Hushed tones, cool marble counters, the smell of cash, pens chained to tables with blank deposit slips, solid steel doors with impressive locks, velvet-lined cords directing customers to the appropriate teller—a bank is an important place. Banks are everywhere. In the time it takes to walk from one Starbucks to another, you’ll pass at least a few banks! From small towns to large cities, the ubiquity of banks reveals their importance to the economy. Much maligned of late, banks are an integral part of the economy. Without them, capitalism would not function.
The roots of banking can be traced to the earliest civilizations. The Egyptians and early societies of the Middle East developed the prototype upon which modern banking is based. Agricultural commodities were stored in granaries operated by the government, and records of deposits and withdrawals were maintained. Ancient civilization introduced the moneychangers, who would exchange currency from different countries so that merchants, travelers, and pilgrims could pay taxes or make religious offerings.
In the Renaissance era, Italian city-states were home to the first banks, which financed trade, the state, and the Catholic Church. In order to avoid the Church’s prohibition against usury (charging interest), the bankers would lend in one currency but demand repayment in another currency. Profit was thus earned by using different exchange rates at the time the loan was made and when it was repaid. The successes of the Italian bankers induced a spread of banking further across the continent. In England, goldsmiths were responsible not only for storing gold and issuing receipts, but also for developing what is now termed fractional reserve banking. By issuing more receipts than there was gold on deposit, the goldsmiths increased the profit potential of the banking industry.
From the time of the American Revolution to the Civil War, the United States saw an expansion of relatively unregulated banking that helped finance the growth of the young republic. Modern banking in the United States traces its origins to the National Bank Act of 1863, which gave the government a means to finance the Civil War.
Banks serve a variety of functions in the economy. They act as safe places for people to store their wealth, they help to facilitate trade by providing alternative methods of payment, but most important, they bring together savers and borrowers. Each of these functions is critical to the smooth operation of the economy.
In John Locke’s Second Treatise of Civil Government, he observes that in order for people to enjoy their private property, they must be secure in that property. Thomas Jefferson paraphrases Locke in the Declaration of Independence when he states: “they are endowed by their Creator with certain unalienable rights, that among these are life, liberty and the pursuit of happiness.” What Jefferson refers to as happiness, Locke refers to as property. Although Locke and Jefferson were not referring to banks, but governments, banks do serve an important security function. When you know that your private property is secure, then you are better able to enjoy your freedoms.
Historians trace the development of the check to the Knights Templar and Hospitallers, who used signed documents in order to transfer wealth among their orders’ houses.
By providing their customers with check-writing privileges, debit cards, credit cards, and cashier’s checks, banks help to facilitate trade. With multiple means of access to stored wealth, consumers are able to make purchases more often and in more places. This allows businesses to employ more land, labor, and capital, which in turn results in a fully employed economy.
Acting as a go-between or intermediary between savers and borrowers is probably the most important function of banks. Banks induce people to save their money by offering to pay interest. These savings are then lent to borrowers at an interest rate higher than that paid to savers, allowing the bank to profit. The saver benefits because he earns interest on a safe and relatively liquid financial investment without having to evaluate whether a potential borrower is a good risk. The borrower benefits by having access to a large pool of funds. This is important to the economy because borrowers can now purchase durable goods or invest in capital or housing, which creates jobs and leads to economic growth.