I've been reading some interesting stuff about the history of banking and how it was that fractional reserve banking and paper money came to be a big thing in the Anglo world and enabled capitalism.
Ok, since you asked.
Fractional reserve banking (FRB) is where a bank holds in reserve just a fraction of what it lends out by means of bits of paper - bank notes - that have no intrinsic value other than a promise to pay the bearer, in coin, the amount specified on the note.
Coin used to be made of your actual precious metals or alloys containing precious metals.
The idea of a gold reserve acted as a sort of monetary sea anchor but it became stretched when the paper money supply outstripped gold reserves, and was abolished in the digital-era to enable the money supply to expand massively to create global corporate capitalism's vast cyber-fortunes.
But, back in the day, a lender was supposed to hold enough actual cash in reserve to pay the holder of a note the amount specified, in the coin of the realm.
King Charles II, when denied a huge loan, appropriated all the treasures the rich had stored for safekeeping in the Royal Mint, and demanded a ransom -in the form of a £40k loan - for its return.
The rich folk of London obliged him but thought 'sod that for a game of thrones' and were a bit loath to expose themselves to that risk again.
English goldsmiths – operating mostly in London – spotted a market opportunity and provided safe storage for the treasures of the rich - for a fee.
(Poor people, who had sod all money and lived hand to mouth had no need of banks - what changes?)
Now, if you take a fee for a safekeeping service, the money you are safeguarding belongs to the depositor. You don’t have the right to on-sell, invest, lend out that money – that would be theft.
A couple of things happened here. As we know, the money you deposit in a bank is not the actual money you get back – it’s just the same value – you hope.
The precious metal in coins back in the day was not always very accurately measured and some had a bit more gold or silver than others. The London goldsmiths exploited these discrepancies and made a lot of bullion.
They began to lend out their fortunes and charged interest on the loans – but they lent it out by means of ‘promissory notes’ made out to bearer and thus paper money was born.
But there were constraints on this – while they needed to lend to the value of their cash (coin) reserve, they were limited in how many notes they could issue.
They could look to increase their reserves by acquiring more coin, but the more coin they held, the more safe storage they needed, and the more vulnerable they were to theft. Coin is cumbersome in more ways than one.
Or they could operate on a fractional reserve, that is lend out more by promissory notes than they held in reserve - which increased their risk because, if all the people they owed coin to demanded it all at the same time, the bank would go bust. The lower the reserve, the greater the return, but also the greater the risk.
At this point the goldsmiths were creditors in that they were owed loads of dosh in the form of the principal of the loans they made and the interest owed on them.
Then something really sneaky happened- the really big shift in banking was in the goldsmiths' ability to utilise depositors’ cash as if it belonged to them. And they achieved this by paying interest on deposits and thus became both creditors and debtors.
At the time in England, interest was paid by the Crown on government bonds – latterly known as gilts. You loaned the Crown your fortune by means of buying bonds and they paid you a guaranteed bi-annual interest at 3 – 5 % per annum.
The lower interest rate fund was known as the Consul – a long-term consolidated fund; the higher rated, shorter term funds were known as the four- or five–percents and they provided the very rich with a low-risk, guaranteed annual income, plus protection of the principal and they gave the Crown the money it needed to maintain the state's infrastructure, wage wars, expand empires, spend up large on estates, palaces and such like.
Someone who bought 5% government bonds with a value of £200k would get an annual income of £10k – a Mr Darcy sized fortune and worth millions in today’s money.
The Crown - as a seller of the bonds, effectively borrowing from investors, used the money as it saw fit – as long as it paid out the interest and could repay the principal when required - both necessary to ensure investor confidence and avoid being overthrown or beheaded.
When the London goldsmiths began to offer interest on deposits they became borrowers and, as borrowers, rather than providers of a safe keeping service, they could claim a right to use the money deposited with them in any way they saw fit – such as lending it to third parties at a higher rate of interest.
They could not exceed the interest rate on a loan of 5% or so set by the anti-usury laws (except to the Crown which might pay up to 10%) so they offered deposit interest of 2- 3% and a loan interest of 5% - making a profit from the difference and enabling them to put even more notes into circulation.
They also got together and decided that, if they all accepted each others’ promissory notes at face value – they could reduce the risk they all faced of a run on their bank - and they could safely keep many more notes in circulation.
These innovations of the City of London's goldsmith-bankers greatly increased the liquidity that enabled the growth of capitalism, created a mutuality of interests between the British Crown and other governments, and laid the foundations of the emergence in the early 19th century of powerful banking complexes that had and still have massive global reach and influence.
Ching ching.
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