Banks and Banking

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BANKS AND BANKING

The formalized provision of specialist banking services was beginning to develop in Europe at the opening of the nineteenth century, largely spurred by the growing financial demands of industrialization. Although historians since the 1970s have increasingly considered Europe's modern economic growth to have been a gradual rather than a revolutionary process, they have continued to apply the term financial revolution to England at the end of seventeenth century, and to the Continent as a whole during the mid-nineteenth century. The phrase English financial revolution relates to the state's increasing use of long-term, funded borrowing for prosecuting war, with the Bank of England's chartering in 1694 being one part of this significant development. The phrase nineteenth-century European financial revolution has been used by historians attempting to encapsulate the emergence of large commercial corporate banks starting in the 1850s, in particular, of institutions pursuing both credit and investment banking—"mixed" banking—as undertaken by the ultimately ill-fated French Société Générale de Crédit Mobilier.

These introductory sentences require some immediate qualification and for at least two reasons. Industrialization was a process of regional, if not local, economic change that was more intense in northwestern Europe. As a result, the Continent had a "gradient" of economic transformation throughout the nineteenth century, with the forces of industrialization and their related demands for formalized banking services being progressively weaker toward the Continent's eastern and southern margins. Second, banking was not a new activity, emerging as a response to the Continent's structural economic changes. In particular, merchant bankers had long been present, primarily financing trade—local, regional, and international—with some, such as Hope & Co. in Amsterdam, also becoming increasingly engaged starting in the 1750s in raising loans for European states. Merchant bankers remained a very important group of financial intermediaries, especially in London and Paris, where the most prestigious houses were called collectively la haute banque. They continued to facilitate international trade, which expanded rapidly from the 1830s with Europe's industrialization to become global by the 1880s. As before 1800, the major firms, all private partnerships, constituting "high finance" also issued long-term loans, and their security issues enabled infrastructure projects, such as railway building, to be undertaken in Europe starting in the 1830s and around the world in the 1850s.

Although banking's modernization over the nineteenth century was primarily a private, market response to the gamut of industrialization's financial demands, the state played a significant role, as in England at the close of the seventeenth century. Positively, the state chartered a select number of banks, initially called "public banks" and, later, "national banks of issue," some evolving over subsequent decades to be the central banks of the twentieth century. The motives for founding these sizable and powerful—by contemporary standards—institutions were varied, and consequently they fulfilled a wide range of functions for some considerable time. The Austrian National Bank was established in 1815 to assist the Habsburg Monarchy's government in resolving the financial problems caused by the French Revolutionary and Napoleonic Wars (1792–1815). The Bank of France was formed by Napoleon in 1800 to finance his expanding empire. It undertook the state's business and issued notes but also, like merchant bankers, provided credits by discounting bills of exchange. The bank was reorganized in 1805–1806 and again in 1814–1815, when its governor made an unsuccessful attempt to free it from government influence so that it could be a "simple commercial bank." The Bank of France did not become a national bank of issue until the political and economic crises of 1848 resulted in it gaining a monopoly of issuing banknotes.

The foundation of "national banks" beginning in the nineteenth century's early decades was related to the emergence of nation-states. This was particularly the case in Greece where, following the revolt against Ottoman rule (1821–1829), establishing a bank was regarded as a key ingredient of consolidating the new liberated state. Efforts were made starting as early as 1827 but were not successful until 1841 when the National Bank of Greece commenced business. It not only acted as the government's bank and a bank of issue but also was a commercial bank providing mortgage loans as well as discounting bills. Political liberation and unification, however, did not always result in one "national bank of issue." When Italy was created in 1861, it inherited the banks of issue of the former kingdoms and states, and the establishment of a single note issuer was thereafter opposed in parliament and by public opinion. Furthermore, resolving the consequences of the 1866 financial crisis led to a forced solution maintaining a plural note issue. Finally, a compromise 1874 law restricted the number of banks of issue to six. These continued in operation until the severe financial crisis of 1893 resulted in the Bank of Italy's establishment, formed by merging three banks of issue. Nevertheless, the Italian note issue was not to be fully unified and in the hands of the central bank until 1926.

German monetary union preceded political unification. Its germ lay in Prussia's need to have a common coinage in its eastern and western provinces following the kingdom's territorial enlargement at the peace settlement of the Napoleonic Wars. This was achieved by the Coinage Law of 1821, which introduced a common silver standard, the taler—silver currency being common then in Europe. The formation of the Prussian-led Zollverein (customs union) in 1834 and its subsequent extension provided the context for, and made necessary, greater monetary union among its growing number of member states. This was brought about by the Munich Coinage Treaty of 1837 and the Dresden Coinage Convention of 1838. The next step forward came with the Vienna Coinage Treaty of 1857 between Austria and the Zollverein that confirmed the taler's now dominant role and required German state banks of issue to circulate only notes convertible into bullion. In 1867 responsibility for monetary policy was transferred from the Zollverein to the North German Confederation. The creation of the German Reich in 1871, following the Franco-Prussian War (1870–1871), quickly led to the introduction of a new common currency for the German Empire—the gold-based mark—by the coinage laws of December 1871 and July 1873. Soon thereafter, in 1876, the Reichsbank was established, modeled on the Bank of Prussia, which had previously accounted for 66 percent of the total note issue in the German states. The terms of the Reichsbank's charter were deliberately framed to prompt the existing thirty-three note-issuing banks to surrender their circulation rights, while the Reichsbank's own rapid establishment of a considerable branch network together with its inception of giro payments also brought about this desired outcome.

The development of extensive branch networks by some national banks of issue, as in Austria-Hungary, France, and Germany, had the effect of sustaining small, local banks and quasi banks. The Bank of France had 94 provincial branches in 1890, rising to 143 by 1913. These provided a wide range of services that included rediscounting the bills of exchange by which local private houses provided credit to their own customers. In 1891 there were still at least 404 private banks of some size in the French provinces, and a further "census" of French financial institutions in 1908 also enumerated a further 1,200 discount houses and 100 "counting houses" that also provided some banking services, including current accounts.

The ability of these small banks to continue in business until the early twentieth century stemmed from many factors, including local particularism, but one factor that had been significant until the last quarter of the nineteenth century in many European countries was the state's hostility to the establishment of joint-stock banks. This derived from the view that such banks in particular, together with joint-stock companies in general, generated destabilizing speculation. It chimed with individual enterprise being regarded as superior as well as the proper moral basis for conducting business through bankers and other businessmen fully responsible for meeting the debts they incurred. This mind-set among not only legislators but also business communities was especially directed against the free incorporation of joint-stock companies whose shareholders enjoyed limited liability. The result was to delay the substantial development of commercial joint-stock banking until either the impact of financial crisis forced governments to reconsider or the growing demand for credit and other financial facilities led governments, first, to be more readily prepared to charter individual banking institutions and, then, to introduce company law codes permitting free incorporation.

In very broad terms, two forms of commercial joint-stock banking developed across Europe. In England, the emphasis was on these banks taking deposits from the public whereas in Germany and other countries it was their assets that were stressed, Kreditinstitut becoming a synonym for the word bank. A range of factors was responsible for the long persistence of these differing views of the prime function that a bank performed, but a number have particular importance. England was the first industrialized country with a middle class that was fully developed earlier than in other countries and needed a safe place of deposit for their funds, socioeconomic factors that, in turn, resulted in a very much greater use of checks for making payments than elsewhere in Europe, even in 1914. As a country experiencing the full onset of industrialization somewhat later, the key financial demand in Germany was for credit to facilitate expanding trade and manufacturing.

Commercial joint-stock banking had begun in Scotland during the eighteenth century, undertaken by three chartered banks and subsequently also by provincial banking companies, with Scottish law, exceptionally, not being hostile to banks having large numbers of partners. The "Scottish system" pioneered precociously not only the joint-stock organization of banks but also the granting of overdraft facilities in the form of "cash credits" and the establishment of branch networks. Scottish joint-stock banks accepted deposits, but the initial prime reason for their branches and agency offices was to give each the widest distribution of its notes, put in circulation through discounting. Elements of the Scottish system were subsequently emulated in Ireland, England, and Wales as well as other European countries, including Sweden.

Developing commercial joint-stock banking within Ireland and, then, England and Wales, required overturning the corporate monopolies of both the Bank of Ireland and the Bank of England. The severity of banking crises experienced in Ireland in 1820 and in England in 1825 and 1826 caused the state to intervene. The resultant legislation of 1821, 1824, 1825, and 1826 substantially circumscribed the privileges of, first, the Bank of Ireland and, then, the Bank of England, enabling the ready formation of commercial joint-stock banks in the provinces beyond Dublin and London. The state accepted the argument that the country private banks, which had become numerous since the 1780s, had failed in 1820 and 1825 to 1826 because they lacked equity capital by being restricted by their charters to having no more than six partners. This contention was persuasive because Scotland, with its joint-stock institutions, had not been plagued by bank failure for many years. Nonetheless, shareholders in the new joint-stock banks were not given limited liability by the crisis-induced legislation, whereas the great majority of those subsequently formed in England and Wales did not become branching institutions, but rather remained rooted in their localities for the ensuing half century. Furthermore, until the 1840s managements of the joint-stock banks regarded note issuing as the basis of their businesses.

Joint-stock deposit banking on a substantial scale was developed in London starting in 1833, when its inception was permitted by legislation that confined even further the Bank of England's corporate privileges. From 1834, beginning with the London & Westminster Bank, a growing number of major joint-stock banks of deposit were established in the English metropolis. By mid-1851, their deposits amounted to £14.13 million. A concentration on deposit banking was not an entirely new departure because London private banks, many of which had their origins in goldsmith shops of the late seventeenth century, had developed it over the preceding century. But while London private bankers had supplied, and continued to supply, their services to select clienteles—the aristocracy and major merchants—the new joint-stock banks turned to cultivate their customer bases among the metropolis's growing middle classes, in particular, by the innovation of paying interest on current (or drawing) accounts. In this, there was a further diffusion of Scottish banking practice, the London & Westminster being established by Scotsmen, whereas, with London and the southeast being the English economy's wealthiest region, there was a ready consumer market to penetrate and develop. Undertaking banking through mobilizing deposits liable to be withdrawn on demand or at seven days notice meant that these banks' assets were to comprise primarily short-term bills or overdrafts. These needed to match, in terms of maturities, their liabilities—deposits—so they required an emphasis on maintaining liquidity. This in turn, called for their managements to concentrate principally upon extending short-term credit, for

which discounting the self-liquidating, three-month bill of exchange arising from trade—domestic or international—was an ideal instrument.

It has been argued that countries that industrialized somewhat later than England—"follower countries"—encountered financial problems of different order, which were reflected in the patterns of business pursued by the joint-stock banks that came to be established. In these countries, industrialists sought capital, as well as credit, to exploit the new centralized techniques of production that had been developed in England beginning in the mid-eighteenth century. Furthermore, the supply of capital to manufacturers for building and equipping factories was constrained because investors were risk averse and, consequently, primarily subscribed for government bonds that had stipulated returns rather than the more speculative shares of industrial companies. This particular constellation of financial demand and supply led to the formation of corporate investment banks—active development institutions—of which the French Société Générale de Crédit Mobilier, established in 1852, is regarded as the prototype.

Although the Crédit Mobilier was emulated in many European countries, leading to the term mobilier banking, its underlying conception was not new. The possible need for such a financial institution had been considered in Austria in the late eighteenth century whereas the first corporate investment bank was established in the Low Countries. The Algemeene Nederlandsche Maatschappij ter begunstigung van de Volksvlijt (subsequently the Société Générale de Belgique) was founded by William I on 23 December 1822 to aid the economic development of his new kingdom's southern provinces. Despite this intention, its management did not embark upon investment banking until the late 1820s and then only to a limited degree. A full involvement in mobilier banking commenced in 1835, when the bank issued the shares of two colliery companies and the bank's directors joined the boards of these mines to assist the management of their respective affairs. This innovative step was taken when the bank was beginning to encounter competition from a newly formed, imitative rival, the Banque de Belgique. Over the next four years, the two banks floated fifty-five joint-stock companies, but, as Belgian investors were hesitant over acquiring their shares, they were forced to form holding, or trust, companies, such as the Société Nationale pour Entreprises Industrielles et Commerciales (1835), to take up and retain the securities that the public would not buy. A financial crisis in 1838 was followed by a decade of agricultural depression and a slump in the linen industry that brought the Belgian banks' precocious experiment in investment banking almost to an end.

The banner of investment banking was firmly taken up, almost brazenly so, by the Crédit Mobilier, chartered in 1852 by the regime of Louis-Napoleon Bonaparte (subsequently Napoleon III), whose coup d'état had received little backing from either the Bank of France or among the Parisian haute banques. Its management pursued the approach to banking that had been initiated in Belgium over the second quarter of the nineteenth century, albeit concentrating primarily on financing railway building and public works. These interests led the Crédit Mobilier to establish comparable, affiliated banks elsewhere in Europe, such as in Spain and Italy, but a growing involvement in the urban development of Paris and other French cities from the early 1860s led to its crash in 1867.

France's enduring corporate banks were established from 1859, beginning with the chartering of the Crédit Industriel et Commercial. Initially, the founders intended to introduce English deposit banking and the use of the check into France, but over its first years the bank's management largely developed a pattern of business comparable to that of the Crédit Mobilier. With the liberalization of French company law in 1863 and 1867 that allowed free incorporation, further joint-stock banks were formed, of which the most important proved to be the Crédit Lyonnais and the Société Générale pour Favoriser le Développement du Commerce et de l'Industrie en France (to be generally known as Société Générale). Both their managements under-took some investment banking, but its importance declined with the depression encountered by the French economy during the 1870s. This led the two banks to become more like their English counterparts through being institutions that accepted deposits and discounted bills. Furthermore, they, together with the Comptoir d'Escompte (formed by the government in 1848 to overcome the year's financial and economic crisis, but which had become a chartered commercial bank in 1854), began to set up extensive branch networks, including overseas offices. This move into branching, a decade or more before it was developed on any extensive scale by English joint-stock banks, led to France having a "hybrid" banking structure. By the 1890s, branches of the Comptoir d'Escompte, Crédit Lyonnais, and Société Générale could be found on the principal streets of every French city and town, whereas the numerous local and regional joint-stock banks together with their private counterparts had their offices on side roads or backstreets.

Investment banking had a somewhat different development path in the German states, being initially pursued by private bankers, the heirs of the previous century's court bankers. These banks were located in the principal German cities and continued to be the main agents for financing state governments, undertaken by further developing funding and issuing techniques that their partners were later to employ in assisting private enterprise. This was carried out through mobilizing the houses' equity capital—their clients' deposits—and extending acceptance credits. When their short-term credits were continually renewed, it allowed industrial clients to utilize them for financing capital outlays. This primarily occurred in the Rhineland, bequeathed a liberal economic regime by its Napoleonic occupation, and resulted, for instance, in the overhaul of Gutehoffnungshütte, an integrated iron-making and engineering works, being financed during the 1830s by two private banks: A. Schaaffhausen and von der Heydt-Kersten und Söhne. Rhenish private bankers turned to railway finance and forming insurance companies during the 1830s, and subsequently founded joint-stock banks, with in nearly every case retaining a managing interest in their corporate progenies' affairs. Following the lead that the private banks in the Rhineland took in this form of banking, which involved a close, direct connection with the businesses of major customers, were their counterparts in Berlin, Saxony, and Silesia. During the mid-1850s private bankers in both Rhenish Westphalia and Silesia and, then, Berlin also promoted a number of joint-stock industrial companies.

The baton of investment banking in the German states began to be passed to corporate banks—the Kreditbanken—after 1848, when the private bank of A. Schaaffhausen was rescued from collapse, caused by the year's political revolution, by its conversion into a joint-stock company. It resumed business in Cologne as Schaaffhausen'schen Bankverein. The first entirely new institution was the Disconto-Gesellschaft, Berlin, established in 1851 on the model of the French Comptoir d'Escompte, and that, following its reconstitution in 1856, began to develop banking in the mode of the Crédit Mobilier. The problems of financing fixed capital were soon experienced by the Bank für Handel und Industrie zu Darmstadt (generally known as the Darmstädter), set up in 1853. It supported enterprises in the southern German states but, ultimately, to its cost, which, together with the negative effects of the 1857 crisis, led to its management subsequently pursuing more conservative policies. The suite of Germany's foremost corporate banks was filled out by the formations of the Berliner Handelsgesellschaft in 1856, the Deutsche Bank in 1870, and the Dresdner Bank in 1872.

When highlighting the economic development role of corporate investment banks, or "mixed banks" as they became in Germany starting in the 1870s, emphasis is frequently given to their promotion of joint-stock companies, especially industrial undertakings, and their directors becoming board members of these incorporated enterprises, thereby constituting lasting personal interlocks between banking and manufacturing. However, and comparable to the business of private bankers, these corporate banks' importance lay more in their supply of credit, often continually renewed, so that they became, in effect, providers of medium-term finance. Furthermore, as in Germany starting in the 1880s, the managements of investment or mixed banks tended to concentrate on large-scale firms, such collieries or iron and steel works, because they perceived these to involve less risk. Consequently, it has been argued that the patterns of business followed by the mixed banks of the German Empire had the effect of distorting the economy's structure through supporting heavy industry while neglecting the financial requirements of small and medium-sized firms—the Mittelstand of manufacturing industry.

Drawing a dividing line between deposit banking and investment banking can be taken too far because the differences between the businesses pursued by joint-stock banks in England and on the European continent, at least until the 1890s, were more a matter of degree than arising from totally different approaches to meeting customers' requests. Although English joint-stock bankers did not undertake company promotion, their clients had ongoing overdraft facilities that were equivalent to rolled-over, or repeatedly renewed, lines of credit. Furthermore, English bankers "nursed" their manufacturing customers when they experienced major financial problems, if only because bankers had as much interest in ultimately having their loans repaid as industrialists had in rebuilding their businesses. Finally, when an industrial client required capital financing, English bankers would assist by providing advice and indications of where those funds might be obtained.

In 1914 London and Paris were Europe's two major centers of banking. London was the location of 141 bank head offices, and these various banks had in total 6,173 branches. Among them were some of the biggest joint-stock banks in the world—London, City & Midland; Lloyds; London, County & Westminster; and National Provincial Bank of England. They had grown in stature with the onset of the amalgamation movement within English domestic banking during the 1880s, a process that greatly accelerated from the beginning of the twentieth century. Alongside them were British multinational banks, whose fields of operations lay in Africa, Australasia, the Orient, and South America, financially reflecting the British economy's global reach. These institutions were the British expression of the European financial revolution of the mid-nineteenth century, their numbers having substantially increased starting in the late 1850s, following the reform of company law that allowed free incorporation. Uniquely, London also had a money market in which the principals were the discount houses whose operations intermeshed the various businesses undertaken by all of the City's financial undertakings, domestic, colonial, and foreign. This structure, in turn, had arisen from a banking and financial system characterized by each of its component parts increasingly pursuing a specialized function.

Financially, Paris was less than half the size of London, with 57 bank head offices and being the node of branch networks that totaled 1,875 offices. Nevertheless, some of its principal institutions—Crédit Lyonnais, Société Générale, and Comptoir d'Escompte—were equal in size to those of London. Although primarily joint-stock deposit banks, their managements undertook "mixed" banking through developing overseas branch networks, although primarily within the Mediterranean world, and with an increasing turn to investment banking starting in the 1890s.

While Deutsche Bank was the biggest bank in the world in 1914, and Dresdner, Disconto-Gesellschaft, and the Darmstädter featured among the twenty-five largest, Berlin ranked third after London and Paris. This position was particularly pointed up by Berlin-based banks having limited branch networks, the total number of their various constituent offices amounting to only 152. One factor in play was Germany's still developing economic and financial unification. For instance, while Deutsche Bank had formally only fourteen branches in 1914, this was extended through pooling arrangements (Interessengemeinschaft) by which it took interests in key provincial banks, although outwardly these linked institutions retained their independence as a gesture to local particularism. Nonetheless, some German provincial banks sustained their autonomy and grew in size, resulting in Bayerische Hypotheken- und Wechsel-Bank, Bayerische Veriensbank, and Schaaffhausen'schen Bankverein being among Europe's largest in 1914. Another shaping characteristic had been the major banks substantial concentration on meeting the demands of the domestic market. Although Deutsche Bank had initially been conceived as an institution for supporting German overseas trade, this strategy began to be successfully executed only in the mid-1880s, when it established an affiliate, Deutsche Uebersee-Bank, and subsequently took an interest in Deutsche-Asiatische Bank.

Starting in the 1880s Europe entered an age of great banks, preeminently those of Britain, France, and Germany, whose "reign" was to continue until the Great Depression of the 1930s. Their size provoked debates at the beginning of the twentieth century over "finance capitalism"—the extent of the power that these great banks wielded over the economies and politics of the nations of Europe. These banks had developed with industrialization and had played some role, which historians continue to debate, in furthering the Continent's economic development. Their growth had also depended upon the state's attitude—whether to permit the establishment, let alone the free formation, of joint-stock banks—and the state's need, as a borrower, for financial resources. In the European rivalry that developed beginning in the 1880s, banks also came to be seen as valuable buttresses of foreign policy through aiding overseas colonial expansion, and by supplying resources to an ally in the alliances that were developing, being most especially the case with the French banks' support of tsarist Russia starting in the 1890s. Furthermore, at the beginning of the twentieth century a persisting question arose regarding the extent to which the state should regulate the activities of banks.