Summary of the History of Central Banking

The origin of the central banking can be trace for about 400 years ago. As time goes by
the Central Banks have evolved into various stages to become what they are today. Many years
ago, precious metals such as gold or silver are used as the means of transaction for goods and
services. These metals are accepted as a medium of exchange and a good store of value.
Furthermore, these metals could be used as units of account as well.

As the society developed, the use of precious metals as a medium of exchanged are
formalized and standardized. The metals were made into coins with seals or signs certifying their
weight and value, which made it easier to classify. But in Europe during the seventh century,
risks about the usage of coins might occur, such us precious metal content became diminished or
people might intentionally clipped them. To avoid the risk related to coin usage, in 1609
merchants and the city of Amsterdam decided to set up the Bank of Amsterdam to the task of
sorting, classifying, and storing coins. Because of its success other European cities and sovereign
decided to set up banks along the lines of the Bank of Amsterdam.

In 1656, the Bank of Stockholm was established in Sweden inspired of the Bank of
Amsterdam. The bank took in copper coins and lent out against tangible assets such as real
estate. Five years later, when the amount of copper in newly minted coins was reduced, older
coins became more valuable. The public rushed to get their hands on older coins and a bank run
threatened the Bank of Stockholm's survival. As a solution they issue notes to credit called
kreditivsedlar to those depositors who wanted to withdraw their copper coins which becomes a
success until the Bank of Stockholm could not redeem notes at their face values and the
government had to intervene.

In 1668, the Swedish parliament approved a new bank to replace the Bank of Stockholm
and become the present-day Swedish central bank, the Sveriges Riksbank, the world’s oldest
central bank. But in the year 1819 the Bank of Amsterdam collapsed. Despite the demise of the
Bank of Stockholm, the use of banknotes as a medium of exchange survived and gradually
became embedded in our modern economies. In addition to serving as a center for traders,
Swedish Riksbank was established to lend money to the government. Later, numerous additional
central banks were established to aid in funding government expenditures, particularly funding
for wars. The Bank of England (1694), the Bank of France (1800), and the Bank of Spain (1782)
are some banks that helps to finance their government, spending and manage government
finances, these early central banks enjoyed close relationships with their governments, along
with good profits.

By the nineteenth century, the central banks' close ties to their governments and the
widespread acceptance of their banknotes, in many cases, their dominance on note issuance had
encouraged commercial banks to open accounts and deposit money with the central banks as
well, effectively turning them into their clients. The banker-to-banker role became more and
more pronounces as the foundations of modern started taking shape.
 Panics and bank failures were fairly common in early banking systems. Banks and other
financial institutions are accustomed to taking out short-term loans from depositors and then
lending those funds out as long-term loans. Different occurrences like poor harvests, defaults,
and conflicts could send bank depositors into a panic and prompt them to withdraw their money.
Banks may not be able to call in loans quickly enough to reimburse the depositors, placing
crippling pressure on them. The United States' return to central banking was prompted by the
requirement for a central bank to deal with financial panics. Bank panics and bank failures were
frequent during the 80 years that the United States was without a central bank. The United States
needed a central bank, and a major banking crisis in 1907 made that clear. As a result, the
Federal Reserve System was established in 1913.

Many central banks thought it useful to establish a formal authority to audit commercial
banks' operations, check commercial banks' books, and possibly issue regulatory orders to the
banks when judged appropriate in order to assure the safety and soundness of commercial banks'
operations ex ante. In other words, central banks began to take on formal regulatory and
supervisory roles for banks after assuming the lender-of-last-resort role.
Summary of the History of Central Banking