Domestic and Multinational Banking: The Effects of Monetary Policy by Rae Weston

Part 1 
THE NATURE OF BANKING 

1 THE ORIGINS OF MODERN BANKING 
'Many banking practices are a response to regulation and 
would not exist if banking were unregulated.' (Fischer Black, 
'Bank Funds Management in an Efficient Market', Journal of 
Financial Economics, vol.2 (1975), p.324.) 
The antecedents of modem banking appear to be the activities of gold-

smiths in seventeenth-century England -who, of necessity requiring 
strongrooms to hold the materials of their trade, found that they were 
able to rent out the excess space for the safekeeping of money and 
other valuables. From the provision of this facility there developed the 
practice of customers depositing money in return for a receipt or 
certificate of deposit, and gradually not requiring the identical coin 
they had left but merely coin of equal value. In practical terms the 
goldsmiths assumed ownership of the coin on deposit and employed it, 
but they always held sufficient to convert certificates of deposit on 
demand. From this beginning of deposit-taking, the goldsmiths next 
began the practice of chequing when they enabled a merchant who 
wished to pay another merchant to write an order to his goldsmith 
asking for the transfer of money from his account to that of his creditor 
without having his deposit certificate converted into coin. 
These early embryo commercial banks commenced the issue of notes 
in small denominations instead of issuing one certificate of deposit to 
cover a customer's deposit and as these notes became generally accept-

able for payment the goldsmiths made them payable to bearer. After 
their notes began to circulate as a medium of exchange it became 
possible for goldsmiths to make loans by using the notes not in return 
for a deposit of coin but for a promissory note given to the goldsmith 
by the borrower. Provided that not all notes were returned simul-

taneously for conversion into coin, notes could be issued for a greater 
value than the goldsmiths held in coin. In most circumstances the gold-

smiths were able to predict with considerable accuracy the amounts 
of coin that were likely to be redeemed from them. However, when 
depositors as a whole decided to convert their paper money into coin, 
as happened for example when news of the destruction of the British 
fleet at Chatham reached the country in 1667, the goldsmiths were 
unable to satisfy the demand and became bankrupt. 
Not only goldsmiths but also merchants issued notes only fractionally 

Domestic and Multinational Banking: The Effects of Monetary Policy by Rae Weston