The Origin of Modern Banking

The origin of modern banking can be traced to the operations of the goldsmiths of 17-century England. The goldsmiths had strong rooms for the safekeeping of the materials of their trade. Extra space in these rooms was often rented with merchants and others to safekeep valuables, including large sums of money. At first the money was accepted in locked and seals boxes that were returned to their owners in the same condition in which they had been left for safekeeping. Later, it became common for customers to deposit coin in return for a receipt or certificate of deposit. In time the goldsmiths observed that their depositors did not demand the identical coin initially left with them, but only coin equal to the value shown on the certificates of deposit. The goldsmiths assumed ownership of the coin deposited with them and employed the coin as required, being careful that they always held the amount sufficient to convert certificates of deposit into coin on demand. This marked the beginning of deposit taking, a characteristic of commercial banking as distinct from the function of safekeeping.

The goldsmiths also observed that a predictable quantity of coin was always left with them. They could gauge the quantity by observing the activities of the merchants, many of whom deposited their coin with the same goldsmith. When one merchant wished to make payment to another, he would simply write an order to his goldsmith requesting the transfer of coin from his own account to that of his creditor without covering his deposit certificate into coin. This was the beginning of chequing or clearing, another characteristic of commercial banking.

As a rule, the goldsmiths were men of wealth. It had therefore not been uncommon for them to land to customers from their own resources. When it became a common practice for their notes to circulate as a medium of exchange, the goldsmiths began to make loans not by using their own coin or coin deposited with them, but their notes. These notes were the same as the notes given to depositors of coin, with one important exception: they were not issued in return for a deposit of coin, but in return for a promissory note left by the borrower with the goldsmith. The distinction is important. As long as all the notes issued by the goldsmiths were not turned in at one time for conversion into coin, the goldsmiths could issue notes to a greater value than the value of the coin they held. This marked the beginning of fractional reserve banking.

The total quantity of notes that the goldsmiths could issue against a given reserve base of coin depended on the note holders’ propensity to redeem them in coin. The goldsmiths soon learned form experience how much coin would remain with them during any given period and that this amount fluctuated with the temper of the times.

Although fractional reserve banking is usually traced to the operations of the goldsmiths, it was by no means confined to them. Soon after the goldsmiths began the practice, if not simultaneously, merchants began to issue notes that were only fractionally secured by specie and served as a medium of exchange. Moreover, governments started to grant charters incorporating companies authorized to conduct banking operations that included accepting deposits, clearing or transferring money, and issuing notes only fractionally secured by reserves of specie. Among the first charted banks were the Bank of Sweden (1656), the Bank of England (1694), and the John Law’s Bank in France (1716).

3.1. Answer the questions to the text:

1.What is the reason of the banking appearance? 2. In what condition were the

goldsmiths given money at first? 3. What capital did the goldsmiths have at their disposal? 4. How could one merchant pay to another? 5. What is “chequing” (clearing)?. 6. How did the goldsmiths use the notes? 7.What is the distinction between the goldsmith’s note and the note which was given to a merchant for his coin? 8.What is “fractional reserve banking”? 9.What did the total quantity of the goldsmiths’ notes depend on? 10.What are the first banks?