Banking, Definition of Banking, Historical evolution of banking, Importance of Banking in the Economy

Banking Introduction 

Banking can be defined as a financial intermediary that accepts deposits, makes loans, and provides other money-related services, such as financial management and products like mutual funds and credit cards. 

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Banks derive profit from the difference between the costs of attracting and servicing deposits and the income they receive through interest charged to borrowers or earned through securities.

Banking, Definition of Banking, Historical evolution of banking, Importance of Banking in the Economy

Definitions of Banking 

“Banking is the business of receiving deposits, making loans, and providing other financial services to individuals and businesses.” – The Federal Reserve Bank of San Francisco

“Banking is the process of storing and lending money. Banks are financial institutions that accept deposits from customers and use those deposits to make loans to other customers.” – Investopedia

“Banking is the system of managing money and credit. It includes the activities of banks, other financial institutions, and the government.” – The World Bank

“Banking is the business of providing financial services to individuals and businesses. These services include accepting deposits, making loans, and providing other financial products and services.” – The American Bankers Association

Historical Evolution of Banking

  1. Ancient origins
  2. Early banking
  3. Merchant banking
  4. Specialization

Ancient origins

Banking can be traced back to ancient Mesopotamia, where temples, royal palaces, and some private houses functioned as storage facilities for valuable commodities like grain. 

The ownership of these commodities could be transferred through written receipts. Temples in Babylon were known to make loans as early as 2000 BCE.

Early banking

Companies of traders in ancient times provided banking services, dealing primarily in coin and bullion. Their businesses involved money changing and supplying foreign and domestic coins of the correct weight and fineness. 

Full-fledged banks emerged in medieval times, specializing in depositing and lending money and creating generally spendable IOUs.

Merchant banking

 In Europe, “merchant bankers” assisted merchants in making distant payments using bills of exchange instead of actual coins. They played an essential role in facilitating international trade and held assets at different points along trade routes.


By the 16th century, banks in Europe could be divided into two classes: exchange banks and banks of deposit. Exchange banks, such as the Bank of Hamburg and the Bank of Amsterdam, dealt with foreign exchange and facilitated trade with other countries. 

Banks of deposit, like the Bank of England, the Bank of Venice, and the Bank of France, received deposits, made loans, and became associated with the trade and industries of a country.

Importance of Banking in the Economy

  1. Facilitating trade
  2. Lending and investment
  3. Safekeeping of assets
  4. Financial management
  5. Money creation
  6. Monetary policy

Facilitating trade: Banks have played a significant role in facilitating trade since ancient times. They have provided a means for merchants to make distant payments and exchange currencies, thereby promoting global commerce.

Lending and investment: Banks provide loans to individuals and businesses, enabling them to invest in projects, purchase goods and services, and expand their operations. This stimulates economic growth and creates jobs.

Safekeeping of assets: Banks offer a secure place for individuals and businesses to store their money and other valuable assets, protecting them from theft or loss.

Financial management: Banks offer financial management services. Such as investment counselling and portfolio management, assisting people and businesses in making informed financial decisions.

Money creation: Banks play an important part in money creation through the practise of fractional reserve banking. In which they lend out a portion of their deposits while keeping a fraction as reserves.

This process increases the economy’s money supply and influences interest rates, which affects investment, consumption, and economic growth.

Monetary policy: Central banks, such as the Federal Reserve in the United States, play an important role in executing monetary policy. In order to maintain price stability, limit inflation, and ensure the financial system’s smooth operation.

Banking Evolution Over Times

  1. Central banks
  2. World War II and modern banking
  3. Digital banking

The establishment of central banks

The formation of central banks, such as the Federal Reserve in the United States in 1913, marked a significant shift in the banking sector. Central banks were created to regulate the banking system, maintain financial stability, and implement monetary policy.

World War II and modern banking

World War II played a crucial role in saving the banking industry from complete destruction. The massive financing required for the war led to the creation of companies. With huge credit needs, spurring banks into mergers to meet the demand. These large banks spanned global markets, and the advent of deposit insurance and widespread mortgage lending led to increased consumer confidence in the banking system.

Digital banking

Since the late twentieth and early twenty-first centuries, digital banking has profoundly revolutionized the financial business. The introduction of online banking, which took off with the growth of the internet in the mid-1990s. 

It has had a significant impact on how banks operate and how their consumers engage with them. According to a 2021 J.D. Power survey, the growth of smartphones and mobile banking apps has expedited this trend, with 41% of clients going digital-only.

The 55+ age group saw the greatest increase in utilisation of online web banking, with 60% utilising it more frequently. 

Among those who have used digital banking services more since the pandemic began, 35% of 18-24 year olds increased their usage, followed by 32% of 25-34 year olds and 31% of 35-44 year olds.

Digital transformation has led to significant disruption in the banking sector, with both start-ups and established banks innovating. And adapting to new business models. 

The emergence of FinTechs has contributed to this disruption, with new opportunities in terms of business models and the optimization of costs through intelligent automation.

However, digital transformation also presents challenges for banks, including strategy, leadership, and attracting and retaining digital talent. As the digital landscape continues to evolve, banks must adapt and invest in new technologies to stay competitive and meet customer expectations.

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