One of history’s most important financial innovations was banking, which was closely bound up with credit. The main problem spurring on this development was the need to safely transport large amounts of cash over long distances in order to carry on trade across Europe. Such journeys were particularly beset by two dangers: natural disasters, especially storms, and attacks by pirates or brigands. Luckily, there were two parties with complementary needs that led to a solution. One was the Church, which needed to send its taxes to Italy from all over Europe. The other consisted of Italian merchants who wanted to take money from Italy to destinations across Europe in order to carry on trade.
At some point, a merchant started sending agents to other countries to trade. However, instead of carrying cash, they had letters of credit that they would present to local Church officials in return for cash that they could use there for trading. When they or church officials returned to Italy, they would bring letters of credit worth the amount borrowed from the Church and present them to the Italian merchant who would then give the church the money he owed them. In that way, both parties could transfer large amounts of money across Europe without carrying any cash.
As this practice caught on, there were other people who wanted to transfer funds across Europe without the risks that came from traveling with cash. Therefore, they would deposit cash with a merchant who had branch offices all over Europe, take a letter of credit to their destination, and reclaim their cash from the merchant’s branch office there. Naturally, the merchant would charge a fee for this service. He would also use the money deposited with him for his own business deals, hopefully making a profit on the depositor’s cash before he reclaimed his money. Thus was born our modern institution of banking, an essential ingredient in the capitalist system.