Banking

B

The European Continent

Until recently, European banking was very different from banking in the United States. European banks were frequently owned by the government and could engage in activities that were prohibited to banks in the United States. Most of these prohibited activities involved investment banking such as security underwriting (selling a firm’s stock or bonds at a guaranteed price) or security placement (finding buyers for a firm’s stock or bonds). These services are important to businesses and being able to provide them gave European banks an advantage over U.S. banks. These differences are rapidly disappearing. Most European banks are now privately owned and recent U.S. legislation has allowed U.S. banks to engage in investment-banking activities through the bank holding company form of organization.

Two differences remain between U.S. and European banking. The first is that many European banks can own nonbank commercial and industrial businesses. Such ownership is still prohibited, for the most part, for U.S. banks and holding companies. As a result, banks in Europe tend to be more business oriented and much more involved with corporate governance (corporate decision-making) than their U.S. counterparts. This also explains why most European companies rely more heavily on bank loans to finance their activities than do U.S. companies which rely more on funds raised by selling stocks and bonds in financial markets.

The second difference is that banking is much more concentrated in Europe. In other words, banking markets are dominated by a few large banks whereas in the United States many banks compete for a customer’s deposits and loans. This stems from the fact that European countries have had very liberal branching laws allowing banks to have extensive deposit-gathering networks in their home country and also from the fact that most European countries are not as concerned about monopolies as are U.S. regulators. It is not clear how long this difference will last, however, as legislation in the United States in 1994 allowed banks to establish banks and branches in other states.

The establishment of the Economic and Monetary Union (EMU) in 1992 created a new banking system in Europe that parallels that of the United States in many ways. The EMU created a new European Central Bank (ECB) that will coordinate monetary policy throughout most of continental Europe. It also established a uniform currency in Europe called the euro that beginning in 2002 was the currency used throughout Western Europe, except in Denmark, Sweden, and the United Kingdom. The EMU also allowed banks to branch throughout Europe and not just in their home country.

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C

United Kingdom

Since the 17th century Britain has been known for its prominence in banking. The capital, London, still remains a major financial center, and virtually all the world’s leading commercial banks are represented there.

Aside from the central Bank of England, which was incorporated, early English banks were privately owned rather than stock-issuing firms. Bank failures were common; so in the early 19th century, stock-issuing banks, with a larger capital base, were encouraged as a means of stabilizing the industry. By 1833 these corporate banks were permitted to accept and transfer deposits in London, although they were prohibited from issuing money, a prerogative monopolized by the Bank of England. Corporate banking flourished after legislation in 1858 approved limited liability for stock-issuing banks. The banking system, however, failed to preserve the large number of institutions typical of U.S. banking. At the turn of the 20th century, a wave of bank mergers reduced both the number of private and stock-issuing banks.

The present structure of British commercial banking was substantially in place by the 1930s, with the Bank of England, then privately owned, at the apex, and 11 London clearing banks ranked below the Bank of England. Clearing banks sort and then forward checks to the bank from which they were originally drawn for payment. Two changes have occurred since then: The Bank of England was nationalized (became government-owned) in 1946 by the postwar Labour government; and in 1968 a merger among the largest five clearing banks left the industry in the hands of four: Barclays, Lloyds (now Lloyds TSB Group), Midland (now part of HSBC Holdings), and National Westminster (taken over by the Royal Bank of Scotland in 2000).

The larger clearing banks, with their national branch networks, dominate British banking. They are the key links in the transfer of business payments through the checking system, as well as the primary source of short-term business finance. Moreover, through their ownership and control over subsidiaries, the big British banks influence other financial markets such as consumer and housing finance and merchant banking. The dominance of the clearing banks was challenged in recent years by the rise of “parallel markets,” encompassing financial activities by smaller banking houses, building societies (banking institutions similar to SLAs in the United States), and other financial concerns, as well as local government authorities. The major banks responded to this competition by offering new services and competitive terms.

A restructuring in the banking industry took place in the late 1970s. The Banking Act of 1979 formalized Bank of England control over the British banking system, which was previously supervised on an informal basis. Only institutions approved by the Bank of England as “recognized banks” or “licensed deposit-taking institutions” are permitted to accept deposits from the public. The act also extended Bank of England control over the new financial intermediaries that have flourished since 1960.

D

Developing Countries

The type of national economic system that characterizes developing countries plays a crucial role in determining the nature of the banking system in those countries. In capitalist countries a system of private enterprise in banking prevails. In state-managed economies, banks have been nationalized. Other countries have patterned themselves after the social-democracies of Europe; in Egypt, Peru, and Kenya, for instance, government-owned and privately owned banks coexist. In many countries, the banking system developed under colonialism, with banks owned by institutions in the parent country. In some, such as Zambia and Cameroon, this heritage continued, although modified, after decolonization. In other nations, such as Nigeria and Saudi Arabia, the rise of nationalism led to mandates for majority ownership by the indigenous population.

Banks in developing countries are similar to their counterparts in developed nations. Commercial banks accept and transfer deposits and are active lenders, especially for short-term purposes. Other financial intermediaries, particularly government-owned development banks, arrange long-term loans. Banks are often used to finance government expenditures. The banking system may also play a major role in financing exports.

VIII

International Banking

The expansion of trade in recent decades has been paralleled by the growth of multinational banking. Banks have historically financed international trade, but a notable recent development has been the expansion of branches and subsidiaries that are physically located abroad, as well as the increased volume of loans to foreign borrowers. In 1960 only eight U.S. banks had foreign offices with a total of 131 branches. By 1998 about 82 U.S. banks had about 935 foreign branches.

Similarly, the number of foreign banks with offices in the United States has increased dramatically. In 1975, 79 foreign banks were chartered in the United States, accounting for 5 percent of U.S. bank assets. In 1998, 243 foreign banks had U.S. offices, accounting for 23 percent of U.S. bank assets. Most of these banks are business-oriented banks, but some have also engaged in retail banking. In 1978 the U.S. Congress passed the International Banking Act, which imposed constraints on the activities of foreign banks in the United States, removing some of the advantages they had acquired in relation to U.S. banks.

As banks make more international loans, many experts believe that there must be greater international cooperation regarding standards and regulations to lower the risk of bank failure and international financial collapse. In 1988 the Basel Committee on Banking Supervision, an international organization of bank regulators based in Basel, Switzerland, took the first steps in this direction with the Basel Capital Accord. The accord established a global standard for assessing the financial soundness of banks and required banks to maintain a minimum ratio of capital to risky assets. Many banking experts believe this accord became the primary tool for strengthening the safety of international banking. The accord was eventually adopted by 100 countries. In 2001 the Basel Committee recommended a new set of regulations known as the New Basel Capital Accord to replace the 1988 agreement.

IX

History of Banking

A

Origins of Banking

Many of today’s banking services were first practiced in ancient Lydia, Phoenicia, China, and Greece, where trade and commerce flourished. The temples in Babylonia made loans from their treasuries as early as 2000 bc. The temples of ancient Greece served as safe-deposit vaults for the valuables of worshipers. The Greeks also coined money and developed a system of credit. The Roman Empire had a highly developed banking system, and its bankers accepted deposits of money, made loans, and purchased mortgages. Shortly after the fall of Rome in ad 476, banking declined in Europe.

The increase of trade in 13th-century Italy prompted the revival of banking. The moneychangers of the Italian states developed facilities for exchanging local and foreign currency. Soon merchants demanded other services, such as lending money, and gradually bank services were expanded.

The first bank to offer most of the basic banking functions known today was the Bank of Barcelona in Spain. Founded by merchants in 1401, this bank held deposits, exchanged currency, and carried out lending operations. It also is believed to have introduced the bank check. Three other early banks, each managed by a committee of city officials, were the Bank of Amsterdam (1609), the Bank of Venice (1587), and the Bank of Hamburg (1619). These institutions laid the foundation for modern banks of deposit and transaction.

For more than 300 years, banking on the European continent was in the hands of powerful statesmen and wealthy private bankers, such as the Medici family in Florence and the Fuggers in Germany. During the 19th century, members of the Rothschild family became the most influential bankers in all Europe and probably in the world. This international banking family was founded by German financier Mayer Amschel Rothschild (1743-1812), but it soon spread to all the major European financial capitals.

The Bank of France was organized in 1800 by Napoleon. The bank had become the dominant financial institution in France by the mid-1800s. In Germany, banking experienced a rapid development about the middle of the 19th century with the establishment of several strong stock-issuing, or publicly owned, banks.

Banking in the British Isles originated with the London goldsmiths of the 16th century. These men made loans and held valuables for safekeeping. By the 17th century English goldsmiths created the model for today’s modern fractional reserve banking—that is, the practice of keeping a fraction of depositors’ money in reserve while extending the remainder to borrowers in the form of loans. Customers deposited gold and silver with the goldsmiths for safekeeping and were given deposit receipts verifying their ownership of the gold deposited with the goldsmith. These receipts could be used as money because they were backed by gold. But the goldsmiths soon discovered that they could take a chance and issue additional receipts against the gold to other people who needed to borrow money. This worked as long as the original depositors did not withdraw all their gold at one time. Hence, the amount of receipts or claims on the gold frequently exceeded the actual amount of the gold, and the idea that bankers could create money was born.

A

1

History of Banking in the United States