What Are The History Of Credit And The Banking System?
The history of credit goes back to primitive communities, which according to conventional accounts used barter as a form of exchange and value, to the extent that the complexity of economic systems was not so high.
However, although the narrative of liberal economics points to debt or credit as a construction that emerged after the invention of fiat money, many scholars have come from this perspective. One of them is the American anthropologist David Graeber.
The beginning of the economic surplus
As a result of the agricultural revolution of the Neolithic, around the year 8000 BC, the first surpluses or surpluses in the economy begin to be created, which means that the production was sufficient to satisfy the needs of the population and a kind of saving was generated. in the form of assets that should be kept and deposited in trusted institutions.
However, before this happened, it must be understood that primitive economies had no concept of credit or debt, their exchange and favor systems were based on barter and the economy of gifts or solidarity. When someone did a favor to another, that other ended up “owing” that favor that he could return or not, but in amounts that were not quantifiable. The “I owe you one” would soon be replaced by “I owe you an amount of…”.
The first debts
As agricultural societies become more complex, economic surpluses are created and state authorities with the help of writing, 3000 BC, begin to keep records of those surpluses and issue certificates of deposit of goods in granaries in form of coins. A coin given to a farmer could mean that he had in the king’s barn an amount of 100 pounds of wheat, for example. This meant that the king owed that farmer 100 pounds of wheat.
The arrival of coins and the use of written records mark the beginning of the debt, to the extent that it is possible to quantify the services and goods owed to whoever has the certificate of value (currency) in their possession. Thus, money also arises as a way to keep track of what is owed to someone and as a way to simplify exchanges in society to overcome barter and its drawbacks.
Currency as a unit of exchange
The first coins in history were in metals such as gold, silver, and copper since their scarcity made them attractive and they were easy to transport. After the money was used as a depository unit of value to guarantee the payment of physical debts (in wheat, food, favors, military services), the power used to support debts of various kinds began to be used as a unit of exchange such as a standard unit of value – since it supported the payment of multiple debts.
Among the first coins in history, we have the shekels, the minerals, the drachmas, the darics, and the silver and gold talents that were widely used in the Asian world.
An alternative history of credit and money
In his book In Debt, the American anthropologist David Graeber argues that credit is at the origin of the entire world financial system, even long before money itself or barter existed.
In Graeber’s Debt, it has been proposed as an alternative history of the world economy, however, despite not being part of the traditional line of thought, its approach is very convincing. In this book, Graeber points out that debt precedes all forms of money, including fiat money and barter. Debt from the historical perspective established by Graeber is conceived as a moral obligation, as a sin, and at the same time as a tool for economic development.
Debts were the first form in which money was established, since they served as the first unit of account instrument, at the same time they were units of exchange, and to the extent that they were not paid, they served as obligations that were endorsed from one carrier to another.
Likewise, debts have always involved the establishment of institutions, be they families, kingdoms, laws such as Islamic sharia, the prohibition of usury in medieval Christianity, or regulations in modern states that prevent excessive indebtedness…
If we think about it, the modern money that we all handle is a type of debt. To put us in perspective, Graeber gives us a simple example:
A man named “Carlos” needs to buy some item, it can be a pair of shoes. Assuming that there is no means of payment such as cash, Carlos agrees with the cobbler to pay the equivalent of the shoes in 10 pounds of flour. However, Carlos does not have the 10 pounds of flour at the moment, so he issues a document in which he agrees to pay the shoemaker for the 10 pounds of flour.
After a while, the shoemaker forgets about the debt and wants to buy something in the market. We can assume that is four pounds of meat. Since the shoemaker has no money, he gives the butcher Carlos’s debt certificate and tells him that whenever he wishes he can charge Carlos the equivalent of the meat in pounds of flour (the 10 pounds of flour that Carlos owes). . The debt certificate can be traded indefinitely as long as everyone is confident that Carlos will pay off his debt at some point. Paradoxically, for the system to work, it is necessary that no one ever collect the original debt from Carlos again.
In this same sense, the central banks act as issuers of debt every time that, through the national printing presses, they create money. All the money that is created in the economy is a guarantee or a kind of certificate that someone at some point will return to us with a value similar to what we carry in our bills, coins, or savings accounts.
Debt, from Graeber’s perspective, and as a unit that gives rise to modern money, is fundamentally based on trust relationships that can arise between individuals. Without trust or without institutions such as states that give us the security that debts will be paid, it would be quite difficult to create social relationships that would give rise to large monetary flows and with them the economic development that these same flows entail.
For these reasons, debts are a necessary element for the current development of capitalist economies, even for the same development of mixed economies or command economies such as socialist ones.
From a critical perspective, it is also important to consider, Graeber points out, that the history of credit has always been marked by a whole series of abuses and large-scale moral catastrophes. It has not been uncommon for even multiple human beings to have been purchased as units of debt or money. Human trafficking, dowry payments in primitive societies, and slavery itself have contributed to the dehumanization of institutions where what was established was always the prevalence of the interests of creditors.
Taking history as a reference, Graeber’s invitation in his book is for us to question the role of debt in our lives. For example, debts should serve the development of nations and when this is not the case, the principle of the prevalence of creditors’ interests should be questioned. Institutions such as the World Bank or the International Monetary Fund, as well as the large investors in international debt, could play a more active role in the development of nations if, instead of giving debt payment a moral character, that is, instead of From Conceiving their payment as a sacred duty, they will consider debts as a tool to help all those who for one reason or another see their immediate resources seriously limited.
The word credit- concept
The word credit has its etymological origin in the Latin credititus, which in turn comes from the verb credere, which means to believe or trust. In this context, credit is born as trusting and believing in something or someone by granting them a good or money for their care; like the farmers who entrusted their wheat harvests to the barns and in return received a coin or certificate of deposit. Over time the coins themselves became credited for their ability to be easily exchanged.
Credit, since ancient times, is a transaction between two parties, in which one trusts the other with a certain sum of money for a certain term and with an agreed interest according to the time in which the money is slow.
Credit with interest
Since entrusting a sum of goods or money to someone always meant a risk, lenders began to place interest on the loans they made. In ancient Rome credit with interest was a common practice and was not regulated by any type of authority, so it was common for those who got into debt to end up paying high-interest rates, even with their lives or properties or being enslaved.
Julius Caesar’s assassin, Brutus, is said to have granted credits at the “modest” forty-eight percent interest.
Money in the Middle Ages and the appearance of the banking system
With the arrival of Christianity in Europe, loans with interest begin to be seen as something sinful, since money was considered to have no value in itself but rather was a unit for the exchange of value.
Being something that was viewed with bad eyes by Christian society, the only ones who dedicated themselves to loans with interest were the Jews, not without provoking rejection and disdain – and also a strong anti-Semitic sentiment.
Little by little, the Jewish quarters became centers of the banking system and some Christian families like the Medici also ventured into the business, managing to accumulate great fortunes.
At the same time, the Catholic order of the Templars ventured into the banking business, granting loans to families, merchants, nobles, and even kings, becoming one of the most powerful organizations of its time due to its ability to manage money efficiently. effective.
Over time, the Catholic Church relaxes its position toward credit and also becomes a regular client of these entities, owing large sums of money to these banking families to finance the construction of churches and the Basilica of Saint Peter. The history of credit gains momentum due to the complexity that the political, economic, and religious institutions of the 16th century take on.
Money as an investment
Soon the credits would cease to be used to simply cover basic needs and the banking systems, governed by wealthy families, began to distinguish between credits out of necessity, for which lower interest rates were charged, and credits for investment and risk (in financial activities). ). commercial and business of all kinds) for which higher interest is charged.
Henry VIII is one of the first figures in history who is concerned about predatory lending and begins to regulate interest on credits, establishing the crime of usury for those who will charge a rate higher than ten percent per month. Queen Elizabeth renewed the law of Henry VIII, but it is James I who reduces the usury rate to eight percent, to later limited to five percent. The regulation of interest is one of the fundamental aspects of credit history.
With the strengthening of commercial institutions after the processes of the conquest of the New World and trade with Asia, as well as the emergence of large companies such as the Dutch East India Company, there is a greater need for credit for various commercial adventures, in the same way as for the financing of the great wars that Europe experienced in the 17th century.
In this scenario, the first large banks such as the Bank of Sweden and the Bank of England emerged – central in the history of credit – the first modern banks in the world, which dealt with the process of minting currency and lending it through contracts with the debtors in agreed terms and at an interest rate for a certain period.
The role of the fractional reserve in the development of credit and modern banking
The fractional reserve system, in which banks keep only a portion of the money that depositors save, while lending or investing the rest, has had a great influence on the development of contemporary economy and finance.
This system even predates central banks, tracing its existence back to the first banks that issued paper money, such as the Bank of Amsterdam in 1609 or the Bank of Stockholm in 1656.
In the 19th century, a period known as “free banking” in the United States and in which banks were poorly regulated, the issuance of money units without bank backing proliferated. The risk of this monetary issue without backing money meant that those who had money issued by banks could not redeem bank notes in dollars when the banks went bankrupt.
Currently, most banks in the world are required to hold a fractional reserve of at least 5% or 10% of savers’ deposits, to prevent financial speculation and unlimited money creation. backless.
Even so, that the banks must have only 5% or 10% of the savers’ deposits is something that allows them to create money practically from nothing. If a saver has, for example, 100,000 dollars in a bank, the bank will be able to lend 90,000 dollars, thus maintaining two money accounts, one that affirms that there are 100,000 dollars in the bank and another that maintains that the bank has lent $90,000. Thanks to this fractional or fractional reserve mechanism, the bank can create money and stimulate the economic development of a society.
The problem of this can arise if all the savers decide to go to the bank to claim the money entrusted to them. In this case, the bank would have no way to respond, since the real, physical money is not inside the bank and only appears in the entity as an account. This possible situation has been foreseen by central banks and regulatory entities and that is why they require banks to keep that fractional amount of between 5 or 10% in their reserves, sometimes it is more. Similarly, when credit issuance becomes uncontrolled and threatens to create financial bubbles or economic crises, central banks raise interest rates, limiting the supply of circulating credit and limiting inflationary or speculative effects.
The role of credit in financial crises
Excessive credit issuance can lead to the development of large-scale financial crises. One of the most recent and most impactful examples is the 2008 financial crisis in the United States, which gave rise to the Great Recession. Several years before the crisis, around 2001, the United States Federal Reserve had lowered its interest rates to minimal amounts to stimulate economic development. However, traditional banks, instead of allocating that money to grant loans for productive activities, used it to issue cheap and easy money for all those people who wanted to buy a home, even if they were high-risk debtors.
In simple terms, it can be said that the banks lent large amounts of money to people who could not pay it, and from the created credits they developed more complex financial instruments such as subprime mortgages that began to trade in the secondary market. When, in 2007, investors realized that subprime mortgages had no value, because the debtors were not going to pay, they sold their assets en masse, generating a total collapse of the economy.
The 2008 financial crisis forced the United States government to think more actively about its role as the regulator of the financial system and led to the enactment of the Dodd-Frank Act to protect financial consumers, limit credit creation, and prevent banking abuse.
This event reminds us that while credit can be important in fostering economic development, it is also important to regulate it so as not to cause chaotic financial cycles in which asset prices artificially over-appreciate and then have massive drops in prices. its value.
Finance and microcredit enter the scene in the 20th century
One of the most exciting modern developments in the world of banking and credit is microcredit. Microcredits became popular at the end of the 20th century thanks to businessman Muhammad Yunus. Yunus created the Grammen Bank Foundation to make credit a more accessible reality for the poorest.
Micro credits are small loans at interest rates slightly higher than those of traditional banking and that allow people living in conditions of extreme poverty to significantly improve their life prospects.
The innovative fact with microcredit is that the poor could not offer payment guarantees to the big banks and for this reason they did not lend them money. But Yunus developed financial entities that were in charge of getting to know the poor in the areas where they lived and committing themselves to reducing the delinquency rate among the poorest.
Despite negative forecasts, poor people managed to pay off their debts and Grammen Bank achieved great global recognition for its role in fighting poverty. In 2006, Muhammad Yunus and the Grammen Bank received the Nobel Peace Prize for promoting microcredit as a tool to combat poverty.
Today microcredits are widespread throughout the world and thousands of institutions, including neobanks, have advanced with more inclusive banking projects that favor the financial inclusion of the poorest.
On a global scale, the popularization of microcredit is an important milestone in the history of credit.
The bank currently
More recently, due to the need for money as a way of financing the last three industrial revolutions, banks and credit systems have become a central aspect of modern economies. In this scenario, the banks become the allies of the companies by providing money that does not exist in the present economy, but that can be backed by the future production of a company, as well as by the profits that it will generate.
Industrial revolutions are very important in the history of credit since they increase the need for money by producing a greater number of products with economic benefits.
This is how large banking institutions arise such as the Rothschild family bank, the Bank of France founded by Napoléon Bonaparte, the Federal Reserve of the United States, JP Morgan, The Deutsche Bank, and Bank of America, among countless other institutions that have prospered due to the centrality of money as a form of investment in the future to obtain benefits and increase the surpluses of companies, families, states and other institutions of society.
The new chapter in credit history
After the 2010s and with the arrival of new financial instruments such as cryptocurrencies (2008) and digital assets such as NTFS (in the 2020s), the role of banking in the modern world has had to be rethought. Today traditional banks no longer have a monopoly to generate loans. Many people today can request loans from unconventional entities such as cryptocurrency exchanges or neobanks.
Precisely entities such as neobanks are the companies that present the greatest challenges for traditional banks. Companies like Nubank provide their credit services completely online, which allows them to lower costs and make the distribution of money in the economy more efficient.
Many banks have already begun to migrate their services to digital options and have created subsidiary financial entities that work completely online, such is the case of entities such as Nequi, a subsidiary company of the Bancolombia group. Likewise, entities such as Lulo Bank, also in Colombia, emerged after the development of traditional banking entities, such as the GNB Sudameris bank.
The digitization processes of banking services and the entry of new players into the competition, which have gradually begun to break down traditional banking oligopolies, may end up creating greater efficiency in the credit market and making their participation more inclusive for sectors of society that had traditionally been excluded from the financial world.