Banks are rather curious institutions. While we may not recognize it today, the idea that your money is safer in the hands of a stranger is a tough sell. If a random person came up to you on the street and offered a quarter percent more interest for your savings, claiming his vault was more fortified than that of your current bank, would you accept his offer? We leave our money only with strangers we can trust, preferably a long established, well-regulated bank with an acceptable reputation. But remember that there was a time before banks. There was an era that saw people change from leaving their money under a mattress to leaving it with a bank. What convinced them to try out such a thing?
The Crucial 17th Century
It was the 17th century that saw the emergence of modern finance, and banking in particular. In London, it was the century of the creation of the Lloyd’s insurance market, the Bank of England, and its first informal stock exchange, Exchange Alley. It was the century that saw the emergence of paper banknotes issued by some of the first ‘modern’ banks. In Europe, it was also a century of disorder. Inflation, famine, and civil war wreaked havoc in Britain and on the European continent.
In the 1640s and early 1650s, both England and France were simultaneously experiencing civil war. The beginning of the century saw persistent inflation in Europe, especially in Spain, due to the importing of large amounts of new gold from the Americas. The 1600s also saw cooling temperatures around the world, the Little Ice Age, which caused famines in France, Scandinavia, and Estonia later in the century. So cold were some of those years that even the Bosphorus strait, separating Europe and Asia in modern day Turkey, froze over in 1622.
The 17th century was a formative one in finance in Europe but a dismal one in most other respects. You may ask how finance and banking overcame the disasters around it? It turns out you would be asking the wrong question. In fact, it was those disasters that were responsible for many of the financial innovations of that century, especially the creation of banks whose business models we would recognize today.
Prelude to the English Civil War
Disputes between King Charles I and Parliament led to the English Civil War in the 1640s. Charles I and his predecessor had attempted to govern without Parliament to the greatest extent possible by raising other sources of funds besides increasing taxes, which would have needed Parliament’s approval. Among the tools used were compulsory loans. In one scheme, various London guilds were forced to make a loan of £52,000 to the monarch, then James I. As it happens, the London guilds, which included a guild of goldsmiths, were given land in Ireland in exchange (specifically the area including Derry, which given this association with London would become officially known as Londonderry thereafter).
Just before the outbreak of the Civil War, Charles I confiscated £200,000 deposited in the London Mint, which as an official and fortified institution was thought of as a safe place to leave gold bullion and coins. Charles I eventually returned it only if the depositors loaned him money. You can see why this guy wasn’t too popular. The act shattered the reputation of the state Mint as a safe depository.
But it was the outbreak of war that saw the creation of a new kind of depository institution after the discrediting of the old one, the Mint. It also came, rather curiously, in the form of the London goldsmiths, mentioned earlier.
The political and economic turmoil of the 17th century and the civil war during which England was disintegrating would seem hardly the time to get into the banking business, but that was essentially what the goldsmiths of London did. To understand this, it is crucial to see how the war made clear that money was no longer safe at home. If I were a lord of the manor in 17th century England and I saw that my neighbor’s estate was plundered and house raided for valuables by marauding soldiers, I would certainly be more inclined to search for a safer place to put my money.
This is where the goldsmiths came in. The goldsmiths of course work with valuable gold and as such were smart about protecting valuables. Perhaps the troubled country lords could trust them with their gold. After all, the goldsmiths had their own vaults which were necessary to protect their precious raw material and inventories. The civil war led people who had money to deposit it with others who could better protect it, perhaps not out of trust, but out of desperation.
Though this is the common story of how London’s goldsmiths got into the business of taking deposits, it is not the full story. Remember that the London Mint had a vault too and that proved no match for Charles I’s decrees. The vaults of the goldsmiths were no safer. If the Mint could be raided for quick cash, why not the goldsmiths, especially now that the country was in the midst of civil war.
The goldsmiths were clever however; they knew that they could protect themselves from plundering, and make more money, if they never actually kept the gold on them. Rather, they would lend it out and keep none of it, or at least as little as possible, with them at any time. If anyone broke into the vault thinking they would find all the gold kept on deposit with the goldsmith, they would be disappointed. Rather than in a vault, depositors’ money was in the hands of numerous borrowers whom the goldsmiths had lent too. The money was safer lent in small sums to many people than kept in any vault. The dire situation of the war meant that the credit risk of lending was actually less than the storage risk of not lending. Notably, it was not stability and trust that created these institutions we would recognize as banks, but chaos and desperation.
Survival after the War
The scheme worked well enough that the concept of the goldsmith-banker continued long after the war. Goldsmiths continued to provide banking services, until the industrial revolution saw the founding of numerous new banks outside the goldsmithing trade. They survived even despite continued financial upheaval for the remaining part of the 17th century. For example, in 1672, King Charles II suspended all payments on state debts for one year and many of London’s goldsmiths had deposits invested in government debt obligations. The act drove at least some goldsmiths into bankruptcy.
But there are other legacies of this era of banking besides just the formation of banks themselves. It was also the period that saw the proliferation of paper banknotes. This was due to the way the goldsmiths tracked deposits. Instead of keeping records of the original owners of the deposits, they issued receipts which could then be traded to others. In this way, the deposits were payable to the bearers of the receipts, not necessarily to the original depositors. These paper banknotes became a preferred medium of exchange, in place of coins, and because banknotes became the new medium of exchange, these receipts were being issued both to those who had deposited money as well as to those who borrowed it from the goldsmiths. Thus, the goldsmiths also helped develop our modern conception of what money is and how it is created.
There are several interesting lessons here. The story of London’s goldsmiths teaches a lot about the birth of modern banking and the connection between banking and the nature of money. But it also reveals a surprise about the circumstances that saw the creation of banks. Despite all the importance placed on trust and stability for the development of a financial system, the conditions that saw the development of Britain’s earliest banks were characterized by anything but trust and stability. This isn’t to say that they are overrated, but it seems that convincing people to place their valuable gold with a stranger actually took some chaos and desperation but as they say, necessity is the mother of invention.
1. “Goldsmith Bankers.” Encyclopedia of Money, 2010.
2. “History of the Company.” The Goldsmiths’ Company, The Goldsmiths’ Company, 2016.
3. Kim, Jongchul. “How Modern Banking Originated: The London Goldsmith-Bankers’ Institutionalisation of Trust.” Business History, vol. 53, no. 6, 2011, pp. 939–959., doi:10.1080/00076791.2011.578132.
4. “Object 32: Goldsmith’s Ledger, 1671-72.” RBS History in 100 Objects, Royal Bank of Scotland, 2017.