The Genesis Of Banking part 1

The genesis of banking started in England during the era of the early Blacksmith days (good ol’ Smithy!) that made strong boxes for customers who wanted to store his or her valuables. Whenever a person who had excess Gold for safekeeping, he would take it to Smithy, who always had an extra “safe” or strong box in the back of his place. The Blacksmith would issue a warehouse receipt so that he could collect his gold on demand after paying a “warehouse fees”.

As usual with human nature, the Blacksmith became greedy; they assumed that since everybody didn’t go to collect their gold all at the same time, he could lend some out on a rental basis. And this was the birth of illiquid banking which we now term as “Fractional Reserve Banking”.

Eventually the governments got on to this scheme as well and when there was not enough Gold or Silver in their coffers to punch out hard money or you can say par value money.They recognized the profit and the power to create money out of thin air, just by simply printing “warehouse receipts”. When the Government took over this scheme the receipt was renamed “currency” and the created banks called their receipts “Cheques”.

Currencies were guaranteed by the reserves of gold or silver in the bank, while the bank Cheques were guaranteed by the capital of the banks. The governments had rarely had that much of gold or silver in their reserves, plus borrowings could equal all the requests for gold redemptions at any one time. Since the people had trust in Governments to redeem on demand there was no demand. (All depositors assumed that the gold was available!)

Banks made incredible profits as long as there no mismanagement and they had the ability to create money of thin air and lending at interest to eight or ten borrowers at the same time. The method greatly expanded the system of expansion of money supply and it became the most profitable business.

The Banking function operates the opposite to all other types of business as the cash deposited into the bank is a liability to the bank as it is owed to the depositor. Money is then lent out to the borrowers which will capture in the books of the banks as a profit/asset.

To put it in weird circumstances if you deposit one Ringgit it has become a liability to the bank as it has to lend out to eight people simultaneously and creates eight ringgit out of thin air. So as you can see the banks are indeed risky because they accept deposits which they guarantee to repay on demand, and lend out for a 20 years mortgage.

If a major problem arises and a majority of depositors tried to withdraw all at the same time, most banks would just go belly up. It is so strange that most people would trust banks as they are the most illiquid institutions on earth.