1.1 The origins of banking
The origins of financial services pre-date the industrial and agricultural revolutions and even the emergence of developed patterns of international trade. If we take the activity of money-lending as being a precursor to the banking industry, then we can find references to the early years of financial services in the Bible.
In the book of Exodus, we learn that the laws of Moses forbade money-lending, whereas in the book of Nehemiah there are references to the condemnation of usurers (money-lenders) who ‘upon lending money to their poorer kinsfolk, exacted pledges of vineyards and even children, and demanded interest’ (cited in Harvey, 1976). Within England during the Middle Ages, the Usury Laws, based on the doctrines of the Bible’s Old Testament, made it illegal to require interest to be charged on lent money. These laws were eventually repealed in 1545. For some religious groups, however, usury is still forbidden with the result that alternative arrangements, like Islamic finance, have to be used to facilitate borrowing and lending activities.
The transition of the ill-regarded activity of money-lending into the respectable profession of banking was linked to the development of trade and also the needs of government. A key development in England occurred in the later Middle Ages when merchants from Italy settled in London. Many were goldsmiths who dealt in gold and silver, but augmented this business by undertaking money-lending against the provision (pledge) of an asset (such as gold plate) as security. Prior to their abolition, the Usury Laws were sidestepped by charging the borrowers a fee either for the custody of the pledge or for its redemption on repayment of the borrowed money.
The seventeenth century saw the growth in affluence of the merchant classes (those engaged in domestic and international trade), who deposited their stocks of bullion with the goldsmiths for safe-keeping. Receipts were issued by the goldsmiths for the valuables deposited, and these receipts later became known as bank notes. Merchants found that they could exchange these notes to settle their financial obligations – in effect, starting the use of paper currency in the economy. Recognising that withdrawals of bullion by their owners only normally constituted a small proportion of that held in safe custody – a pattern reinforced by the practice of merchants using bank notes to settle debts, rather than drawing on their deposited bullion – the goldsmiths found that they could extend their lending business. They did this by issuing bank notes totalling in excess of the value of bullion held on deposit – so leading to the process of credit creation that is an integral feature of current banking practice. With the issuance of bank notes to support money-lending, the goldsmiths became the first banks.