While the idea of banking dates back to the Renaissance around the 14th century in Italy, its earliest forms hardly resemble the modern structure we are familiar with. Banking is a business and as a business, they are constantly trying to generate and maximize profits. So how exactly do banks generate revenue?
The key lies in fractional reserve banking and promissory notes, which find their origins from the goldsmiths of Old England. Essentially, the more account activity from you, the customer, the higher profits they receive.
How Banking Came To Be
In the early 17th Century fractional reserve banking was born. Businessmen and traders would need a place to store gold which was the common currency of the time.
Goldsmiths took advantage of this need by storing a person’s gold in a vault. As this practice became more popular, goldsmiths had the opportunity to lend out money from the different deposits made by his customers. The goldsmith would pay interest on the deposits and a promissory note would be issued.
Promissory Notes and Fractional Reserve Banking
The promissory notes were payable on demand, and the loans to the goldsmith's customers were repayable over a longer period of time. This became the basis of fractional reserve banking, where a trusted line of credit was established by the goldsmiths.
Because of the availability of money and only having to repay loans over long periods of time, goldsmiths we able to give out loans with little risk of default.
Unfortunately this same process is what plagues our economy today.
This system has made it possible for banks to lend out the majority of money a person deposits with every transaction, resulting in high profits. Not only are banks benefiting from every deposit you make, but now they are charging for debit card transactions.
Because they see it as a convenience for you, their customer, to have a debit card with their bank, they will now charge you for using it. The fees will not only charge you for taking out your own money, but tax you on every purchase.
Banking is a business. CEO’s are increasingly becoming more greedy and continuously find ways to suck money from their clients. The 1-2% interest that you accrue on your account may annually is most likely null compared to the fees and taxes you end up paying.
Banks generate revenue in a variety of schemes. All of them revolve around customer activity. Without customers borrowing money and depositing money into checking or savings, the banks would have no purpose.
This relationship between customer and institution is how banks thrive. The more activity, the more money available for loans, the more profit they generate.
Our financial system has turned into a game of what interest rate will be higher, what rate are they are given out at and what rate must the loans be paid back at.
Those rates are what bankers and economists use as a gauge to determine the strength of the economy and its financial institutions. You better believe that banks benefit from increased activity from its account holders.
Check out more of our personal finance articles