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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 New York in its series Staff Reports with number 85.

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Date of creation: 1999
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Handle: RePEc:fip:fednsr:85
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  1. Raghuram G. Rajan, . "The Past and Future of Commercial Banking Viewed through an Incomplete Contract Lens," CRSP working papers 337, Center for Research in Security Prices, Graduate School of Business, University of Chicago.
  2. Bengt Holmstrom & Jean Tirole, 1996. "Private and Public Supply of Liquidity," NBER Working Papers 5817, 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. Flannery, Mark J, 1994. "Debt Maturity and the Deadweight Cost of Leverage: Optimally Financing Banking Firms," American Economic Review, American Economic Association, vol. 84(1), pages 320-31, March.
  5. Bryant, John, 1997. "Coordination, Credit, And An Elastic Currency," Macroeconomic Dynamics, Cambridge University Press, vol. 1(04), pages 770-779, December.
  6. Douglas W. Diamond & Raghuram G. Rajan, 2000. "A Theory of Bank Capital," Journal of Finance, American Finance Association, vol. 55(6), pages 2431-2465, December.
  7. Scott Freeman, 1993. "Clearinghouse banks and banknote over-issue," Research Paper 9326, Federal Reserve Bank of Dallas.
  8. Edward J. Green, 1996. "Money and Debt in the Structure of Payments," Macroeconomics 9609002, EconWPA, revised 09 Sep 1996.
  9. Stewart C. Myers & Raghuram G. Rajan, 1998. "The Paradox Of Liquidity," The Quarterly Journal of Economics, MIT Press, vol. 113(3), pages 733-771, August.
  10. 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.
  11. Freeman, Scott, 1996. "The Payments System, Liquidity, and Rediscounting," American Economic Review, American Economic Association, vol. 86(5), pages 1126-38, December.
  12. Douglas W. Diamond & Raghuram G. Rajan, 1999. "Liquidity Risk, Liquidity Creation and Financial Fragility: A Theory of Banking," NBER Working Papers 7430, National Bureau of Economic Research, Inc.
  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. Diamond, Douglas W & Dybvig, Philip H, 1983. "Bank Runs, Deposit Insurance, and Liquidity," Journal of Political Economy, University of Chicago Press, vol. 91(3), pages 401-19, June.
  15. repec:cup:macdyn:v:1:y:1997:i:4:p:770-79 is not listed on IDEAS
  16. 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.
  17. Gorton, Gary & Pennacchi, George, 1990. " Financial Intermediaries and Liquidity Creation," Journal of Finance, American Finance Association, vol. 45(1), pages 49-71, March.
  18. 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.
  19. Bryant, John, 1980. "A model of reserves, bank runs, and deposit insurance," Journal of Banking & Finance, Elsevier, vol. 4(4), pages 335-344, December.
  20. Nobuhiro Kiyotaki & John Moore, 2004. "Credit Chains," ESE Discussion Papers 118, Edinburgh School of Economics, University of Edinburgh.
  21. Williamson, Stephen D., 1992. "Laissez-faire banking and circulating media of exchange," Journal of Financial Intermediation, Elsevier, vol. 2(2), pages 134-167, June.
  22. Diamond, Douglas W, 1984. "Financial Intermediation and Delegated Monitoring," Review of Economic Studies, Wiley Blackwell, vol. 51(3), pages 393-414, July.
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