The Evolution of Banking Systems
Banks. Love them or hate them; you must admit that they are necessary. If you listen to the news, you are constantly bombarded with the evils of the banking system—many rails against banks, demanding that they are broken up or more heavily regulated.
However, many do not realize that banks have been around even before the first currencies were minted. While they have become a more predominant part of society over the last 400 years, there is no doubt that they have played a significant role in society for 3000 years or more.
Let’s Understand What Banking Is Today
Before digging in too deeply into how banking has evolved, it is important to understand where it is today. When most of us think of the bank, the primary thing that comes to mind is the place where you store your money.
The vast majority of people use banks for two primary reasons, savings or checking. It serves two different purposes, safeguarding your money and acting as a payment processing centre. That payment processing may come in your writing checks or using some form of credit or debit card.
However, banks have evolved into much more than this. These days, banks also offer loan services and investment counselling. Even smaller credit unions or savings and loans offer these services. Banks have turned into a one-stop shop for assisting you with all your financial needs.
But how did it get this way? How did banks become such an essential part of society?
Where It All Began
There is a common belief that banking was one of the very first professions established. There is enough of a record to believe that banking actually began even before coins were created. That seems illogical, but there is some archaeological evidence that supports this belief.
It is believed that banking first began in ancient Mesopotamia as many clay tablets have been found that were used to record the transfers of property and assets from one party to another. The Code of Hammurabi (dated to about 1755 BC) provides significant detail regarding the banking industry. This has many believing that this was a flourishing industry that existed long before the code was written.
We like to believe that loans are a relatively new part of the banking industry, but records that point to letters of credit, interest, and loans date back to the world's first great civilizations. Instead of investors, lenders, or depositors putting money in the bank in some coin or currency, records were kept on tablets.
We are fond of believing that a completely digitized system without any hard currency is an innovation, but that was actually how they did business back then. While it was not digitized, as computers were not invented yet, there was no hard currency to pass from one person to another. Instead, all these records were kept on these clay tablets. The tablet then became the earliest form of bankbook, although a fairly heavy one to carry around.
In many of the earliest Egyptian writings, there are records regarding the deposit of grains by farmers. The amount of grain and their value were recorded as a form of “deposit receipt.” This gave the farmer a certain amount of wealth that could be used for other means, including purchasing equipment, paying taxes, or making donations to the gods.
The need for banking extended beyond the locality. As large civilizations grew, they began to trade with other great nations that surrounded them. This led to the need to have some form of reference for the trading of goods. It also helped to make many merchants, farmers, and traders quite rich. These men were able to make a lot of money trading between nations, and that money was deposited in a bank as recorded on the tablets.
The Rise of Hard Currency
While this system worked, as civilizations became advanced and spread across large areas, it became necessary to create a system where the value of a person’s assets could easily be ascertained and valued. This is where the need for hard currency developed.
A serious issue arose with the tablets. After all, if a person was carrying their tablet from the capital Assyria, Nineveh, to an outlying area or another nation, there were issues regarding how the amount recorded was valued.
The sensible way to rectify this problem was to create a currency worth the same standard no matter where someone travelled in the Empire. Coins were minted, with the first known coins appearing in 600 BC in Lydia, an ancient Greek city. The Greeks made this a common practice, helping to set a standard that is still used today.
However, it was the Romans who perfected coinage. The problem with the Greek system was that every major city-state had their own form of coin. This required some form of conversion to determine which coins were more valuable about the other, which may have been different from one city to another, maybe even from one person to another.
The Romans changed this, however. They created coins that were universally recognized at one standard value throughout their empire. Because Rome spread over an extensive amount of land, covering more than 5,000,000 km² at its height, this system worked perfectly. A person could be confident that their coin had the same value, whether they were in the capital city of Rome, Gaul, Britain, or Alexandria.
The Romans did far more than developing a universal coin system. They are actually credited with creating the first bank building. Before this, many banking services were conducted through the temples, which was one of the primary reasons they were raided by invading armies. It was where all the money was kept.
The Romans created distinct buildings. This allowed customers to deposit funds, obtain loans, and make payments and enabled the Roman government to use it to collect taxes and store their own assets. Julius Caesar even used banks to seize property where loans were not properly paid.
While the Roman Empire eventually collapsed, its banking system thrived afterwards. Now, instead of acting under the authority of Caesar, they acted with the pope’s blessing. This became a major issue as many questioned the church allowing for usury to be charged when the Bible firmly forbade this practice.
Acting with a Freehand
Since the first banking structure was created, the Roman government had control over how these financial institutions operated. This practice continued for nearly 1800 years, as monarchs throughout Europe, emperors in the East, and other leaders had state-controlled banks under the government's complete authority.
In 1776, things changed. While this date is recognized as the year of American independence from Britain, it is also the year that Adam Smith created the “invisible hand” theory. Smith proposed a self-regulated economy, where bankers and other moneylenders controlled the sector with very little involvement by the state. This opened the door to the idea of free-market capitalism.
The founding fathers widely accepted this idea, who wanted very little oversight by a large federal bureaucracy. The objective of this idea was to let the market control which banks prospered. Those that could not compete or did not offer services that customers valued would find it difficult to survive, and that is exactly what happened. Most banks lasted less than five years, with notes from those banks that defaulted becoming completely worthless.
The major issue was that banks were issuing their own notes. So, if a bank defaulted, those banknotes no longer had any value. They had no value because there was no bank to support its value.
This changed when Alexander Hamilton established a national bank that created banknotes universally accepted across the country. It took some time, but a national currency was eventually created and fully accepted in every state. This gave customers peace of mind in knowing that their notes would still have value even if their bank failed.
The Rise of the Depression
The banking industry had its troubles through much of the first 130 years of the country’s existence but faced even greater challenges during the depression that occurred in the 1920s. Several small banks and savings and loans were unable to stay in business when a run on the banks occurred, as customers were desperate to get their money, feeling their bank could collapse at any moment.
This helped larger financial institutions become even bigger, as they were able to withstand the run, often purchasing people’s banknotes from other banks for pennies on the dollar. A story played out in the Christmas classic. It’s a Wonderful Life.
The depression also led to a new type of bank coming into existence – the merchant bank. Because of the banking industry's volatility, many were looking for a more stable financial system to withstand any potential disaster. This is where smart businessmen such as Goldman and Sachs, J.P. Morgan, and Chase jumped in.
They created the merchant bank. A financial institution whose primary role was to manage big corporations' financial assets and individuals who had large amounts of money. This ensured the bank’s viability because of the large number of assets available to it. That was good news for small investors or depositors as well, as they could rely on these businesses to ensure the bank's viability.
The Rise of Credit
The banking industry struggled for much of the first half of the 20th century. It took several years to get out of the doldrums caused by the depression, but World War II changed everything for the banking industry.
While countless millions were losing their lives, banks were taking in more money than ever. Not only were they helping fund the government’s war machine but were also taking in large amounts of money from soldiers on the battlefield and from their wives back home who suddenly entered the workforce.
After World War II, many of these families had a significant amount of money they had saved during the war. However, it may not have been enough actually to purchase a house. This led to many of these financial institutions offering mortgages and other credit lines to make large purchases.
Credit cards also came into existence as we know them today. These cards were issued by banks, enabling customers to spend the money at any business or organization that accepted the cards.
Several financial institutions made large amounts of money off these credit cards. They work with major credit cards brand names, such as Visa and MasterCard, and partnered with large corporations to become the store's credit provider. Thus, businesses like JCPenney, Sears, and even Walmart today can offer customers a line of credit to use at their establishments.
Into the Cloud
Oddly enough, we are reaching a time where it is more common that people use their debit or credit card to make purchases than to use the hard currency. The Internet age has made it so that financial transactions can be instantly approved, allowing customers to make any purchase, whether it is to buy a new dishwasher or purchase toothpaste.
In this way, it is kind of remarkable how the banking industry has come full circle. At one time, all of these transactions were recorded on a clay tablet, which became a person’s “line of credit” to make purchases. There was no actual currency passed from one person to the next to complete the transaction.
Customers carry small plastic cards in their wallet; some even use their thumbprint to complete transactions. No doubt, this industry has gone through some dramatic changes, and it will be interesting to see what awaits this financial sector over the next 50 years. Could we reach a point where you pay for things by saying you will pay for it? It would not be surprising to see that become a reality.