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Payment intermediation and the origins of banking

  • James McAndrews
  • William Roberds

The medieval banks of continental Europe facilitated trade by serving as payment intermediaries. Depositors commonly would pay one another by transferring bank balances with the aid of overdraft credit. We model this process in an environment of intermediate good exchange with incomplete contract enforcement. Our model suggests that the early banks were capable of accessing the "netting credit" that exists by virtue of there being a high proportion of offsetting transactions in an economy. Individual traders are unable to net their individual positions because of difficulty in enforcing contracts for future performance with the other traders. Banks, by standing between buyer and seller on a centralized basis, can internalize the offsetting nature of the whole set of trades. This original role of banks is still a vital one.

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Paper provided by Federal Reserve Bank of Atlanta in its series FRB Atlanta Working Paper No. with number 99-11.

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Date of creation: 1999
Date of revision:
Handle: RePEc:fip:fedawp:99-11
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  1. Douglas W. Diamond & Philip H. Dybvig, 2000. "Bank runs, deposit insurance, and liquidity," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Win, pages 14-23.
  2. Douglas W. Diamond & Raghuram G. Rajan, 1999. "A Theory of Bank Capital," NBER Working Papers 7431, National Bureau of Economic Research, Inc.
  3. Donald P. Morgan & Katherine A. Samolyk, 1998. "Piggy banks: financial intermediaries as a commitment to save," Staff Reports 50, Federal Reserve Bank of New York.
  4. Scott Freeman, 1993. "Clearinghouse banks and banknote over-issue," Research Paper 9326, Federal Reserve Bank of Dallas.
  5. Raghuram G. Rajan, 1998. "The past and future of commercial banking viewed through an incomplete contract lens," Proceedings, Federal Reserve Bank of Cleveland, issue Aug, pages 524-550.
  6. repec:cup:macdyn:v:1:y:1997:i:4:p:770-79 is not listed on IDEAS
  7. Douglas W. Diamond & Raghuram G. Rajan, . "Liquidity Risk, Liquidity Creation and Financial Fragility: A Theory of Banking," CRSP working papers 476, Center for Research in Security Prices, Graduate School of Business, University of Chicago.
  8. Nobuhiro Kiyotaki & John Moore, 1997. "Credit Chains," ESE Discussion Papers 118, Edinburgh School of Economics, University of Edinburgh.
  9. Edward J. Green, 1999. "Money and debt in the structure of payments," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Spr, pages 13-29.
  10. Bryant, John, 1997. "Coordination, Credit, And An Elastic Currency," Macroeconomic Dynamics, Cambridge University Press, vol. 1(04), pages 770-779, December.
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  13. Bernanke, Ben S, 1990. "Clearing and Settlement during the Crash," Review of Financial Studies, Society for Financial Studies, vol. 3(1), pages 133-51.
  14. Freeman, Scott, 1996. "The Payments System, Liquidity, and Rediscounting," American Economic Review, American Economic Association, vol. 86(5), pages 1126-38, December.
  15. Bengt Holmstrom & Jean Tirole, 1996. "Private and Public Supply of Liquidity," NBER Working Papers 5817, National Bureau of Economic Research, Inc.
  16. Williamson, Stephen D., 1992. "Laissez-faire banking and circulating media of exchange," Journal of Financial Intermediation, Elsevier, vol. 2(2), pages 134-167, June.
  17. Mark J. Flannery, 1991. "Debt maturity and the deadweight cost of leverage: optimally financing banking firms," Proceedings, Federal Reserve Bank of San Francisco, issue Nov.
  18. Diamond, Douglas W, 1984. "Financial Intermediation and Delegated Monitoring," Review of Economic Studies, Wiley Blackwell, vol. 51(3), pages 393-414, July.
  19. Baer, Herbert L. & France, Virginia G. & Moser, James T., 1994. "Opportunity cost and prudentiality : an analysis of futures clearinghouse behavior," Policy Research Working Paper Series 1340, The World Bank.
  20. Gorton, Gary & Pennacchi, George, 1990. " Financial Intermediaries and Liquidity Creation," Journal of Finance, American Finance Association, vol. 45(1), pages 49-71, March.
  21. Cooley Thomas F. & Smith Bruce D., 1995. "Indivisible Assets, Equilibrium, and the Value of Intermediation," Journal of Financial Intermediation, Elsevier, vol. 4(1), pages 48-76, January.
  22. Calomiris, Charles W & Kahn, Charles M, 1991. "The Role of Demandable Debt in Structuring Optimal Banking Arrangements," American Economic Review, American Economic Association, vol. 81(3), pages 497-513, June.
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