I'm doing a medieval fantasy project and I wanted to include a banking faction. The main issues I've run into are: banks during the middle ages don't seem to be profitable.
What factors would allow banking to be profitable in the middle ages (specifically the high period, approximately 1000 to 1250)?
What changes to the economy would be necessary to allow the bank to make profit off of the mainly barter economy that was common throughout Europe?
I would refer you to Pratchett's excellent "Making Money" novel. Obviously, it is satirical and simplistic, but it captures the core principle, in my opinion.
Medieval understanding of economy suffered from the idea that the price of the goods depends on their inherent value. So the preoccupation with valuable metals in coin also strongly depended on the feeling that gold and silver had inherent value.
Minting coins was the prerogative of kings. One of the kinds of bankers that existed in Middle Ages was moneychanger. But the only profit a moneychanger made was from skimming the tops from the conversion between different kinds of coin.
In order for banking to make significant profit before the 14-15th centuries, when there were all those business ventures and high-volume trade, minting coin should've been outsourced to a banking clan.
Depending on the particularities of a state on question and the level of trust from other states to its economy, this idea can just as easily flop.
Banking has actually been around for a very long time. The first examples were merchants from ca. 2000 BCE who made grain loans to farmers and traders carrying good between cities.
Money lending was common in the Roman empire, with common interest rates of 4-12 percent, but they could be as high as 48 percent. The first Council of Nicea (AD 325) forbade the clergy from lending money at interest (usury).
Merchant banks emerged in the Middle Ages from the Italian grain and cloth merchants community and started to develop in the 11th century during the large European fair of St. Giles in England.
In medieval Europe, an early example of banking was during the Crusades. Henry II levied a tax in 1167 to finance his crusade, and the Knights Templar functioned as his bankers in the Holy Land. According to Wikipedia,
The Templars' wide flung, large land holdings across Europe also emerged in the 1100–1300 time frame as the beginning of Europe-wide banking, as their practice was to take in local currency, for which a demand note would be given that would be good at any of their castles across Europe, allowing movement of money without the usual risk of robbery while traveling.
The answer to your question then seems obvious: Banking establishments in early medieval times did, in fact, make money from charging interest on loans, and from making promisory demand notes, and hence, your banking establishment could do the same.
You could also introduce the more modern banking practice of borrowing and lending: Banks keep people's money safe while giving a small interest, and then lend the money out to others at higher interest rates. Trust in banks might be an issue, and banking crises have been known since the 13th century.
Banks would hold money for persons without the private wherewithal to do so effectively - travelling merchants for example do not want to carry their wealth and do not have guarded castles to hide it in.
Banks would lend money to fund potentially profitable endeavors - probably to the same travelling merchants. An expedition has up front expenses and requires money, which a profitable expedition will recoup. The bank will provide the upfront money.
If the endeavor was profitable the bank would be repaid with the principal and interest, or the principal and a percentage of the profit of the endeavor.
This is how banks and investors work now. The key to profitability would be identifying profitable endeavors undertaken by persons likely to pay their debts. Identifying a profitable endeavor requires some skill, but a bank might judge that a group who had travelled to Cathay and returned with saleable silks twice before could do it again and so would be a good risk. A person who hoped to get loans again in the future would be likely to repay a debt. A person with valuable but illiquid collateral held by the bank would be likely to repay a debt to reclaim the collateral. A high born person who is not afraid of the bankers and is capable of reclaiming collateral by force would be a poor risk.
This is not that creative. The creative piece can be the profitable undertakings that the banks underwrite, and how the bankers arrange to be repaid. Merchants will be their main clientele as above. I could imagine mercenaries or princes wanting a loan to equip themselves for military ventures; the bank would have to think about how to do that with minimal risk.
They could sell promissory notes to merchants who want to travel without bags of coins. Once that's a going thing, they could buy notes at a discout if the note is due inconventiently far away.
They could become investment banks, giving loans to finance the seed for the next harvest, or wool for a weaver.
You will need to change whole economic system.
Banking is profitable when money flows through the bank.
Money will flow when you have a lot of trade going on.
You will have trade when people start producing with surplus.
To produce surplus you may need to turn medieval produce-everything-locally system, to specialized-production-centers system.
You need a continwntal wide program to kill rats.
Raise cats. Work on a cultural shift that makes them super popular.
Also make baths great again. The romans had public baths and they thought being clean was cool.
If people are not dying left and right due to the Plague, they will have more time to work and be productive. This will boost all businesses, not only banks. This is mportant because banking is not a profitable business model when your only clients are gravediggers. The church was its own bank, and barbarians didn't save.
