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Banks
The other thing is in the 1600s they gave it deposit insurance, believe it or not,
the Duke of Sienna said he would guarantee all deposits. So deposit insurance
appears to have been invented in Italy, as well. But a lot of people emphasize
when they talk about the history of banking I was reading in preparing for
this history of economic histories to see what they would say about banking
and Professor Clive Day, a professor here at Yale wrote a book called Theory,
History of Commerce in 1907.
You can pick up his book, if you want to, on Google Books. It's past its
copyright. And I had great fun reading it. He's long gone Professor at Yale, but
his history begins in England with the so called Goldsmith Bankers. What
happened was in England in the six-, maybe 1500s, or 1600s, somewhere
around that, Goldsmiths who made gold jewelry had safes when they, good
places to store gold. And so people would go to the Goldsmith and maybe they
were having jewelry made, but then they'd say, could you keep some of my
gold in your vault?
And so the Goldsmith banker would say Alright, I'll do that, and I'll give you a
note saying I'll promise to pay you this amount of gold that's in my vault. So
sometime when you're out shopping, the Goldsmith banker's note would be in
your pocket still, and you'd want to buy something. So you'd say, Well, I've
got this, but you talked to the merchant and you'd say I've got this gold
that's in the Goldsmith I've got his note here. So the merchant would say,
Alright, I'll take that, but you've got to endorse it over to me. Write a note on
the note saying that this thing is being transferred to me. And so I can go to
the Goldsmith and get it out. And that's how paper money got started in
England, it started to circulate with many endorsements on it. And then finally,
the Goldsmith said, Let's forget about endorsing it through one person. Let's
just say to the bearer. And so that paper money started developing kind of
spontaneously.
And then the Goldsmiths noticed, you know, they've got all this gold in their
vault. They can lend it out. Why not? Because nobody ever comes and asks for
it. Now that these paper notes are circulating, nobody asks for it, so I'll start
lending it out. And they didn't have to pay any interest on the notes because
people would hold them anyway just because they valued the safekeeping. I
guess they were paying interest in the sense that they were providing the
safekeeping.
Commercial Banks
So that's how banking got started in England but it was really, preceded in Italy.
The most important type of bank is called a commercial bank. And these are
banks that take deposits. You can put your money in the bank and then, it will
pay you interest.
And it will also make loans of various kinds but most characteristically,
business loans. Commercial banks were the most even more prominent 100
or 200 years ago because they didn't do mortgages and consumer loans then.
It was all business loans, initially, so this is kind of the historic important kind of
bank.
And in 2010 the total assets, of US commercial banks, uh, of US located
commercial banks was 14.6 trillion. But actually, a lot of that was foreign
commercial banks operating in the United States, of that 14.6 trillion only, 10.1
was US charted banks. The bankers operate all over the world. So we have
banks like H I've mentioned Hong Kong and Shanghai Bank Corporation
(HSBC), or the various Swiss banks that have big operations or Deutsche Bank
big operations in the United States, so they account for almost a third of our
commercial banks.
But then there are other kinds of banks and they are smaller in terms of this
is assets of the banks. It's not their market cap, market cap would be much
lower, because remember, off setting these assets or liabilities, they owe to the
depositors.
Saving Banks
So but there's other kinds of banks. There are savings banks and in the US the
savings banks had only 1.2 trillion. These savings banks were generally they
tend to be old institutions that have grown very large over time. The result of a
savings bank movement in the 19th century which was a philanthropic
movement to set up banks for lower income people, because commercial
banks traditionally wouldn't take deposits from small, you'd have to have a
minimum size.
They didn't care about; they didn't deal with ordinary people. So they created
savings banks to encourage thrift and saving. Actually, it follows on a UK
movement, a savings bank movement in the UK, and they're still with us but
they're not as not so big.
Credit Unions
And there are also credit unions. That's another social movement, and they're
only 0.9 trillion, or about 900 billion in assets. Credit unions are basically clubs
of people that belong together in some group. So you can, if you have a
company, you can set up a credit union for the employees of your
company.there they make, both savings banks and credit unions make a lot
of mortgage loans. That's kind of their characteristic business.
I wanted to mention the theory of banks was laid out in the Diamond-Dybvig
Model. In The Journal of Political Economy 1988.
They were both colleagues of ours at Yale. They've moved on. So I know them
both. Doug Diamond and Phil Dybvig. But what they described is a mod
I'm not going to give you the model, just to tell you about it. The theoretical
model of banks as providers of liquidity. That liquidity is an economic good that
you can somehow get for nothing. It comes out of, well, it's just like portfolio
diversification we don't need to expend any resources to get diversification.
We just have to manage our portfolios right. Similar, you set up a bank and lo
and behold, liquity appears and it makes it possible for people to live their
lives better.
I mentioned how you can live in a house for 30 years or you can move
whenever you want. But the problem with it is that their multiple equilibri.
Their model has a good equilibrium and bad equilibrium and it depends on our
expectation that people think that the banking system is sound and it's going
to work well. It works splendidly but the problem is all it takes is for people to
suddenly change their expectations and then it falls apart, because you have a
run, you have a bank run. So what Diamond and Dybvig did is to provide an
economic rationale for deposit insurance. It's a system insuring deposits
against the default of the bank. Helps people, helps prevent bad outcomes.
Keeps us in the right equilibrium.