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Finance always has a few giants
Markets as networks
Just as Google is the center of search in the United States and Baidu is in China, and just as Amazon has its network effect, a small set of commercial banks or market makers sits in the middle of the financial markets. Commercial banks are the ones that collect deposits and make loans.
The fast deer
The advantage of the middle is information: the firm at the center sees more and better of it. Economists call that information asymmetry, and it makes trading with a less informed person every day a good business. On Wall Street the broad public used to be described as the slow deer and Goldman Sachs or Morgan Stanley as the fast deer. Now the firms at the center may be Citadel, Jane Street, and Jump Trading.
Leverage and runs
Another recurring feature is leverage, which means borrowing money and trying to make money on the borrowed money. Banks do it. When they get into trouble, people want their money back, and that is a run on the bank.
Why do networks concentrate finance in a few firms?
A trader wants to deal where many others are quoting prices, because that is where buying and selling is cheap and fast. Each added trader makes a market more attractive to the next one. The firms in the middle also see more orders than anyone else, which lets them price risk better. This feedback loop is why a handful of intermediaries tend to sit at the center of each market.
How did the Medici bank work?
Giovanni di Bicci de' Medici founded the bank in Florence in 1397, and it later opened branches in cities such as Rome, Venice, Geneva, Bruges, and London. It moved money across borders with bills of exchange, which let merchants pay in one city and settle in another without carrying coins. Those bills also let lenders earn interest in ways that skirted the medieval church's ban on usury. The Medici family was expelled from Florence in 1494, and the bank closed soon after.
How does leverage lead to a bank run?
A bank keeps only a small share of deposits as cash and lends out the rest. If depositors fear that others will withdraw first, taking money out early becomes the sensible move for each of them. Economists Douglas Diamond and Philip Dybvig described this logic in a 1983 paper. Congress created the Federal Deposit Insurance Corporation in 1933 to stop the cycle in the United States.
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