeded in raising money for the government at relatively low rates.

In 18th-century London the Bank of England had a monopoly over corporate banking, and even large partnerships were prohibited. But private banks, though relatively small, personal enterprises, continued to find profitable business in discounting merchants' bills. In the latter half of the century small banks in country towns grew rapidly in number and needed "correspondent" banks in London with which they could deposit and invest funds. The London banks in turn settled accounts in Bank of England notes, and by the end of the century many kept their own deposit accounts with the Bank of England.

The 18th century, especially in its later years, saw increased bank competition and the substitution of checking accounts for promissory notes. With close ties to the government and as the principal repository for bullion and coin, the Bank of England gradually emerged as a "central bank" and a lender of last resort. In the 18th century there were also periodic overissues of bank notes, suspension of specie payments, financial crises, insolvencies, and bank runs Experience demanded careful consideration of how much specie should be held in reserve, the value of notes to be issued, and the kinds of assets banks should hold: that is, experience led to the development of banking theory. By the end ot the century the basic configuration of modern commercial banking had taken shape.