The Evolution of Banking Over Time

From the ancient world to the digital agei

Banking has been in existence since the first currencies were minted and wealthy people realized they needed a safe place to store their money. Ancient empires also needed a functioning financial system to facilitate trade, distribute wealth, and collect taxes. Banks were to play a major role in that, just as they do today.

Key Takeaways

  • Religious temples became the earliest banks because they were seen as safe places to store money.
  • Before long, temples got into the business of lending money at interest, much as modern banks do.
  • By the 18th century, many governments gave banks a free hand to operate, based on the theories of economist Adam Smith.
  • Numerous financial crises and bank panics over the decades eventually led to increased regulation.

Banking Is Born

The barter system of exchanging goods for goods worked reasonably well for the earliest communities. It prove problematic as soon as people started traveling from town to town in search of new markets for their goods and new products to take home.

Over time, coins of various sizes and metals began to be minted to provide a store of value for trade.

Coins, however, need to be kept in a safe place, and ancient homes did not have steel safes. Wealthy people in Rome stored their coins and jewels in the basements of temples. They were seen to be secure, given the presence of priests and temple workers, not to mention armed guards.

Historical records from Greece, Rome, Egypt, and Babylon suggest that temples loaned money in addition to keeping it safe. The fact that temples often functioned as the financial centers of their cities is one reason why they were inevitably ransacked during wars.

Coins could be exchanged and hoarded more easily than other commodities, such as 300-pound pigs, so a class of wealthy merchants took to lending coins, with interest, to people in need of them. Temples typically handled large loans, including those to various sovereigns, while wealthy merchant money lenders handled the rest.

Banking in the Roman Empire

The Romans, who were expert builders and administrators, extricated banking from the temples and formalized it within distinct buildings. During this time, moneylenders still profited, as loan sharks do today, but most legitimate commerce—and almost all government spending—involved the use of an institutional bank.

According to the World History Encyclopedia, Julius Caesar initiated the practice of allowing bankers to confiscate land in lieu of loan payments. This was a monumental shift of power in the relationship of creditor and debtor, as landed noblemen had previously been untouchable, passing debts on to their descendants until either the creditor’s or debtor’s lineage died out.

The Roman Empire eventually crumbled, but some of its banking institutions lived on in the Middle Ages through the services of papal bankers and the Knights Templar. Small-time moneylenders who competed with the church were often denounced for usury.

European Monarchs Discover Easy Money

Eventually, the monarchs who reigned over Europe noted the value of banking institutions. As banks existed by the grace—and occasionally, the explicit charters and contracts—of the ruling sovereignty, the royal powers began to take loans, often on the king’s terms, to make up for hard times at the royal treasury.

This easy access to financing led kings into gross extravagances, costly wars, and arms races with neighboring kingdoms, not to mention crushing debt.

In 1557, Philip II of Spain managed to burden his kingdom with so much debt due to several pointless wars that he caused the world’s first national bankruptcy—as well as the world’s second, third, and fourth, in rapid succession. These events occurred because 40% of the country’s gross national product (GNP) went toward servicing the nation's debt.

The practice of turning a blind eye to the creditworthiness of powerful customers continues to haunt banks today.

Adam Smith Gives Rise to Free-Market Banking

Banking was already well-established in the British Empire when economist Adam Smith introduced his invisible hand theory in 1776. Empowered by his views of a self-regulating economy, moneylenders and bankers managed to limit the state’s involvement in the banking sector and the economy as a whole. This free-market capitalism and competitive banking found fertile ground in the New World, where the United States of America was about to emerge.

In its earliest days, the United States did not have a single currency. Banks, cities, and pretty much anyone could create a currency and distribute it to anyone who would accept it. The average life span of an American bank was five years, after which most of the banknotes that it had issued became worthless. A single bank robbery could crush a bank and its customers. Compounding these risks was a cyclical cash crunch that could disrupt the system at any time.

Alexander Hamilton, the first secretary of the U.S. Treasury, established a national bank that would accept member banknotes at par, thus keeping banks afloat through difficult times. After a few stops, starts, cancellations, and resurrections, this national bank created a uniform national currency and set up a system by which national banks backed their notes by purchasing Treasury securities, thus creating a liquid market. The national banks then pushed out the competition through the imposition of taxes on the relatively lawless state banks.

The damage had been done, however, as average Americans had grown to distrust banks and bankers in general. This feeling would lead the state of Texas to outlaw corporate banks with a law that stood until 1904.

Merchant Banks Come Into Power

Most of the economic duties that would have been handled by the national banking system, in addition to regular banking business like loans and corporate finance, soon fell into the hands of large merchant banks. During this period, which lasted into the 1920s, the merchant banks parlayed their international connections into enormous political and financial power.

These banks included Goldman Sachs; Kuhn, Loeb & Co.; and J.P. Morgan & Co. Originally, they relied heavily on commissions from foreign bond sales from Europe, with a small backflow of American bonds trading in Europe. This allowed them to build capital.

At that time, a bank was under no legal obligation to disclose its capital reserves, an indication of its ability to survive unanticipated loan losses. A habit of secrecy meant that a bank’s reputation and history mattered more than anything else. While upstart banks came and went, these family-held merchant banks had long histories of successful transactions.

As large industries emerged and created the need for major corporate financing, the amounts of capital required could not be provided by any single bank. Initial public offerings (IPOs) and bond offerings to the public became the only way to raise the amount of money needed.

Successful offerings boosted a bank’s reputation and put it in a position to ask for more to underwrite an offer. By the late 1800s, many banks demanded a position on the boards of the companies seeking capital, and if the management proved lacking, they ran the companies themselves.

J.P. Morgan Rescues the Banking Industry

J.P. Morgan & Co. emerged at the head of the merchant banks during the late 1800s. It was connected directly to London, then the world’s financial center, and had considerable political clout in the United States.

Morgan & Co. created U.S. Steel, AT&T, and International Harvester, as well as duopolies and near-monopolies in the railroad and shipping industries, through the revolutionary use of trusts and a disdain for the Sherman Antitrust Act.

It remained difficult, however, for average Americans to obtain loans or other banking services. Merchant banks didn’t advertise and rarely extended credit to the “common” people. Racism was widespread. Merchant banks left consumer lending to the lesser banks, which were still failing at an alarming rate.

The collapse in shares of a copper trust set off the Bank Panic of 1907, with a run on banks and stock sell-offs. Without a Federal Reserve Bank to take action to stop the panic, the task fell to J.P. Morgan personally. Morgan used his considerable clout to gather all the major players on Wall Street and persuade them to deploy the credit and capital that they controlled, just as the Fed would do today.

The End of an Era, the Birth of the Fed

Ironically, Morgan’s move ensured that no private banker would ever again wield that much power. In 1913, the U.S. government formed the Federal Reserve Bank (the Fed). Although the merchant banks influenced the structure of the Fed, they were also pushed into the background by its creation.

Even with the establishment of the Fed, enormous financial and political power remained concentrated on Wall Street. When World War I broke out, the United States became a global lender, and by the end of the war, it had replaced London as the center of the financial world.

At that point, the government decided to put some handcuffs on the banking sector. It insisted that all debtor nations pay back their war loans—which traditionally were forgiven, especially in the case of allies—before any American institution would extend them further credit.

This slowed world trade and caused many countries to become hostile toward American goods. When the stock market crashed on Black Tuesday in 1929, the already-sluggish world economy was knocked out. The Fed couldn’t contain the damage, which led to some 9,000 bank failures from 1930 to 1933.

New laws emerged to salvage the banking sector and restore consumer confidence. With the passage of the Glass-Steagall Act in 1933, for example, commercial banks were no longer allowed to speculate with consumers’ deposits, and the Federal Deposit Insurance Corp. (FDIC) was created to insure accounts up to certain limits. The insured limit as of 2023 is $250,000 per account.

World War II and the Rise of Modern Banking

World War II may have saved the banking industry from complete destruction. For the banks and the Fed, the war required financial maneuvers involving billions of dollars. This massive financing operation created companies with huge credit needs that, in turn, spurred banks into mergers to meet the demand. These huge banks spanned global markets.

More importantly, domestic banking in the United States finally settled to the point where, with the advent of deposit insurance and widespread mortgage lending, the average citizen could have confidence in the banking system and reasonable access to credit. The modern era had arrived.

Banking Goes Digital

The most significant development in the world of banking in the late 20th and early 21st centuries has been the advent of online banking, which in its earliest forms dates back to the 1980s but really began to take off with the rise of the internet in the mid-1990s.

The growing adoption of smartphones and mobile banking apps further accelerated the trend. While many customers continue to conduct at least some of their business at brick-and-mortar banks, a 2021 J.D. Power survey found that 41% of them have gone digital-only.

What Does a Central Bank Do?

A central bank is a financial institution that is authorized by a government to oversee and regulate the nation’s monetary system and its commercial banks. It produces and manages the nation's currency. Most of the world’s countries have central banks for that purpose. In the United States, the central bank is the Federal Reserve System.

Who Regulates Banks in the U.S. Today?

Depending on how they are chartered, commercial banks in the United States are regulated by a number of government agencies, including the Federal Reserve, the Office of the Comptroller of the Currency (OCC), and the Federal Deposit Insurance Corp. (FDIC).

State-chartered banks are also regulated by the state in which they do business.

Investment banks are largely regulated by the U.S. Securities and Exchange Commission (SEC).

What Is the Difference Between a Commercial Bank and an Investment Bank?

Commercial banks provide services to the general public and to businesses. They take deposits, issue loans, and operate ATMS.

Investment banks provide services only to large companies, institutional investors, and some high-net-worth individuals. Those services include helping companies raise money by issuing stocks or bonds or obtaining loans. They may also be deal-makers, facilitating corporate mergers and acquisitions.

The Bottom Line

Banks have come a long way from the temples of the ancient world, but their basic business practices have not changed much. Although history has altered the finer points of the business model, a bank’s purposes are still to make loans and to protect depositors’ money.

Even today, where digital banking and financing are replacing traditional brick-and-mortar locations, banks still perform these fundamental functions.

Article Sources
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  1. World History Encyclopedia. “Banking in the Roman World.”

  2. World History Encyclopedia. “Caesar as Dictator: His Impact on the City of Rome.”

  3. New World Encyclopedia. “Philip II of Spain.”

  4. Adam Smith Institute. “The Theory of Moral Sentiments.”

  5. Federal Reserve History. “The Panic of 1907.”

  6. Federal Deposit Insurance Corp. “The First 50 Years: A History of the FDIC.”

  7. J.D. Power. “U.S. Retail Banks Nail Transition to Digital During Pandemic, J.D. Power Finds.”

  8. Federal Reserve Bank of San Francisco. “Are All Commercial Banks Regulated and Supervised by the Federal Reserve System, or Just Major Commercial Banks?