Sunday, May 10, 2009

how did bank loans evolve?

as society began using commodity money as a medium of exchange,a need for a safe place to deposit money developed.Early banks were depositories in which individuals paid a fee for the privilege of depositing commodity money such as gold.Due to the transactions costs associated with having to go to the bank to obtain gold to use in transactions,demand deposits (checking accounts)and bank notes emerged. As these forms of "paper money"became widely accepted as the medium of exchange,banks recognized they had much more gold in their vaults than they needed to honor demands for gold by depositors. Consequently,they began loaning out a fraction of their deposits to earn additional profits in the form of interest payments. Today,banks function as middlemen,or intermediaries,in financial markets by (1)borrowing sort and lending long,(2)pooling small deposits into large loans,(3)diversifying risk,and (4)economizing on transactions costs relative to engaging in direct finance.

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