Abstract
Much of the current financial structure can be traced to three innovations in the 17th century. The first of these was the establishment of a system of bank transfers that has survived to this day in the form of cheque issuance and inter-bank transfers. The second was the foundation of fractional reserve banking that enabled banks to lend substantially more than the amount of deposits they carried on their books. The third was the creation of the Bank of England as the official issuer of bank notes, which were initially backed by gold bullion, and the keeper of bank reserves. The modus operandi of banking was twofold: on the one hand, a bank had to be able to guarantee its depositors that they could withdraw their money whenever they wanted; on the other hand, the same bank had to lend the funds out so it could generate income in order to be able to pay interest to encourage the depositors to place their funds. The three innovations were the original measures that made possible the institution of modern banking.1 Essentially reserve banking means that, if the reserve requirement is, for example, 10 per cent, a bank can lend out 90 per cent of say $100, that is $90, to another person who may deposit that amount at another bank, which in turn can lend out $81 to a third person, and this goes on to the next bank and borrower. The initial deposit of $100 has created loans of $171 and is capable of creating even further loans, so this is called the ‘multiplier effect’ in money creation, and this allows banks to greatly expand lending.
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Notes
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© 2015 Jes Villa
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Villa, J. (2015). Views of Banking Ethics. In: Ethics in Banking. Palgrave Macmillan Studies in Banking and Financial Institutions. Palgrave Macmillan, London. https://doi.org/10.1057/9781137340283_2
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