The Economic History of Banking

Among the most important functions of a financial system is intermediation: channeling the aggregate savings of an economy toward productive use.1 In the absence of intermediators, individuals, firms, and governments in need of finance and savers with surplus funds seeking investment opportunities would have to find each other and negotiate detailed contracts. These contracts would have to specify whether the funds are be loaned or to purchase a share of the enterprise. If loaned, the contract must stipulate the term and interest rate of the loan, as well as the amount and quality of collateral to be pledged as security. If the funds purchase an ownership share, the contract must stipulate the fraction of the profits and seats on the board of directors the new investor will be entitled to and, if the enterprise fails, how much liability will the shareholder bear. Without financial intermediators, negotiating such arrangements would be so costly and time-consuming that many worthwhile projects would go unfunded. The consequences for economic development would be severe. The importance of finance for long term economic growth has been debated for years