Bankers earn a living by lending money at interest, and also by charging offer certain services that they perform for their customers. In lending money they have to balance their natural desire to make a good living with the necessity to play safe and maintain a good liquidity position. Liquidity and profitability are direct opposites; one cannot have both at once.
If we lend money for long periods we earn a lot of interest, but if we lent so much that we have to stop our customers getting their money out when they want it we will be very unpopular.
The whole banding structure, a pyramid the second part the same pyramid inverted. The assets are now in the order of permanence. The whole banding structure is poised upon the tiny cash holding. If the general public eat into this cash base by withdrawing funds unexpectedly from the bank, even for the most worthy reasons, the whole unstable edifice of banking could come crashing down, and with it the economy of the nation.
The beginning of each World War the British Government’s first act was to close the banks. They feared that while people were worried and agitated about their own and the country’s situation, they might withdraw funds which would ruin the banking system. In a few days, when the public had grown accustomed to the idea of being at war, the banks re-opened without any serious effects upon their liquidity. Successful banding depends upon confidence- confidence in the political and economic stability of the whole country.
How the Basic Functions of Banking were developed
(i) Lombard Street- The first bankers in Britain were Lombards, from the Plains of Lombardy in northern Italy. Here had grown up a group of independent cities called the Lombard League. Merchants and traders from this cradle of European liberty came to do business in the City of London, and their home, Lombard Street, is still the centre of British Banking.
The Lombards, after a century or so of business in London, were eventually make bankrupt because they loaned money to kings who did not repay the loans. After the departure of the Lombards, banking came to be conducted by the goldsmiths as a sideline to their normal activities in the bullion and jewellery fields.
The early goldsmiths had to have large vaults which were soundly built and heavily guarded. The idea grew up of letting one of these goldsmiths take care of hour wealth if you had more than you could safely defend yourself.
The person who deposited his surplus funds with the goldsmith became take care of your wealth if you had more than your could safely defend yourself. The person who deposited his surplus funds with the goldsmith became know as a ‘depositor’ and naturally paid for the privilege of became known as a ‘depositor’ and naturally paid for the privilege of having his money defended in this way. These payments were called ‘bank charges.’ The depositor who needed funds, to pay wages or debts, could call at the bank and collect such sums as he required.
(ii) Origin of Bank Credit-The goldsmiths soon noticed that only a very small proportion if the funds of each depositor was in use regularly, being drawn out and paid in as funds were used or received. The proportion left on permanent deposit was about 92 percent of the average depositor’s funds. It seemed sensible to lend some of this money to people anxious to borrow for industrial and commercial reasons.
The two requirements for a sound credit policy are:-
(i) That the depositor whose funds are being used shall be content to leave them on deposit without making sudden demands upon the bank. To encourage this it is usual to pay interest to the depositor.
(ii) That the borrower shall be credit-worth, and shall offer-if requested-some security. This may take the form of a guarantee from some credit-worthy person, or the deeds of a hose or piece of land.
The latter is sometimes called collateral security, security lying alongside the debt. Life assurance policies are often used as security or small debts, and provided the surrender value is great enough they offer good security to the banker. Stocks and shares are often used as security.
During the course of the Industrial Revolution the banks had much to do with finding the necessary funds to finance the mines, mills and shipyards on which the property of Britain was built.
(iii) Origin of the Cheque System
Before long it became clear that unnecessary risks were being run by depositors who needed to pay money to creditors. The depositor had to collect the money and deliver it to the creditor who promptly had to return it to the bank.
Why not simply order your banker to transfer funds from our deposit to the creditor’s deposit?
This was the origin of the cheque system. A cheque is an order to a banker to pay money from your account to, or into the account of, another person without the need for the money to leave the safety of the bank.