How did banking begin?

Imagine for a moment that you are a merchant in ancient Greece or Phoenicia. You make your
living by sailing to distant ports with boatloads of olive oil and spices. If all goes well, you will be
paid for your cargo when you reach your destination, but before you set sail you need money
to outfit your ship. And you find it by seeking out people who have extra money sitting idle.

They agree to put up the money for your voyage in exchange for a share of your profits when
you return . . . if you return.

The people with the extra money are among the world’s first lenders, and you are among the
world’s first borrowers. You complain that they’re demanding too large a share of the profits.

They reply that your voyage is perilous, and they run a risk of losing their entire investment.

Lenders and borrowers have carried on this debate ever since.

Today, people usually borrow from banks rather than wealthy individuals. But one thing hasn’t
changed: Lenders don’t let you have their money for nothing.

Lenders have no guarantee that they will get their money back. So why do they take the risk?
Because lending presents an opportunity to make even more money.

For example, if a bank lends $50,000 to a borrower, it is not satisfied just to get its $50,000
back. In order to make a profit, the bank charges interest on the loan. Interest is the price
bor-rowers pay for using someone else’s money. If a loan seems risky, the lender will charge more
interest to offset the risk. (If you take a bigger chance, you want a bigger pay-off.)

But the opportunity to earn lots of interest won’t count for much if a borrower fails to repay
a loan. That’s why banks often refuse to make loans that seem too risky. Before lending you
money, they look at:

• how much and what types of credit you use, such as credit cards, auto loans, or other
  consumer loans;


• whether or not you have a history of repaying your loans, and


• how promptly you pay your bills.

Banks also use interest to attract savers. After all, if you have extra money you don’t have to
put it in the bank. You have lots of other choices:

• You can bury it in the backyard or stuff it in a mattress. But if you do that, the money will
  just sit there. It won’t increase in value, and it won’t earn interest.


• You can buy land or invest in real estate. But if the real estate market weakens, buildings
  and land can take a long time to sell. And there’s always the risk that real estate will drop
  in value.


• You can invest in the stock market. But like real estate, stocks can also drop in value, and
  the share price might be low when you need to sell.


• You can buy gold or invest in collectibles such as baseball cards, but gold and collectibles
  fluctuate in value. Who knows what the value will be when it’s time to sell? (In 1980, gold
  sold for $800 an ounce. By 1983, the price had sunk below $400.) Or you can put the money in a bank, where it will be safe and earn interest. Many types of bank
  accounts also offer quick access to your money.

Interest is the price borrowers pay for using someone else’s money.

Source from : http://www.bos.frb.org