Banking. A raison d'être. Efficient Capital flows

Having defined the scope, Partitioning and the Primitivization techniques can now be used to start building the Retail banking system.  In this blog the word core banking is used for all of retail banking.  The two words are used interchangeably.

Partitioning is not really required as retail banking is not such a complex system.  Partitioning would have been necessary if either the system was complex or it was perceived to be complex because of limitations of domain knowledge.

Primitivization will be the primary technique used for designing the core banking system.  To recap Primitivization requires that we reduce he system to its core behaviors.   Identification of core behaviors require an exploration of the Primary need serviced by the bank i.e. the reason for which banks exist.

The starting point for building a resilient core banking system then is to explore the raison d’être’s of a bank.  History or rather the origins of the system (in this case banking) provides a useful starting point for understanding what fundamental need does a system fulfill.  This is because at the very beginning of the evolution, the functions that a system performs, caters only to the very essential needs. It is only with passage of time that the subsequent layers of sophistication, that obscure the essential purpose of the system, get added. 

If one looks at the origins of banking, the needs that a bank satisfies are of a simple kind. These are needs that arise early in a community that engages in commerce or industrial activity.

The essence of commerce is the exchange of value.  Often commerce started not with money but with barter as a fundamental tool.  Barter required a system to equate goods of different nature.  The practice of Barter introduced the fundamental concept of “value”.   It required for instance two bushels of wheat to be say equal in value to 1 bundle of silk. Such a system that worked on value-pairs could work as long as, the number of commodities traded were limited.  As the number of commodities multiplied the number of value-pairs to be maintained increased exponentially and made the system too complex to sustain itself. 

Burgeoning commerce led to the emergence of a standard measure of value, which in the early stages was often Grain or Silk.  All commodities were equated in value to certain amount of Grain or Silk.  This laid the foundation for emergence of Money as the store of value.  In due course of time different kings introduced their own coins that acted as a value store.  It was often the responsibility of the kingdom’s treasury to issue the coins.

This function of issuing of money is today performed by the central banks of the country. This is the essential function of the Central banks of the world.  I will build upon this in a later blog when I discuss how to design a resilient central banking system. The current blog is dedicated to building a resilient core banking system and hence I will return to the topic of commerce.

The creation of coins i.e. currency removed significant friction from trade. It allowed people to trade more easily. As the trade flourished, traders desired to expand their operations. Since the capacity to trade was limited to goods that one had, there was a natural desire to increase this capacity by borrowing. The advent of money allowed people to borrow from each other more easily and use that borrowing capacity to be deployed in trade.   

This fundamental need for borrowing is at the root of banking.  As trade flourished further, the process of borrowing capital from individuals became the constraint.  In response to this constraint emerged large lenders who had surplus money with them.

Commerce often resulted in surplus money with merchants from time to time.  So while on the one hand commerce related pockets of demand for money and on the other it created pockets of surplus money.  This surplus money sough both safety from theft as well as avenues for gainfully deploying that surplus.  The process of connecting pockets of demands with pockets of surplus money was not efficient when individual merchants became moneylenders.

Banks emerged in respond to the need for efficiently connecting the “surplus pockets” to “demand pockets”.  

This – the need to efficiently connect surplus pockets of capital with demand pockets – is the fundamental raison d’être for which a bank exists.

In the process of acting as a connector it serves two powerful needs of the economic being

(1) The need to borrow capital to embark upon enterprises beyond their means

(2) The need to seek a return on surplus capital