Credit is older than money. Yes, really.
Credit history is much talked about, but what about the history of credit — something that’s in all likelihood as old as human history itself. The idea of credit, logically, would have originated much before the idea of money itself. Or for that matter even before the system of barter took shape.
When a favour is extended on the promise of it being returned some day in the future, all that’s needed to enable that exchange is ‘trust’. It is only in the case of a lack of trust that you need a system of money or barter to facilitate trade.
When humans began to cooperate at scale or enjoy being devious, mere promise of a future repayment wouldn’t have been enough. This inherent mistrust would naturally make the lender want something of commensurate value then and there that would make for a barter or collateral.
But finding something of equal value is no easy task. And even if you do, it’s not necessary that the other party would find what you have to offer equally valuable.
Hence, emerged the idea of money — a unit of measure of value. The idea of money took physical form as currency — which evolved over time from shells and cowries to digital cash and now finally Central Bank Digital Currencies (CBDCs)
Therefore, in actuality, the history of money is really the history of servicing credit.
Then vs now
A neolithic farmer borrowing an axe from a mason to plough his field on the promise of grains after harvest is the stone age version of modern-day P2P lending.
The difference? Creditors and debtors now discover each other on a virtual platform. Of course, this is not to discount the complexities of P2P lending — rolling third party money is not the easiest business out there. This is simply to point out that the means of discovery may have changed, but the core remains the same. The earliest record of a credit system dates back to Mesopotamia that suggests that the fundamentals of credit have remained the same for well over 3500 years. In 1780 BC, the Code of Hammurabi set a ceiling on interest rates — 33% on grains and 20% on silver per annum. To be valid, loans had to be witnessed by a public official and recorded as a contract. Jump to 2022, we have RBI’s regulatory oversight on interest rates. Modern-day approvals and validations are generally done by intermediaries such as banks. And now that’s changing too. Smart contracts (self-executing agreements) are taking over, reducing transaction costs significantly.
The Code of Hammurabi
Earliest known banking was born in the temples of Mesopotamia. That’s because temples offered the best security to guard people’s wealth — thanks to fear of God. Today, wealth is stored as digital cash and is protected by a cyber security solutions stack.
Then came the Romans who extricated banking from the temples and formalised it within buildings. Not long after, Julius Caesar had to deal with widespread debt. He changed the law allowing bankers to confiscate land in lieu of loan payments. This led to a massive shift in power in favour of banks, diminishing borrowers’ clout including that of noblemen who were beyond all reach until then. Ever since, lenders have had the upper hand for the longest time. However, banking is now experiencing a diametrically opposite trend. Thanks to digital lending, the balance of power has now tilted towards customers.
Written in wax: Tibullus, a freedman, writes that he owes Gratus, another freedman, 105 denarii. Bloomberg tablet (top), London, 8 January AD 57, and transcription. photograph © Andy Chopping/MOLA.
A few centuries down the line, came the era of central banking. Joint stock banks were established in the seventeenth century, most famous being the Bank of England, to lend the government funds (for financing wars) and to act as clearing houses. Later, they began to consolidate various instruments that people were using for currency and provide financial stability. Thus came about the 'bank of banks' that regulate monetary policies — which now pull the strings from behind the stage, engineering the lending space. This is being increasingly proven by a growing volume of research that is attempting to quantify effects of monetary policy on credit.
Time did a 180 on credit-money relationship — from developing monetary systems to just service credit to having monetary institutions dictate and reign over the kingdom of credit.
This vintage cartoon shows how there was a widespread understanding in the early 20th century of the danger posed by private bankers if they were allowed to seize control of the financial system. Credits: divinecosmos.com
After having endured the dizzying complexity that comes with centralized regulation, the world is trying to get its head around decentralized finance, what’s popularly called DeFi. It is an emerging digital financial infrastructure that theoretically eliminates the need for a central bank or government agency to approve financial transactions. CNBC called it the ‘wild west’ of cryptocurrency and not surprisingly, it’s been on banking regulators’ hit list.
What changed, what didn’t
All said and done, the fundamentals of credit, the 5 Cs, have remained the same for a few millennia.
Capacity — an assessment of the borrower’s ability to repay
Capital — the borrower’s debt-to-income ratio
Character — the borrower’s credit history
Collateral — an assurance that backs the loan, that now ranges from gold to invoices to mere evidence of ample cash flows
Conditions — the purpose of the loan, the amount involved, and prevailing interest rates.
Only the channels and tools used to originate loans, assess risk, and collect loan repayments have changed.
If there’s one thing that hasn't changed other than the core principles of credit, it is the human proclivity to commit fraud. To get a further appreciation of the evolution of
frauds, we must look back in time. This is a subject that deserves a book of its own. So, we shall only brush over.
The first recorded instance of fraud dates back to 300 BC, Greece. At the time the policy was known as bottomry, wherein, a ship is used as security against a loan to finance a voyage and the lender loses money if the ship sinks. A gentleman named Hegestratos marked the advent of the history of frauds. Rather than repaying the loan with interest after safely arriving at the destination, he chose to sell the cargo, and destroy the ship. He was caught in the act and sadly met his fate trying to escape.
This was only the beginning. People, including administrators, got very creative thereafter. At the peak of bullionism — an economic school of thought that dominated 16th and 17th century Europe — people were convinced that wealth means money or gold. So, how do you amass wealth? By hoarding. So, the crown in its wisdom banned the export of gold and forced national companies to pay for imports with goods instead of money, so that gold does not leave the country.
An even brighter idea that the crown actually implemented was to raise the purchasing power of foreign currencies within its territory, so as to infuse an inflow of money from abroad, saving its precious gold. People, merchants, banks, and the crown itself resorted to illegal monetary techniques such as ‘clipping coins’ (reducing the metallic content of the currency in relation to face values). Well, the web of fraud goes far and wide.
Bottom line
Distance and lack of trust is what forced ancient humans to rely on intermediaries such as moneylenders and banks. Such intermediation arguably added to the efficiency. And now digital credit infrastructure is enabling disintermediation, furthering efficiency (this is not to suggest that banks will have no role to play, in fact, far from it, they will continue to be dominant players in the new economy of credit). However, as the credit juggernaut rolls on, it’s anyone’s guess whether our grandchildren will even recognize a bank note or a plastic card. Form factor could metamorphose from tactile instruments to invisible mediums (for eg. voice) but our intimate relationship with credit is likely to survive as long as our species does.