The banking industry has been around since the first coin was minted, and wealthy individuals wanted safe places to store their fortune. Ancient empires also needed functional financial systems to facilitate trades, collect taxes, and distribute wealth. Financial institutions were to play major roles in this, just like what they are today.
Banking is born
This industry started when empires needed ways to pay for foreign services and goods with something that people could easily exchange. Coins of different sizes and precious metals eventually replaced impermanent and fragile paper bills. But coins needed to be kept in safe places, and ancient houses didn’t have secure steel safes.
So wealthy individuals in Rome stored their jewels and coins in the basements of their temples. They were given a sense of security from the presence of temple workers and priests, who were assumed to be honest and devout, as well as armed guards.
According to historical records from Babylon, Egypt, Rome, and Greece, temples loaned funds in addition to keeping them very safe. The fact that these structures usually functioned as a financial center of cities is a big reason why they were the first to get ransacked during wars.
People could exchange or hoard coins a lot easier compared to other commodities, like a big pig or a cow, so wealthy merchants started to lend valuable coins with interest to individuals in need of them. These temples usually handle large loans to different sovereigns, while rich merchant lenders handle the rest.
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The banking institution in Roman times
Romans are expert administrators and builders. They also extricated the industry from temples and formalized it within certain buildings. During their time, moneylenders still profited, like, what loan sharks are doing today, but most legit commerce (like most government spending) involved the use of institutional banks.
According to historians, Roman leader Julius Caesar changed some Roman laws after his takeover. He initiated the practice of allowing financial institutions to confiscate land instead of debenture payments. It was a significant shift of power when it came to the relationship between debtors and creditors, as noblemen with big lands were untouchable in the past, passing off debts to their descendants until either the debtor’s or creditor’s lineage died out.
The empire eventually disintegrated, but some of its institutions lived on, like papal bankers that started in the Knights Templar and the Holy Roman Empire during the time of the Crusaders. Small-time lenders who competed with the church were usually denounced for loan-sharking.
European monarchs and the discovery of easy money
Eventually, monarchs in Europe noted the value of these institutions as banks existed by the grace of the ruling country (usually, the explicit contracts and charters). The royal power started to take loans, often on the ruling power’s terms, to make up for challenging times at royal treasuries.
This kind of easy financing led royal families into unnecessary extravagances, arms races, and costly wars with neighboring kingdoms that would usually lead to crushing debts. In the 1550s, King Philip II of Spain managed to burden his kingdom with debts because of pointless wars with other kingdoms.
It caused the world’s first, second, third, and fourth recorded national bankruptcy in rapid succession. This happened because forty percent of the country’s GNP, or Gross National Product, went toward servicing the kingdom’s debts. The trend of ignoring the creditworthiness of significant customers continues to haunt financial organizations today.
Adam Smith and the free-market banking
The industry was already well-established in Great Britain when Adam Smith introduced the Invisible Hand theory in 1776. His ideas of self-regulated economies empower it; bankers and moneylenders managed to limit the country’s involvement in the industry or the economy as a whole.
Free-market capitalism, as well as the competitive industry, found a good ground to anchor in the New World, where the United States was about to emerge. Initially, the idea didn’t benefit the industry in the New World. The average life span of American banks was three to five years, after which most of the banknotes they issued became pretty worthless. Bank robberies also meant more than it does now in the insurance deposit age.
The compounding risk mentioned was a cyclical money crunch in the United States
The first secretary of the United States Treasury, Alexander Hamilton, established a state bank that would accept member banknotes, thus floating institutions through hard times. After a couple of stops, cancellations, starts, and resurrections, this state-sponsored bank created a uniform currency.
They set up a better system by which federal banks backed their notes by buying Treasury securities, which created a liquid market. Federally-backed institutions pushed out the competition by imposing taxes on relatively lawless state-backed financial organizations. But the damage has been done, as most Americans had grown to distrust bankers and banks in general. This distrust would lead Texas to outlaw corporate institutions – a law that stood until early 1903-1904.
The rise of merchant financial institutions
A lot of economic duties that the federal banking system would have handled, in addition to regular banking businesses like corporate finances and loans, soon was handled by established merchant banks. During this time, which lasted until the 1920s, merchant banks parlayed their global connections into financial and political power. These organizations included J.P. Morgan and Company; Kuhn, Loeb and Company; and Goldman Sachs.
Originally, these organizations relied heavily on European bond sales commissions, with small backlogs of American bonds trading in the Old World. This allowed them to generate capital gains. At that time, banks were under no legal obligations to disclose their capital reserves.
It is an indication of their ability to survive above-average or bigger loan losses. This practice meant that the history and reputation of institutions mattered more than anything else. While small banks came and went, family-held merchant institutions had long histories of successful transactions.
As bigger industries emerged and created needs for significant corporate financing, the amounts of financial capital needed could not be provided by a single bank, so IPOs or Initial Public Offerings, as well as bond offerings to the public, became a way to raise the needed capital.
Successful offerings increase the bank’s reputation and put it in a position to ask for more to underwrite offers. As a result, by the 1880s, a lot of banks demanded positions in companies looking for capital, and if the organizations proved lacking, they will ran the organizations themselves.
The birth of the federal banking
Ironically, J.P Morgan’s move ensured that no private institutions would ever again wield a lot of power. In 1913, the United States government formed the Fed or the Federal Reserve Bank. Although merchant banks influenced the structure of the Federal Reserve, they were also pushed at the back of its creation.
Even with the Federal Reserve’s establishment, big political and financial power remained pretty concentrated on Wall Street. When World War I started, the United States became the world’s biggest lender, and when the war ended, it replaced London as the world’s financial center. The bad news is that the government decided to put unconventional handcuffs on the industry.
It insisted that all debtors pay back their loans – which were forgiven, especially in the case of their allies – before any American companies would extend them more credits. This move slowed down world trade and caused a lot of countries to become very hostile towards goods from the United States. When the stock market crashed in 1929, the sluggish world economy experienced another blow. The Federal Reserve could not contain the damage, which led to bank failures.
The most important development in this industry has been the advent of digital or online banking, which dates back to the 1980s but really started to take off with the birth of the Internet. The growing adoption of banking for digital businesses, mobile banking, and smartphones further accelerated this trend. While most individuals continue to conduct some of their businesses at traditional banks, studies suggest that at least 40% of people have gone digital.
The bottom line
These organizations have come a long way from the religious temples of the ancient world, but the basics of this business have not been altered much. Although history has changed the finer points of the industry’s business model, the purpose of this industry is still to make debentures and protect depositors’ funds. Even in today’s world, where online banking, as well as financing, are replacing physical locations, financial institutions still exist to perform basic functions.