Information, Trade, and the Origin of Banks

This paper puts forward an explanation for the origin and existence of banks based on the role of information in trade. We consider an economy populated by publicly “visible” institutions, that is institutions whose actions are observable by every agent in the economy. As long as the extent of trade is limited, these institutions can act as “fairs” and sustain trade by recording and disseminating information on agents’ behavior. However, as fairs progressively boost trade the speed at which they can disseminate information becomes too low relative to the speed of trade. When this occurs institutions can continue to sustain trade by transforming themselves into banks and issuing notes for the immediate payment of transactions. The visibility of banks prevents them from overissuing notes and hence renders notes valued in equilibrium.