A History of Lending: Part II- The Emergence of Modern Banking
By the late 16th and early 17th century, the traditional banking functions that we know today had developed. The more standardized issuance of bank debt grew from the practice of goldsmiths owning private vaults where they would charge a fee to wealthy merchants for holding precious metals. Eventually, the goldsmiths began to lend money out on behalf of the depositor, and a fractional-reserve banking developed. While simple practices were sufficient at first, commercial and industrial growth necessitated the expansion of banking practices. This, in combination with the need to fund combative European states, fueled the creation of central banks, and the phenomena of “discounting” business debt came into being.[i]
The Industrial Revolution and growing international trade broadened the scope of banking immensely. In particular, Mayer Amschel Rothschild is credited as the pioneer of international finance.[ii] After working at the firm of Wolf Jakob Oppenheimer, who provided credit to royalty and engaged in international trade, Rothschild returned to his brother’s business in Frankfurt to help expansion efforts. By the turn of the century, he had sent his sons to establish banks in the major European cities of Frankfurt, Naples, Vienna, France, and London.
Following a steady development of centralized banks, building societies began to spring up in the late 18th century. Social movements of the time that promoted the idea of cooperation and mutual benefit and increasingly sophisticated financial practices greatly impacted their creation.[i] At conception, the building societies existed to provide members with houses paid for out of their combined funds. The group would agree to pay a certain amount for a given period of time and then purchase the land to build on. Members would continue making payments to the collective until all of the houses were complete and debts were settled. By the early 19th century, the societies started to act more as savings institutions than building communities. Shortly thereafter, they made their way to the United States.
In 1816, the Philadelphia Savings Fund Society was founded as the first savings bank to do business in the United States, followed by the Oxford Provident Building Association.[ii] The mutual savings bank idea spread to other states in the Northeast, and by 1930 there were 592 savings banks in operation that had combined assets of just under $11 billion.[iii]
In 1913, Congress established the Federal Reserve System under President Woodrow Wilson. It was a decentralized central bank that balanced the competing interests of private banks and populist sentiment.[iv] The economy following the creation of the Federal Reserve system experienced a boom as a result of World War I. European countries needed to purchase larger amounts of US goods which lead to an influx of capital.[v]
Following the war, the Great Depression spurred the creation of the Federal Home Loan Bank Act of 1932 by the Hoover administration. The Act was intended to encourage home ownership by providing a source of low-cost funds for banks to extend mortgage loans, ushering in a new era of mortgage financing.
The 1950’s introduced technology into the practice of lending…stay tuned for part three on the History of Lending for more.