From the fifteenth through the eighteenth centuries banks of deposit flourished in European cities with heavy traffic in international trade. Banks of deposit accepted deposits of domestic and foreign currency and held them as 100 percent reserves, as opposed to using the deposits to finance loans. This policy of retaining possession of the deposits maximized the safety of depositors’ money. Records of each merchant’s deposits were kept in account books, and funds were shifted from one depositor’s account to another’s account without coinage leaving the bank. These deposits constituted so-called bank money, which is a form of money that changes ownership by bookkeeping entries without any coinage or receipts changing hands. This bank money became the principle circulating medium in commercial transactions.
When Italian banks of deposit first emerged in the fourteenth century they required the payer and the payee to appear in person to transfer money in the bank’s account books from one account to another. Later it became possible for the payer and payee to meet elsewhere if a notary was present. In 1494 Fra Luca Pacioli, a Renaissance mathematician and friend of Leonardo da Vinci, published a book famous for including the first written treatment of double-entry bookkeeping. In the tract on double-entry bookkeeping, he gave the following description of banks of deposits:
It is common practice to deal directly with a transfer bank, where you can deposit your money for greater security or for the purpose of making your daily payments to Piero, Giovanni, and Maratino through the bank, because the registration of the transferred claim is as authoritative as a notarial instrument since it is backed by the government. Now suppose you are a banker performing a transfer: If your creditor, without withdrawing cash, orders payment to another party, in your journal you debit that depositor and credit the assignee. Thus you make a transfer from one creditor to another, while you yourself remain debtor. Here you function as an intermediary, a witness and agent of the parties and you justly receive a commission.”
(Lane & Mueller, 1997)
Adam Smith, in a famous digression in the Wealth of Nations (1776), described the class of banks called banks of deposit. He identified the banks of Venice, Genoa, Amsterdam, Hamburg, and Nuremberg as institutions founded as banks of deposit. According to Smith, the currency of small states was made up almost exclusively of the coinage of neighboring states, leaving a small state virtually no control over the quality of its circulating medium. These foreign currencies, becoming worn and clipped, traded at a discount in foreign exchange markets, acting as a hindrance to merchants in the small states. Because small states could not reform domestic currencies, which was mostly foreign, they established public deposit banks as a substitute. Banks of deposit accepted deposits of all currency, new and worn, and exacted a discount of perhaps 5 percent for currency depreciation from wear and tear. The government of the state guaranteed the value of the bank deposits. These deposits, which changed ownership only by means of bookkeeping entries in the bank, represented a uniform quality and, for that reason, often traded at a premium over metallic coinage. According to Smith, the premium on the bank money of the Bank of Hamburg was 14 percent over the clipped, worn, and otherwise diminished currency that poured in from surrounding states.
Aside from the state’s commitment to maintain its integrity, bank money had several advantages over metallic currencies of varying consistencies. According to Smith in his Wealth of Nations (1776):
Bank money, over and above its intrinsic superiority to currency, and the additional value which this demand necessarily gives it, has likewise some other advantages. It is secure from fire, robbery, and other accidents; the city of Amsterdam is bound for it; it can be paid away by a simple transfer, without the trouble of counting, or the risk of transporting it from one place to another.
(Smith, 1952)
Perhaps the growth of paper money during the Napoleonic era put an end to banks of deposit. Unlike coins, paper money could not be debased by “clipping” bits off of it. Thus, the problem of coins with varying degrees of wear and tear was no longer an issue after the advent of paper money. The Bank of Hamburg inherited the precious metal trade from the Bank of Amsterdam and remained active in that trade until 1814, when the Bank of Hamburg was converted into the Netherlands Bank, a different type of institution.
