The Birth of Banks and Banking

There’s a lot of misconception about banks and what they do.

Banks aren’t necessarily the shadowy, all-powerful global players pop culture would have you believe. But then, they’re also global players who, for better or worse, hold immense influence and power in our global economy.

Ask anyone today what a bank or banker does, and you’ll probably get answers like become rich, play with other people’s money, invest in stuff, etc. While that’s partially true, the way banking works today is increasingly complex, making the notion of banks and bankers making (or losing) huge sums of money a very modern phenomena.

Banks started centuries ago as a safe place for individuals to store their money. The banks then loaned that money to people, businesses, and even kings, and charged interest in return, making a profit in the process. This was how they worked, playing a vital role in creating our modern economy.

In fact, the need for loans and credit by seafaring merchants centuries ago was the original reason we invented “merchant banks” in the first place – it was much safer to not carry large sums of money on dangerous sea voyages, and instead just carry an IOU to access your money once you arrived safely at your destination.

People trusted their money was safe, and over time, banks accumulated large reserves by paying a small amount of interest to encourage savers to save with them, while charging higher interest to people they loaned money to.

As the economy grew and the world industrialised, banks accumulated more money (from savings deposits) than they could loan out. They needed to find other ways to use their stockpile of money to generate income – and this is when they started getting into investments.

This happened because, a.) banks were companies run by people who are obviously motivated to want to make more money, and b.) most governments agree that by having a few large institutions sitting on lots of money and doing very little with it is bad for the economy.

Banks lobbied governments to ease financial regulations, and more or less since the 1970s and 80s, were allowed to start selling investment products, like mutual funds.

Fast forward to today, and banks continue to play a critical role in our society, by giving people somewhere safe to put their savings, and loaning that money out to people to buy homes, cars, pay for tuition fees, etc.