This entry includes 9 subentries:
Banking Acts of 1933 and 1935
Banking Crisis of 1933
Banks State Banks
The fundamental functions of a commercial bank during the past two centuries have been making loans, receiving deposits, and lending credit either in the form of bank notes or of "created" deposits. The banks in which people keep their checking accounts are commercial banks.
There were no commercial banks in colonial times, although there were loan offices or land banks that made loans on real estate security with limited issues of legal tender notes. In 1781 Robert Morris founded the first commercial bank in the United States—the Bank of North America. It greatly assisted the financing of the closing stages of the American Revolution. By 1800, there were twenty-eight state-chartered banks, and by 1811 there were eighty-eight.
Alexander Hamilton's financial program included a central bank to serve as a financial agent of the treasury, provide a depository for public money, and act as a regulator of the currency. Accordingly, the first Bank of the United States was founded 25 February 1791. Its $10 million capital and favored relationship with the government aroused much anxiety, especially among Jeffersonians. The bank's sound but unpopular policy of promptly returning bank notes for redemption in specie (money in coin) and refusing those of non-specie-paying banks—together with a political feud—was largely responsible for the narrow defeat of a bill to recharter it in 1811. Between 1811 and 1816, both people and government were dependent on state banks. Nearly all but the New England banks suspended specie payments in September 1814 because of the War of 1812 and their own unregulated credit expansion.
The country soon recognized the need for a new central bank, and Congress established the second Bank of the United States on 10 April 1816. Its $35 million capitalization and favored relationship with the Treasury likewise aroused anxiety. Instead of repairing the overexpanded credit situation that it inherited, it aggravated it by generous lending policies, which precipitated the panic of 1819, in which it barely saved itself and generated wide-spread ill will.
Thereafter, under Nicholas Biddle, the central bank was well run. As had its predecessor, it required other banks to redeem their notes in specie, but most of the banks had come to accept that policy, for they appreciated the services and the stability provided by the second bank. The bank's downfall grew out of President Andrew Jack-son's prejudice against banks and monopolies, the memory of the bank's role in the 1819 panic, and most of all, Biddle's decision to let rechartering be a main issue in the 1832 presidential election. Many persons otherwise friendly to the bank, faced with a choice of Jackson or the bank, chose Jackson. He vetoed the recharter. After 26 September 1833, the government placed all its deposits with politically selected state banks until it set up the Independent Treasury System in the 1840s. Between 1830 and 1837, the number of banks, bank note circulation, and bank loans all about tripled. Without the second bank to regulate them, the banks overextended themselves in lending to speculators in land. The panic of 1837 resulted in a suspension of specie payments, many failures, and a depression that lasted until 1844.
Between 1833 and 1863, the country was without an adequate regulator of bank currency. In some states, the laws were very strict or forbade banking, whereas in others the rules were lax. Banks made many long-term loans and resorted to many subterfuges to avoid redeeming their notes in specie. Almost everywhere, bank tellers and merchants had to consult weekly publications known as Bank Note Reporters for the current discount on bank notes, and turn to the latest Bank Note Detectors to distinguish the hundreds of counterfeits and notes of failed banks. This situation constituted an added business risk and necessitated somewhat higher markups on merchandise. In this bleak era of banking, however, there were some bright spots. These were the Suffolk Banking System of Massachusetts (1819–1863); the moderately successful Safety Fund system (1829–1866) and Free Banking (1838–1866) systems of New York; the Indiana (1834–1865), Ohio (1845–1866), and Iowa (1858–1865) systems; and the Louisiana Banking System (1842–1862). Inefficient and corrupt as some of the banking was before the Civil War, the nation's expanding economy found it an improvement over the system on which the eighteenth-century economy had depended.
Secretary of the Treasury Salmon P. Chase began agitating for an improved banking system in 1861. On 25 February 1863, Congress passed the National Banking Act, which created the National Banking System. Its head officer was the comptroller of currency. It was based on several recent reforms, especially the Free Banking System's principle of bond-backed notes. Nonetheless, the reserve requirements for bank notes were high, and the law forbade real estate loans and branch banking, had stiff organization requirements, and imposed burdensome taxes. State banks at first saw little reason to join, but, in 1865, Congress levied a prohibitive 10 percent tax on their bank notes, which drove most of these banks into the new system. The use of checks had been increasing in popularity in the more settled regions long before the Civil War, and, by 1853, the total of bank deposits exceeded that of bank notes. After 1865 the desire of both state and national banks to avoid the various new restrictions on bank notes doubtless speeded up the shift to this more convenient form of bank credit. Since state banks were less restricted, their number increased again until it passed that of national banks in 1894. Most large banks were national, however.
The National Banking System constituted a substantial improvement over the pre–Civil War hodgepodge of banking systems. Still, it had three major faults. The first was the perverse elasticity of the bond-secured bank notes, the supply of which did not vary in accordance with the needs of business. The second was the decentralization of bank deposit reserves. There were three classes of national banks: the lesser ones kept part of their reserves in their own vaults and deposited the rest at interest with the larger national banks. These national banks in turn lent a considerable part of the funds on the call money market to finance stock speculation. In times of uncertainty, the lesser banks demanded their outside reserves, call money rates soared, security prices tobogganed, and runs on deposits ruined many banks. The third major fault was that there was no central bank to take measures to forestall such crises or to lend to deserving banks in times of distress.
In 1873, 1884, 1893, and 1907, panics highlighted the faults of the National Banking System. Improvised use of clearinghouse certificates in interbank settlements some-what relieved money shortages in the first three cases, whereas "voluntary" bank assessments collected and lent by a committee headed by J. P. Morgan gave relief in 1907. In 1908 Congress passed the Aldrich-Vreeland Act to investigate foreign central banking systems and suggest reforms, and to permit emergency bank note issues. The Owen-Glass Act of 1913 superimposed a central banking system on the existing national banking system. It required all national banks to "join" the new system, which meant to buy stock in it immediately equal to 3 percent of their capital and surplus, thus providing the funds with which to set up the Federal Reserve System. State banks might also join by meeting specified requirements, but, by the end of 1916, only thirty-four had done so. A majority of the nation's banks have always remained outside the Federal Reserve System, although the larger banks have usually been members. The Federal Reserve System largely corrected the faults to which the National Banking System had fallen prey. Admittedly, the Federal Reserve had its faults and did not live up to expectations. Nevertheless, the nation's commercial banks had a policy-directing head and a refuge in distress to a greater degree than they had ever had before. Thus ended the need for the Independent Treasury System, which finally wound up its affairs in 1921.
Only a few national banks gave up their charters for state ones in order to avoid joining the Federal Reserve System. However, during World War I, many state banks became members of the system. All banks helped sell Liberty bonds and bought short-term Treasuries between bond drives, which was one reason for a more than doubling of the money supply and also of the price level from 1914 to 1920. A major contributing factor for these doublings was the sharp reduction in reserves required under the new Federal Reserve System as compared with the pre-1914 National Banking System.
By 1921 there were 31,076 banks, the all-time peak. Every year, local crop failures, other disasters, or simply bad management wiped out several hundred banks. By 1929 the number of banks had declined to 25,568. Admittedly, mergers eliminated a few names, and the growth of branch, group, or chain banking provided stability in some areas. Nevertheless, the 1920s are most notable for stock market speculation. Several large banks had a part in this speculation, chiefly through their investment affiliates. The role of investment adviser gave banks great prestige until the panic of 1929, when widespread disillusionment from losses and scandals brought them discredit.
The 1930s witnessed many reforms growing out of the more than 9,000 bank failures between 1930 and 1933 and capped by the nationwide bank moratorium of 6–9 March 1933. To reform the commercial and central banking systems, as well as to restore confidence in them, Congress passed two major banking laws between 1933 and 1935. These laws gave the Federal Reserve System firmer control over the banking system. They also set up the Federal Deposit Insurance Corporation to insure bank deposits, and soon all but a few hundred small banks belonged to it. That move greatly reduced the number of bank failures. Other changes included banning investment affiliates, prohibiting banks from paying interest on demand deposits, loosening restrictions against national banks' having branches and making real estate loans, and giving the Federal Reserve Board the authority to raise member bank legal reserve requirements against deposits. As a result of the Depression, the supply of commercial loans dwindled, and interest rates fell sharply. Consequently, banks invested more in federal government obligations, built up excess reserves, and imposed service charges on checking accounts. The 1933–1934 devaluation of the dollar, which stimulated large imports of gold, was another cause of those excess reserves.
During World War II, the banks again helped sell war bonds. They also converted their excess reserves into government obligations and dramatically increased their own holdings of these. Demand deposits more than doubled. Owing to bank holdings of government obligations and to Federal Reserve commitments to the treasury, the Federal Reserve had lost its power to curb bank-credit expansion. Price levels nearly doubled during the 1940s.
In the Federal Reserve-treasury "accord" of March 1951, the Federal Reserve System regained its freedom to curb credit expansion, and thereafter interest rates crept upward. That development improved bank profits and led banks to reduce somewhat their holdings of federal government obligations. Term loans to industry and real estate loans increased. Banks also encountered stiff competition from rapidly growing rivals, such as savings and loan associations and personal finance companies. On 28 July 1959, Congress eliminated the difference between reserve city banks and central reserve city banks for member banks. The new law kept the same reserve requirements against demand deposits, but it permitted banks to count cash in their vaults as part of their legal reserves.
Interest rates rose spectacularly all during the 1960s and then dropped sharply in 1971, only to rise once more to 12 percent in mid-1974. Whereas consumer prices had gone up 23 percent during the 1950s, they rose 31 percent during the 1960s—especially toward the end of the decade as budget deficits mounted—and climbed another 24 percent by mid-1974. Money supply figures played a major role in determining Federal Reserve credit policy from 1960 on.
Money once consisted largely of hard coin. With the coming of commercial banks, it came also to include bank notes and demand deposits. The difference, however, between these and various forms of "near money"—time deposits, savings and loan association deposits, and federal government E and H bonds—is slight. Credit cards carry the confusion a step further. How does one add up the buying power of money, near money, and credit cards? As new forms of credit became more like money, it was increasingly difficult for the Federal Reserve to regulate the supply of credit and prevent booms.
Since 1970 banking and finance have undergone nothing less than a revolution. The structure of the industry in the mid-1990s bore little resemblance to that established in the 1930s in the aftermath of the bank failures of the Great Depression. In the 1970s and 1980s, what had been a fractured system by design became a single market, domestically and internationally. New Deal banking legislation of the Depression era stemmed from the belief that integration of the banking system had allowed problems in one geographical area or part of the financial system to spread to the entire system. Regulators sought, therefore, to prevent money from flowing between different geographical areas and between different functional segments. These measures ruled out many of the traditional techniques of risk management through diversification and pooling. As a substitute, the government guaranteed bank deposits through the Federal Deposit Insurance Corporation and the Federal Savings and Loan Insurance Corporation.
In retrospect, it is easy to see why the segmented system broke down. It was inevitable that the price of money would vary across different segments of the system. It was also inevitable that borrowers in a high-interest area would seek access to a neighboring low-interest area—and vice versa for lenders. The only question is why it took so long for the pursuit of self-interest to break down regulatory barriers. Price divergence by itself perhaps was not a strong enough incentive. Rationing of credit during tight credit periods probably was the cause of most innovation. Necessity, not profit alone, seems to have been the cause of financial innovation.
Once communication between segments of the system opened, mere price divergence was sufficient to cause flows of funds. The microelectronics revolution enhanced flows, as it became easier to identify and exploit profit opportunities. Technological advances sped up the process of market unification by lowering transaction costs and widening opportunities. The most important consequence of the unification of segmented credit markets was a diminished role for banks. Premium borrowers found they could tap the national money market directly by issuing commercial paper, thus obtaining funds more cheaply than banks could provide. In 1972 money-market mutual funds began offering shares in a pool of money-market assets as a substitute for bank deposits. Thus, banks faced competition in both lending and deposit-taking—competition generally not subject to the myriad regulatory controls facing banks.
Consolidation of banking became inevitable as its functions eroded. The crisis of the savings and loan industry was the most visible symptom of this erosion. Savings and loans associations (S&Ls) had emerged to funnel household savings to residential mortgages, which they did until the high interest rates of the inflationary 1970s caused massive capital losses on long-term mortgages and rendered many S&Ls insolvent by 1980. Attempts to re-gain solvency by lending cash from the sale of existing mortgages to borrowers willing to pay high interest only worsened the crisis, because high-yield loans turned out to be high risk. The mechanisms invented to facilitate mortgage sales undermined S&Ls in the longer term as it became possible for specialized mortgage bankers to make mortgage loans and sell them without any need for the expensive deposit side of the traditional S&L business.
Throughout the 1970s and 1980s, regulators met each evasion of a regulatory obstacle with further relaxation of the rules. The Depository Institutions Deregulation and Monetary Control Act (1980) recognized the array of competitors for bank business by expanding the authority of the Federal Reserve System over the new entrants and relaxing regulation of banks. Pressed by a borrowers' lobby seeking access to low-cost funds and a depositors' lobby seeking access to high money-market returns, regulators saw little choice but capitulation. Mistakes occurred, notably the provision in the 1980 act that extended deposit insurance coverage to $100,000, a provision that greatly increased the cost of the eventual S&L bailout. The provision found its justification in the need to attract money to banks. The mistake was in not recognizing that the world had changed and that the entire raison d'être of the industry was disappearing.
Long-term corporate finance underwent a revolution comparable to that in banking. During the prosperous 1950s and 1960s, corporations shied away from debt and preferred to keep debt-equity ratios low and to rely on ample internal funds for investment. The high cost of issuing bonds—a consequence of the uncompetitive system of investment banking—reinforced this preference. Usually, financial intermediaries held the bonds that corporations did issue. Individual owners, not institutions, mainly held corporate equities. In the 1970s and 1980s, corporations came to rely on external funds, so that debt-equity ratios rose substantially and interest payments absorbed a much greater part of earnings. The increased importance of external finance was itself a source of innovation as corporations sought ways to reduce the cost of debt service. Equally important was increased reliance on institutional investors as purchasers of securities. When private individuals were the main holders of equities, the brokerage business was uncompetitive and fees were high, but institutional investors used their clout to reduce the costs of buying and selling. Market forces became much more important in finance, just as in banking.
Institutional investors shifted portfolio strategies toward equities, in part to enhance returns to meet pension liabilities after the Employment Retirement Income Security Act (1974) required full funding of future liabilities. Giving new attention to maximizing investment returns, the institutional investors became students of the new theories of rational investment decision championed by academic economists. The capital asset pricing model developed in the 1960s became the framework that institutional investors most used to make asset allocations.
The microelectronics revolution was even more important for finance than for banking. Indeed, it would have been impossible to implement the pricing model without high-speed, inexpensive computation to calculate optimal portfolio weightings across the thousands of traded equities. One may argue that computational technology did not really cause the transformation of finance and that increased attention of institutional investors was bound to cause a transformation in any event. Both the speed and extent of transformation would have been impossible, however, without advances in computational and communications technologies.
Bodenhorn, Howard N. A History of Banking in Antebellum America: Financial Markets and Economic Development in an Era of Nation-Building. Cambridge: Cambridge University Press, 2000.
Gilbart, James William. The History of Banking in America. London: Routledge/Thoemmes Press, 1996.
Mehrling, Perry. The Money Interest and the Public Interest: American Monetary Thought, 1920–1970. Cambridge, Mass.: Harvard University Press, 1997.
Timberlake, Richard H. The Origins of Central Banking in the United States. Cambridge, Mass.: Harvard University Press, 1978.
Wicker, Elmus. Banking Panics of the Gilded Age. Cambridge, Mass: Cambridge University Press, 2000.
Wright, Robert E. Origins of Commercial Banking in America, 1750–1800. Lanham, Md.: Rowman and Littlefield, 2001.
Perry G.Mehrling/a. e.
See alsoBank of America ; Bank of the United States ; Clearinghouses ; Credit Cards ; Credit Unions ; Federal Reserve System ; Financial Panics ; Financial Services Industry ; Savings and Loan Associations .
American financial history to 1934 was characterized by numerous bank failures, because the majority of banks were local enterprises, not regional or national institutions with numerous branches. Lax state government regulations and inadequate examinations permitted many banks to pursue unsound practices. With most financial eggs in local economic baskets, it took only a serious crop failure or a business recession to precipitate dozens or even hundreds of bank failures. On the whole, state-chartered banks had a particularly poor record.
Early Bank Failures
Early-nineteenth-century banks were troubled by a currency shortage and the resulting inability to redeem their notes in specie. States later imposed penalties in those circumstances, but such an inability did not automatically signify failure. The first bank to fail was the Farmers' Exchange Bank of Glocester, R.I., in 1809. The statistics of bank failures between 1789 and 1863 are inadequate, but the losses were unquestionably large. John Jay Knox estimated that the losses to noteholders were 5 percent per annum, and bank notes were the chief money used by the general public. Not until after 1853 did banks' deposit liabilities exceed their note liabilities. Between 1830 and 1860, weekly news sheets called bank note reporters gave the latest discount quoted on the notes of weak and closed banks. All businesses had to allow for worthless bank notes. Although some states—such as New York in 1829 and 1838, Louisiana in 1842, and Indiana in 1834—established sound banking systems, banking as a whole was characterized by frequent failures.
The establishment of the National Banking System in 1863 introduced needed regulations for national (i.e., nationally chartered) banks. These were larger and more numerous than state banks until 1894, but even their record left much to be desired. Between 1864 and 1913—a period that saw the number of banks rise from 1,532 to 26,664—515 national banks were suspended, and only two years passed without at least one suspension. State banks suffered 2,491 collapses during the same period. The worst year was the panic year of 1893, with almost five hundred bank failures. The establishment of the Federal Reserve System in 1913 did little to improve the record of national banks. Although all banks were required to join the new system, 825 banks failed between 1914 and 1929, and an additional 1,947 failed by the end of 1933. During the same twenty years there were 12,714 state bank failures. By 1933 there were 14,771 banks in the United States, half as many as in 1920, and most of that half had disappeared by the failure route. During the 1920s, Canada, employing a branch banking system, had only one failure. Half a dozen states had experimented with deposit insurance plans without success. Apparently the situation needed the attention of the federal government.
The bank holocaust of the early 1930s—9,106 bank failures in four years, 1,947 of them national banks—culminating in President Franklin D. Roosevelt's executive order declaring a nationwide bank moratorium in March 1933, at last produced the needed drastic reforms. In 1933 Congress passed the Glass-Steagall Act, which forbade Federal Reserve member banks to pay interest on demand deposits, and founded the Federal Deposit Insurance Corporation (FDIC). In an effort to protect bank deposits from rapid swings in the market, the Glass-Steagall Banking Act of 1933 forced banks to decide between deposit safeholding and investment. Executives of security firms, for example, were prohibited from sitting as trustees of commercial banks.
The FDIC raised its initial capital by selling two kinds of stock. Class A stock (paying dividends) came from assessing every insured bank 0.5 percent of its total deposits—half paid in full, half subject to call. All member banks of the Federal Reserve System had to be insured. Federal Reserve Banks had to buy Class B stock (paying no dividends) with 0.5 percent of their surplus—half payable immediately, half subject to call. In addition, any bank desiring to be insured paid .083 percent of its average deposits annually. The FDIC first insured each depositor in a bank up to $2,500; in mid-1934 Congress put the figure at $5,000; on 21 September 1950, the maximum became $10,000; on 16 October 1966, the limit went to $15,000; on 23 December 1969, to $20,000; and on 27 November 1974, to $40,000. At the end of 1971 the FDIC was insuring 98.6 percent of all commercial banks and fully protecting 99 percent of all depositors. However, it was protecting only about 64 percent of all deposits, with savings deposits protected at a high percentage but business deposits at only about 55 percent. By the mid-1970s the FDIC was examining more than 50 percent of the banks in the nation, which accounted for about 20 percent of banking assets. It did not usually examine member banks of the Federal Reserve System, which were the larger banks. There was a degree of rivalry between the large and small banks, and the FDIC was viewed as the friend of the smaller banks.
Whereas in the 1920s banks failed at an average rate of about six hundred a year, during the first nine years of the FDIC (1934–1942) there were 487 bank closings because of financial difficulties, mostly of insured banks; 387 of these received disbursements from the FDIC. During the years from 1943 to 1972, the average number of closings dropped to five per year. From 1934 to 1971 the corporation made disbursements in 496 cases involving 1.8 million accounts, representing $1.215 billion in total deposits. The FDIC in 1973 had $5.4 billion in assets. Through this protection, people were spared that traumatic experience of past generations, a "run on the bank" and the loss of a large part of their savings. For example, in 1974 the $5 billion Franklin National Bank of New York, twentieth in size in the nation, failed. It was the largest failure in American banking history. The FDIC, the Federal Reserve, and the comptroller of the currency arranged the sale of most of the bank's holdings, and no depositor lost a cent.
The 1980s and the Savings and Loan Debacle
The widespread bank failures of the 1980s—more than sixteen hundred FDIC-insured banks were closed or received financial assistance between 1980 and 1994—revealed major weaknesses in the federal deposit insurance system. In the 1970s, mounting defense and social welfare costs, rising oil prices, and the collapse of American manufacturing vitality in certain key industries (especially steel and electronics) produced spiraling inflation and a depressed securities market. Securities investments proved central to the economic recovery of the 1980s, as corporations cut costs through mergers, takeovers, and leveraged buyouts. The shifting corporate terrain created new opportunities for high-risk, high-yield investments known as "junk bonds." The managers of the newly deregulated savings and loan (S&L) institutions, eager for better returns, invested heavily in these and other investments—in particular, a booming commercial real estate market. When the real estate bubble burst, followed by a series of insider-trading indictments of Wall Street financiers and revelations of corruption at the highest levels of the S&L industry, hundreds of the S&Ls collapsed. In 1988 the Federal Home Loan Bank Board began the process of selling off the defunct remains of 222 saving and loans. Congress passed sweeping legislation the following year that authorized a massive government bailout and imposed strict new regulatory laws on the S&L industry. The cost of the cleanup to U.S. taxpayers was $132 billion.
In addition to the S&L crisis, the overall trend within the banking industry during the 1980s was toward weaker performance ratios, declining profitability, and a quick increase in loan charge-offs, all of which placed an unusual strain on banks. Seeking stability in increased size, the banking industry responded with a wave of consolidations and mergers. This was possible in large part because Congress relaxed restrictions on branch banking in an effort to give the industry flexibility in its attempts to adjust to the changing economy. Deregulation also made it easier for banks to engage in risky behavior, however, contributing to a steep increase in bank failures when loans and investments went bad in the volatile economic climate. Legislators found themselves torn among the need to deregulate banks, the need to prevent failures, and the need to recapitalize deposit insurance funds, which had suffered a huge loss during the decade. In general, they responded by giving stronger tools to regulators but narrowly circumscribing the discretion of regulators to use those tools.
During the 1990s, the globalization of the banking industry meant that instability abroad would have rapid repercussions in American financial markets; this, along with banks' growing reliance on computer systems, presented uncertain challenges to the stability of domestic banks in the final years of the twentieth century. As the economy boomed in the second half of the decade, however, the performance of the banking industry improved remarkably, and the number of bank failures rapidly declined. Although it was unclear whether the industry had entered a new period of stability or was merely benefiting from the improved economic context, the unsettling rise in bank failures of the 1980s seemed to have been contained.
Calavita, Kitty, Henry N. Pontell, and Robert H. Tillman. Big Money Crime: Fraud and Politics in the Savings and Loan Crisis. Berkeley: University of California Press, 1997.
Dillistin, William H. Bank Note Reporters and Counterfeit Detectors, 1826–1866. New York: American Numismatic Society, 1949.
Lee, Alston, Wayne Grove, and David Wheelock. "Why Do Banks Fail? Evidence from the 1920s." Explorations in Economic History (October 1994): 409–431.
Thies, Clifford, and Daniel Gerlowski. "Bank Capital and Bank Failure, 1921–1932: Testing the White Hypothesis." Journal of Economic History (1993): 908–914.
Walton, Gary M., ed. Regulatory Change in an Atmosphere of Crisis: Current Implications of the Roosevelt Years. New York: Academic Press, 1979.
Donald L.Kemmerer/a. r.; c. w.
Banking Acts of 1933 and 1935
The Banking Act of 1933, approved on 16 June and known also as the Glass-Steagall Act, contained three groups of provisions designed to restore stability to and confidence in the banking system. The first group of provisions increased the power of the Federal Reserve Board to control credit. The second group separated commercial and investment banking functions by prohibiting commercial banks from operating investment affiliates and by prohibiting investment banking houses from carrying on a deposit banking business. (These provisions were repealed by the Gramm-Leach-Bliley Act of 1999, also known as the Banking Modernization Bill.) The third group of provisions dealt with commercial banks and included a provision providing for the insurance of bank deposits under the supervision of the Federal Deposit Insurance Corporation (FDIC). (Creation of the FDIC is one of the New Deal's most important legacies and probably prevented a large-scale banking collapse in the early 1980s.)
The Banking Act of 1935, approved on 23 August, further increased government control over currency and credit. Title I amended the deposit insurance provisions of the Banking Act of 1933, and Title III contained a series of technical amendments to the banking laws governing the operations of the commercial banks. The most important of the act's three titles was Title II, which drastically reorganized the Federal Reserve Board and centralized control of the money market in its hands. The act authorized the president to appoint the seven members of the newly named "Board of Governors of the Federal Reserve System" for fourteen-year terms. It also increased and centralized the board's powers over discount and open market operations of the Reserve banks and materially broadened the discount base.
Dawley, Alan. Struggles for Justice: Social Responsibility and the Liberal State. Cambridge, Mass.: Harvard University Press, 1991.
Leuchtenburg, William E. Franklin D. Roosevelt and the New Deal, 1932–1940. New York: Harper and Row, 1963.
McElvaine, Robert S. The Great Depression: America 1929–1941. Rev. ed. New York: Times Books, 1993.
Frederick A.Bradford/c. p.
See alsoNew Deal .
Banking Crisis of 1933
The outcome of both the large number of bank failures during 1931–1932 and the wave of hoarding which swept the country in response, markedly weakened the banking structure. Attempts by the Reconstruction Finance Corporation to avoid disaster were in large measure nullified by the publication of the names of banks that had borrowed from it, a procedure not calculated to restore confidence to frightened depositors.
Banking difficulties in Michigan finally caused Governor William A. Comstock to declare a bank "holiday" in that state on 14 February 1933. Alarm quickly spread to neighboring states. Banking moratoria were declared in four other states by the end of February and in seventeen additional states during the first three days of March. Finally, on 4 March 1933, on his first day in office, President Franklin D. Roosevelt closed banks in the remaining states.
The situation was serious, and prompt action was imperative. Congress, called in special session by the president, passed the Emergency Banking Relief Act of 1933 on 9 March, thus providing machinery for reopening the banks. Under this act, only sound banks were to be reopened, while those of questionable soundness were to be placed in the hands of conservators and opened later if conditions permitted. The national bank moratorium was extended a few days to permit the provisions of the act to be put into effect. Sound banks reopened on 13–15 March. By the latter date, banks controlling about 90 percent of the banking resources of the country were again in operation, and the banking crisis of 1933 was at an end.
Dawley, Alan. Struggles for Justice: Social Responsibility and the Liberal State. Cambridge, Mass.: Harvard University Press, 1991.
Kennedy, Susan Estabrook. The Banking Crisis of 1933. Lexington: University Press of Kentucky, 1973.
McElvaine, Robert S. The Great Depression: America, 1929–1941. Rev. ed. New York: Times Books, 1993.
Frederick A.Bradford/c. p.
See alsoGlass-Steagall Act ; andvol. 9:Fireside Chat on the Bank Crisis .
The Export-Import Bank of the United States (Ex-Im Bank) is the official export credit agency (ECA) of the United States. Its purpose is to match officially supported foreign competition and to address export financing needs that are unmet by the private sector in order to maximize American exports. Currently, Ex-Im Bank performs this function through direct loans or guarantees of commercial loans to foreign buyers of American exports, working capital guarantees for United States exporters, and export credit insurance. In 2001 it made $871 million in direct loans, $6.1 billion in loan guarantees, and $2.3 billion in export credit insurance.
Franklin D. Roosevelt established the first Ex-Im Bank by executive order. It was chartered on 12 February 1934 as an instrument of his foreign policy and to promote economic recovery from the Great Depression by providing financing for moribund foreign trade. The bank's initial purpose was to facilitate trade with the Soviet Union after the United States extended diplomatic recognition. A second Ex-Im Bank was chartered in March to facilitate trade with a new government in Cuba, but its charter was quickly changed to allow it to finance trade with all countries except the Soviet Union. In June 1935, when it became apparent that government-supported trade with the Soviet Union would not materialize, the two banks were merged. Until 1945 Ex-Im Bank financed its operations by the sale of Reconstruction Finance Corporation stock to the Treasury Department. It primarily financed the foreign purchase of American exports of transportation equipment and agricultural products to Latin America. Ex-Im Bank also supported American exports used in infrastructure projects in strategic nations such as Haiti and Brazil, where Nazi influence was increasing, or in China, which was at war with Japan. These activities led Congress in 1939 to impose a dollar limit on the total loans the agency could have outstanding at any given time. Such congressional limits remain a feature of the bank's operations. The limit as of 2002 was $75 billion.
During World War II Ex-Im Bank's activities were largely confined to Latin America and financing American exports for projects that related to infrastructure and production of strategic materials. Subsequently, Congress passed the Export-Import Bank Act of 1945. It established Ex-Im Bank as an independent agency, with a bipartisan, appointed board of directors, including a chair, confirmed by the Senate. Capital was $1 billion in stock purchased by the Treasury, and Ex-Im Bank had authority to borrow up to $2.5 billion from the Treasury to finance its operations. In 1947 Congress required periodic rechartering of all federal corporations, including Ex-Im Bank. Since that time, Congress has used the process periodically to increase the bank's outstanding loan ceiling. Finally, the 1945 act mandated that Ex-Im Bank not compete with the private sector and that it make only those loans with a "reasonable assurance of repayment," principles that had already become part of the bank's institutional culture.
Immediately after the end of World War II and the termination of the lend-lease program that provided strategic materials to Allied countries, Ex-Im Bank made over $2 billion in loans to Western European nations for purchases of American exports. This pre–Marshall Plan assistance was crucial to European recovery. However, the generous repayment terms dictated by foreign policy considerations were a matter of consternation to many at Ex-Im Bank. After the start-up of the Marshall Plan, the bank was again able to focus on its traditional customers in Latin America. During the 1950s, loans to finance the purchase of American exports by Asian governments increased.
From the end of the 1950s through the early 1970s, the United States incurred substantial international balance-of-payment and budget deficits. Exporter and government pressure on Ex-Im Bank to enhance its assistance to American exporters increased as foreign ECAs became more aggressive supporters of their exporters. By 1971 Congress mandated that Ex-Im Bank's assistance to American exporters and foreign purchasers of American exports be competitive with those of other ECAs. After 1961 the bank increasingly leveraged its assistance to exporters by creating and expanding partnerships with the private sector. It guaranteed loans made by private institutions and underwrote export credit insurance in conjunction with an expansion of its traditional direct loan program. These operations increasingly financed the foreign purchase of new American technologies such as jet aircraft, nuclear power, and communications equipment. Beginning in 1963 Congress specifically authorized annual limits on Ex-Im Bank loan and guarantee activity in addition to its traditional approval of its annual administrative budget.
Increasing federal deficits, the oil price rise, and the end to fixed exchange rates in 1973 brought major changes to Ex-Im Bank's environment. Some critics thought that the end to fixed rates undermined the rationale for Ex-Im Bank's promotional activities. Critics from a variety of political perspectives noted that assistance to exporters was overwhelmingly bestowed on a few firms that exported large capital goods such as aircraft, power generation equipment, and construction machinery. In a period of tight federal budgets, critics also wondered just how effective were Ex-Im Bank's increasing subsidies in creating new export sales.
The high interest rates of the 1970s and intensified competition from foreign ECAs created major financial problems for Ex-lm Bank by the early 1980s. The "spread" between its high cost of borrowing from the Treasury and the lower rates it had to give foreign purchasers of American exports to keep U.S. exports competitive created huge losses and undermined the bank's balance sheet. By the early 1980s the debt crisis in the developing world dramatically reduced demand for foreign trade finance but increased the amount of underperforming or nonperforming loans or guarantees on Ex-Im Bank's books.
Ex-Im Bank's and the Treasury Department's response to the bank's worsening finances was slow in developing, but by the 1990s it had achieved success. Beginning in 1978, a series of increasingly stringent understandings about the terms of international export finance and their enforcement were developed through the Organization for Economic Cooperation and Development. The long-term impact has been to reduce export subsidies in international trade. During the 1980s Ex-Im Bank improved its risk assessment mechanisms and adjusted its fee structure. In 1989 the bank established a nonspecific loss reserve for nonperforming assets in its loan portfolio. Legislation enacted by Congress in 1990 provided a continuing appropriation for nonperforming assets, and by 2000 Ex-Im Bank received an annual appropriation of approximately $1 billion to cover the assessed risk of its ongoing activities. During the 1990s the privatization of state enterprises worldwide, the capital needs of the former Soviet Bloc, and the continued reluctance of private institutions to commit to export finance in many such markets led to dramatic increases in Ex-Im Bank loan guarantee activity.
Adams, Frederick C. Economic Diplomacy: The Export-Import Bank and American Foreign Policy, 1934–1939. Columbia: University of Missouri Press, 1976.
Becker, William H., and William M. McClenahan. The Market, the State, and the Export-Import Bank of the United States, 1934–2000. New York: Cambridge University Press, 2003.
Hufbauer, Gary Clyde, and Rita M. Rodriguez, eds. The Ex-Im Bank in the Twenty-first Century: A New Approach. Washington, D.C.: Institute for International Economics, 2001.
Hillman, Jordan Jay. The Export-Import Bank at Work: Promotional Financing in the Public Sector. Westport, Conn.: Quorum Books, 1982.
Rodriguez, Rita M., ed. The Export-Import Bank at Fifty: The International Environment and the Institution's Role. Lexington, Mass: Lexington Books, 1987.
Investment banks are not banks in the strictest sense of the term. Unlike financial intermediaries (of which commercial banks are the most well-known), investment banks do not themselves acquire funds from savers (lenders) in order to provide those funds to investors (borrowers). Instead, these institutions facilitate the flows of funds from savers to corporations (or government agencies) that wish to raise capital. (This function should be distinguished from the resale of existing securities, a process that is simplified by the existence of organized secondary markets such as the New York Stock Exchange.)
Investment banks work through a process called under-writing. Usually acting in a group or syndicate, the bankers first advise the borrower on what sort of security to use to raise the required funds, the options being equity (stocks) or debt (bonds). Next, the underwriting syndicate itself purchases the new issue from the firm or the government borrower. Finally, networks of agents (brokers) associated with the investment banks sell the bonds or stocks to the ultimate lenders, who might be either individuals or large institutional investors such as life insurance companies and pension funds. If the syndicate has correctly judged the market for these new financial instruments, it will profit from the spread between the price it paid for the new issue and the price at which the syndicate was able to sell the issue. This is the investment banker's return for assuming the risk of marketing the borrower's securities.
Investment banks thus help provide capital for large borrowers, most of whom do not have the necessary expertise to negotiate and market their own financial liabilities. The history and evolution of investment banking in the United States is one of the interplay of three factors: need (the demand for large amounts of capital); opportunity (the supply of available funds); and constraints (the limitations placed on investment bankers by regulators). Despite years of change in environment and practice, however, many of the names of twenty-first century investment banks include those of the proprietors or partners of private investment banks in the nineteenth century. Among these are Morgan, Kidder Peabody, Goldman Sachs, and Kuhn Loeb.
Investment banks were rare in the pre–Civil War period. American business and government had not yet put large capital demands on the economy, so that the small, short-term loans typical of commercial banks sufficed for most enterprises. The few large borrowers called upon loan contractors, who—using personal wealth—bought up securities to resell them at a profit. Stephen Girard and John Jacob Astor acted as loan contractors in the early 1800s, but most American borrowers relied upon the experience of European firms such as London's Rothschild family and the Baring Brothers. Later, as bigger commercial banks were formed in the 1830s, some (such as the United States Bank of Philadelphia, headed by Nicholas Biddle) became involved in buying up new securities for resale to the public.
Civil War Finance
It was not until 1860 that investment banking began its rise to prominence in American financial markets. Between the Civil War and World War I, the supply of funds changed. Instead of a few very wealthy Americans, savings were more widely distributed among individuals at home and abroad. More importantly, demand for funds shifted away from relatively small, commerce-based firms and toward government, public utilities, and industry, whose capital requirements far outstripped the ability of commercial banks to meet them. These changes put investment banks at the forefront of financing the large projects that transformed the American economy in the latter part of the nineteenth century.
Unable to sell all of the federal government's Civil War–generated bond issue in 1861, Secretary of the Treasury Salmon Chase called upon Jay Cooke, who earlier that year had had some success organizing the first syndicate of banks for the purpose of underwriting a large Pennsylvania state bond issue. Cooke, relying upon a far-flung domestic network of commission salesmen, distributed the issue and in 1870 formed a syndicate to refinance the $1.5 billion federal debt. (These two innovations—the distribution network and the syndicate—have characterized much of investment banking ever since.) Other early investment banking houses were involved in distributing the federal debt, including Kuhn Loeb and Goldman Sachs.
The House of Morgan
Cooke was also involved, although less successfully, in financing the other great borrower at the time, the railroads. The scope of railroad building in the 1860s and 1870s—stretching from the Midwest to the Pacific Coast—required vast new amounts of capital. Much of it was raised in Europe, where more funds were available. It was in this arena that the Morgans, arguably the best-known banking family in the country, got their start. Junius Morgan began the dynasty as an agent of the George Peabody Company, selling American railroad securities in London before the Civil War. In 1880, his son, J. P. (Pierpont) Morgan, organized a syndicate that sold a $40 million bond issue for the Northern Pacific Railroad, the largest American railroad bond transaction up to that time.
The activities of Morgan and his son, J. P. (Jack) Morgan, reflect the development of investment banking in the twentieth century. As the railroads forged an increasingly competitive national market, some manufacturing businesses saw the key to profitability in merging into larger, consolidated enterprises; other firms concluded that the key to survival was to reorganize and re-structure. The result was a merger wave at the turn of the century, with both consolidation and reorganization (or, in modern terms, mergers and acquisitions) becoming a primary activity of investment banking. In 1892, for example, J. P. Morgan Company (along with another Yankee firm, Lee Higginson) negotiated and financed the merger of Edison General Electric and Thomson-Houston into the General Electric Company. In 1906, Goldman Sachs underwrote both the consolidation of the United Cigar Company and the expansion of Sears, Roebuck and Company. (The latter was the first instance of an investment bank underwriting the securities of a retail firm—a business that, unlike railroads or manufacturing, had few large physical assets that creditors could liquidate in the event of bankruptcy.)
At about the same time, the United States began exporting capital, particularly to countries needing to fund wars. American investment bankers underwrote the British National War Loan of 1900 (for the Boer War) and Japanese bonds used to finance the Russo-Japanese War of 1904 and 1905. Funding for the allied effort in World War I came from the $500 million Anglo-French loan of 1915, which J. P. Morgan marketed.
While the U.S. government seemed to approve of investment bankers' international role, those bankers' domestic reputation was not as favorable. As a result of their intimate knowledge of industrial structure, many investment bankers in the early 1900s became directors of the corporations whose financial needs they had serviced. This intersection of industry and finance gave rise to worries that economic power was being centralized in what was called a "money trust." After an investigation in 1912 by the Pujo Committee of the U.S. House of Representatives, numerous recommendations were made for federal laws to limit the influence, and increase the federal oversight, of large private investment banking houses such as J. P. Morgan, Kuhn Loeb, and Kidder Peabody. Although none of these recommendations were adopted, the committee's hearings were a warning to the investment banking community that it no longer could expect to function outside regulatory purview.
Nineteenth-century regulation had already limited commercial banks' ability to engage in investment banking. Underwriting was a risky venture, and many regulators believed that an institution that held the public's deposits should not be allowed to use those deposits in what were considered highly speculative activities. Consequently, the National Banking Act of 1864 strictly limited the ability of federally chartered banks to deal in securities other than some government bonds (such as the popular Liberty Bonds issued in World War I). But during the 1920s, profits available from underwriting ran as high as 20 percent as the stock market boom raised both the demand for capital and the supply of small investors' funds. Commercial bankers knew that their established base of borrowers (firms) and savers (depositors) put them in a unique position to deal in securities and regain some of their market share. Thus, banks circumvented federal regulations by establishing state-chartered affiliates that could legally engage in all types of investment banking. Several large commercial bank–investment bank combinations were formed before the Great Depression, including National City Bank–National City Company and Chase National Bank–Chase Securities Company.
By 1930, commercial banks were underwriting half of all new securities issues, but the stock market crash of 1929 (and the bank failures that followed) put the regulatory spotlight back on this activity. Although modern economic research has found no connection between commercial bank failures and the securities business of those banks, Congress passed the Banking Act of 1933 (Glass-Steagall Act) that, in effect, put a fire wall between commercial and investment banks. Commercial banks were required to sever all ties to securities affiliates, and private bankers were forced to choose between engaging in commercial banking or in investment banking. A number of banks soon sheared off their investment banking activities into wholly separate firms. Thus, at the beginning of the twenty-first century, there were investment banks with names like Morgan Stanley, the progeny of J. P. Morgan, and First Boston Corporation, an offshoot of First National Bank of Boston. (In an interesting replay of the Pujo hearings, an antitrust suit was brought in 1947 against seventeen of these investment banks. United States v. Morgan was concluded in 1953, when Judge Harold Medina ruled that these investment banks were not engaged in anticompetitive behavior.)
As part of the financial shake-up of the 1930s, regulation of investment banks increased. Probably the most powerful regulatory measure was the Securities Act of 1933, which required that investment bankers practice "due diligence" and make full disclosure before publicly marketing any security. Such oversight was lessened, however, if new issues were distributed in a "private placement" with a large investor who, it was thought, could assess the risks of a new issue itself. The number of these placements rose rapidly in the late 1930s, but it cannot be determined whether this was the result of investment bankers' attempts to circumvent disclosure laws or the natural outcome of the rise in large institutional investors such as life insurance companies and pension plans.
Modern Investment Banking
Fifty years after the New Deal, some of the financial structures built in response to the Great Depression began to be dismantled. This was, in part, the result of rapid innovation in financial markets (including the money market mutual fund) and unusual variations in inflation and interest rates. At the same time, scholars questioned the received 1930s wisdom that investment and commercial banking should never be mixed, and experts in international finance claimed that universal banking (as practiced in countries such as Germany) seemed to be an efficient and relatively safe way to mobilize capital. As a result, new laws passed in the 1980s blurred the distinctions between commercial banks and savings and loan banks and between commercial banks and investment banks.
At the turn of the twenty-first century, Glass-Steagall still technically reserves securities underwriting to the investment bankers. But commercial bankers were testing this fire wall, and some predicted that the separation of American investment and commercial banks would soon be a thing of the past, perhaps returning, full circle, to the world of late-nineteenth-century financial capitalism.
Benston, George J. The Separation of Commercial and Investment Banking: The Glass-Steagall Act Revisited and Reconsidered. New York: Oxford University Press, 1990.
Calomiris, Charles W. U.S. Bank Regulation in Historical Perspective. New York: Cambridge University Press, 2000.
Carosso, Vincent P. Investment Banking in America: A History. Cambridge, Mass.: Harvard University Press, 1970.
Chernow, Ron. The House of Morgan: An American Banking Dynasty and the Rise of Modern Finance. New York: Atlantic Monthly Press, 1990.
Endlich, Lisa. Goldman Sachs: The Culture of Success. New York: Knopf, 1999.
Hayes, Samuel L., III, and Philip M. Hubbard. Investment Banking: A Tale of Three Cities. Boston: Harvard Business School Press, 1990.
Peach, W. Nelson. The Security Affiliates of National Banks. Baltimore: Johns Hopkins University Press, 1941.
Redlich, Fritz. The Molding of American Banking. New York: Johnson Reprint, 1968.
Sobel, Robert. The Life and Times of Dillon Read. New York: Dutton, 1991.
White, Eugene Nelson. The Regulation and Reform of the American Banking System, 1900–1929. Princeton, N.J.: Princeton University Press, 1983.
The term "private banks" is misleading in American financial history. Virtually all of the banks in the United States were privately owned—even the First and Second Banks of the United States, the nation's "national" banks, sold 80 percent of their stock to private individuals. Apart from a few state-chartered banks owned exclusively by the state governments (the Bank of the State of Alabama and the Bank of the State of Arkansas, for example), all of the financial institutions in the United States were privately held. The confusion arose in the chartering process. If states chartered the banks, they were usually referred to as "state banks," even though they were not owned by the states. Alongside these chartered banks, however, existed another set of privately owned banks called "private banks." The chief difference between the two lay not in ownership, but in the authority to issue bank notes, which was a prerogative strictly reserved for those banks receiving state charters.
Private bankers ranged from large-scale semibanks to individual lenders. The numbers of known private bankers only scratch the surface of the large number of businesses engaging in the banking trade. Some of the larger nonchartered banks even established early branches, called "agencies," across state lines. They provided an important contribution to the chartered banks by lending on personal character and by possessing information about local borrowers that would not be available to more formal businesses. Private bankers also escaped regulation imposed on traditional banks, largely because they did not deal with note issue—the issue that most greatly concerned the public about banks until, perhaps, the 1850s. "Private banking" continued well into the early twentieth century.
Helderman, Leonard C. National and State Banks. Boston: Houghton Mifflin, 1931.
Schweikart, Larry. "Private Bankers in the Antebellum South." Southern Studies 25 (Summer 1986): 125–134.
———. "U.S. Commercial Banking: A Historiographical Survey," Business History Review 65 (Autumn 1991): 606–661.
Smith, Alice E. George Smith's Money: A Scottish Investor in America. Madison: State Historical Society of Wisconsin, 1966.
Sylla, Richard. "Forgotten Men of Money: Private Bankers in Early U.S. History." Journal of Economic History 29 (March 1969): 173–188.
The broad category of savings institutions is made up of several types of legal structures, including savings banks, building and loan associations, and savings and loan associations. Two of the most distinctive features of savings institutions are their mutual ownership structures and operation as cooperative credit institutions, which exempt them from income taxes paid by commercial banks and other for-profit financial intermediaries.
Savings banks originated in Europe. The first ones in the Western Hemisphere were the Philadelphia Saving Fund Society (opened 1816, chartered 1819) and the Provident Institution for Savings in Boston (chartered 1816). The concept of savings banks originated in the philanthropic motives of the wealthy, who wished to loan funds to creditworthy poor who exhibited the discipline of thrift through their savings behavior. Although savings banks provided a safe haven for small accounts, it is doubtful that these banks made many loans to the poor.
Rapid Expansion in the Nineteenth Century
Early savings banks were immediately popular. During their first twenty years of development in the United States, savings bank deposits grew to some $11 million. The popularity of savings banks resulted in part from their reputation for safety. They avoided runs by enforcing by laws that restricted payments to depositors for up to sixty days. As a result of these provisions, no savings banks failed in the panic of 1819. Around nine hundred commercial banks failed in the panic of 1837, but only a handful of savings banks met that fate.
Most savings banks also survived the subsequent panics of the nineteenth century. In the panic of 1873, some eighteen out of more than five hundred savings banks in existence suspended operations nationwide. Losses to savings bank depositors are thought to have been relatively insignificant across most of the nineteenth century. Between 1819 and 1854 no savings banks failed in the state of New York. Between 1816 and 1874, a period that includes the panic of 1873, total losses to savings bank customers in Massachusetts totaled only $75,000 on a savings bank deposit base of $750 million. As a result of their safety, savings banks' popularity surged and by 1890, 4.3 million depositors held $1.5 billion in savings banks across the nation.
The panic of 1893, however, slowed savings bank growth. Through the latter half of the nineteenth century, the class of acceptable investments for savings banks was broadened. By 1890, savings banks were invested in a wide array of assets, including government and state securities and corporate equities and bonds. Moreover, some savings banks began establishing themselves as joint-stock rather than mutual institutions. The combination of these two developments began to blur the distinction between investments of savings banks and commercial banks. Again, in 1893 most savings banks avoided failure by enforcing by laws that restricted payments to depositors. But consumer and business confidence was low and the economic disruption long. As a result, savings bank growth fell off considerably during and after the 1893 panic, although they soon recovered.
Competition, Federal Regulation, and the Democratization of Credit
In 1903 the comptroller of the currency ruled that national banks could hold savings balances. Hence, following the panic of 1907 concern for depositor safety grew in all sectors of the financial services industry. This concern, along with substantial heterogeneity in savings institutions in general and savings bank investments and operations in particular, led to the establishment of the postal savings system in 1910 as a direct competitor to existing savings institutions.
The postal savings system provided a safe haven for commercial bank depositors during the Great Depression. However, savings bank depositors experienced far fewer losses than commercial bank depositors during this period because of their diversification and their by laws allowing the restriction of payments.
New Deal legislation contained many provisions for depositor safety, including an expansion of federal authority over savings banks and building and loan associations. Prior to the 1930s, all savings banks were chartered and regulated by the states in which they operated. The New Deal established federal authority under the Federal Home Loan Bank Board for chartering and regulating savings banks and savings and loans. The creation of the Federal Deposit Insurance Corporation (FDIC) in 1933 and the expansion of the network of savings institutions are undoubtedly related to the demise of the postal savings system in the 1950s.
Savings banks and related institutions are thought to have contributed substantially to the democratization of credit in the United States during the twentieth century. Mortgage lending by these institutions led to widespread home and property ownership. Moreover, nonmortgage savings bank lending was the basis for the development of Morris Plan lending, an early form of consumer finance. Pioneered by Morris Plan Company in 1914, small, short-term (less than one year) loans were made to individuals who repaid them in fifty weekly installments. The loans became extremely popular, and by 1917 Morris Plan loans totaled more than $14.5 million to over 115,000 borrowers.
Although savings banks and savings and loans (and their predecessors, building and loan associations) were cooperative credit institutions, historically the institutions differed in some important ways. Savings and loans (and building and loan associations) concentrated primarily on residential mortgages, while savings banks operated as more diversified institutions. In the twenty years following World War II mortgages were favorable investments, so the difference between savings bank and savings and loan operations was insignificant. However, during late 1966 and 1967 savings banks were able to invest in corporate securities in the absence of mortgage loan demand, while savings and loans were not.
Decline and Resurgence
Many savings banks converted from mutual to joint-stock ownership during the 1980s. Facing new profit pressures from shareholders, the newly converted savings banks adopted portfolios similar to those of savings and loans. When sharply increased interest rates and the fundamental maturity mismatch between short-term deposits and long-term mortgages led to protracted difficulties in the savings and loan industry, many of these newly converted savings banks failed. Although lax supervision led to the replacement of the regulator of both savings and loans and savings banks (the Federal Home Loan Bank Board) with a completely new regulator (the Office of Thrift Supervision), savings bank deposits were insured by the FDIC and thus were not affected by the failure of the Federal Savings and Loan Insurance Corporation.
Although the popularity of savings institutions (including savings banks) waned in comparison with commercial banks following the crisis of the 1980s, savings institutions experienced a resurgence during the 1990s because of competitive loan and deposit rates, their mutual ownership structure and resulting tax advantages, and the broad array of financial services they may offer under contemporary banking law.
Alter, George, Claudia Goldin, and Elyce Rotella. "The Savings of Ordinary Americans: The Philadelphia Saving Fund Society in the Mid-Nineteenth Century." Journal of Economic History 54 (1994): 753–767.
Davis, Lance Edwin, and Peter Lester Payne. "From Benevolence to Business: The Story of Two Savings Banks." Business History Review 32 (1958): 386–406.
Olmstead, Alan L. "Investment Constraints and New York City Mutual Savings Bank Financing of Antebellum Development." Journal of Economic History 32 (1972): 811–840.
Sherman, Franklin J. Modern Story of Mutual Savings Banks: A Narrative of Their Growth and Development from the Inception to the Present Day. New York: J. J. Little and Ives, 1934.
Welfling, Weldon. Mutual Savings Banks: The Evolution of a Financial Intermediary. Cleveland, Ohio: Press of Case Western Reserve University, 1968.
White, Lawrence J. The S&L Debacle: Public Policy Lessons for Bank and Thrift Regulation. New York: Oxford University Press, 1991.
State investment in banks was common before the panic of 1837. The idea behind it was that bank profits would lead to the abolition of taxes. This idea had its roots in the early eighteenth century, when colonies used the interest earned from loans made through loan offices and land banks as revenue to pay the expenses (chiefly administrative salaries) of the provincial governments. For example, between about 1724 and 1754, such income paid most of the cost of New Jersey's government.
In the nineteenth century the state was sometimes the sole owner of a bank, as in South Carolina, but more commonly it was a partial owner, as in Indiana. In some cases the ventures were profitable; in others they were disastrous. In Illinois, where the state owned $3.6 million in stock, the bank's failure forced the state to divorce its interests in 1843. In Mississippi, Arkansas, and Florida, where the investment was nearly $12 million, the result was repudiation of a debt that was never paid. In Louisiana, where the bonds issued to aid banks amounted to $19 million, there was a collapse followed by reform under the Specie Reserve System of 1842.
Among the successful state-owned banks, the State Bank of Missouri was the most important. It continued operation through the panics of 1837 and 1857, and in 1862, when it entered the national system as a private bank, the state sold its stock for a premium. The State Bank of Indiana survived the panics and emerged in 1857, when its charter expired, with a net profit to the state of more than $2 million. The Bank of the State of South Carolina also withstood the panics and continued through the Civil War as one of the strongest financial institutions in the nation.
In the aftermath of the public distrust of banks after the panic of 1819, the political struggle with Andrew Jackson over renewing the charter of the second Bank of the United States, and especially after the panic of 1837, states were presented with three banking options. Some chose to forbid banking altogether—seven of thirty-one states exercised this option in 1852. Others, such as Indiana, Missouri, and Ohio, made banking a state monopoly, or at least set up a state-owned bank. Some indecisive states tried one solution, then another; Iowa, for example, went from prohibition to state banking. The majority—including New York, Michigan, and Louisiana—elected to regulate banking more closely.
With the passage of the July 1865 amendment to the National Banking Act, which imposed a 10 percent tax on state bank notes after 1 July 1866 to force all state banks to join the national banking system, state-owned banks disappeared. State-chartered banks found a way around the law by encouraging borrowers to use check currency.
Hammond, Bray. Banks and Politics in America, from the Revolution to the Civil War. Princeton, N.J.: Princeton University Press, 1957.
Helderman, Leonard C. National and State Banks: A Study of Their Origins. Boston: Houghton Mifflin, 1931.
Sylla, Richard, John B. Legler, and John Joseph Wallis. "Banks and State Public Finance in the New Republic: The United States, 1790–1860." Journal of Economic History (June 1987): 391–403.
Donald L.Kemmerer/a. r.; c. w.
Banking and finance issues in the context of the modern Middle East.
Commercial banks are especially strategic intermediaries between enterprises and investors in most countries of the Middle East and Africa, where alternative sources of private capital, such as stock markets, are relatively underdeveloped. In most of these countries, the banks are also important instruments of political control and patronage. Structural adjustment, undertaken on the advice of international financial institutions since the mid-1980s, has not significantly altered the patterns of political control discussed in this article.
Although the basic instruments of European finance were probably imported from Egypt to Italy (and from there to the rest of Europe) in the early Middle Ages, Britain, followed by France, Germany, and other European powers, introduced modern banking into the region in the nineteenth century. European trading houses founded banks in Alexandria, Egypt, as early as 1842, shortly after the British obliged Muhammad Ali to dismantle his state monopolies. The British opened a bank in rİzmir, Turkey, in the same year. Moses Pariente, a Moroccan Jew operating under British consular protection out of Europe's trading entrepôt of Tangier, opened Morocco's first bank, a trading house tied to the Anglo-Egyptian Bank based in London and Gibraltar, in 1844.
Although Britain's İzmir venture failed, the Ottoman authorities took up the challenge to modernize their finances. The Porte (the Ottoman authorities) prevailed upon two sarraflar (money changers) to establish the Bank of Istanbul in 1847 to trade in sehim kaimesi (treasury bond documents), and Tunisia's infamous finance minister, Mahmud Bin Ayad, immediately followed suit with a central bank, Dar al-Mal, to issue treasury bills. But these experiments in central banking were short lived: Bin Ayad looted his bank and fled the country in 1852. Virtually all of the other commercial banks founded in the nineteenth century were European, and they displaced the moneychangers or, like the National Bank of Egypt, subcontracted with them for business in the informal agricultural sector. The oldest survivor into the twenty-first century is the Osmanli Bankasi (Ottoman Bank), originally founded in London in response to the Ottoman decree of 1856, inspired by Her Majesty's Government, calling for "banks and other similar institutions" to promote and monitor overseas loans to the Ottoman treasury. The Ottoman Bank acquired a distinctly French look after 1863, when a consortium led by Crédit Mobilier doubled its shares and renamed it the Banque Impériale Ottomane (Ottoman Imperial Bank). As the result of a merger in 2001, it became Turkey's ninth largest bank but is wholly owned by an even larger Turkish private sector bank. The National Bank of Egypt, founded in 1898 and nationalized by Gamal Abdel Nasser in 1964, is one of Egypt's two most powerful state banks. The only other recognizable remnant of nineteenth-century European imperialism is the Banque Franco-Tunisienne, founded in 1878 but barely surviving in the twenty-first century after years of mismanagement by a leading Tunisian public sector bank.
National Banking Systems
Banking was too strategic an industry to escape the control of national governments once they achieved a degree of economic and political independence from their foreign sponsors. The patterns of control varied with the political and economic strategies of the respective regimes. The monarchies tended to prefer indirect family control through their business interests, whereas the single-party states, such as Turkey in the 1930s, and Algeria, Egypt, Iraq, Syria, and Tunisia in the 1960s, established public sectors for absorbing most or all of the banks, whether they were foreign or locally owned. Iran followed suit after the revolution of 1979. Israel had to bail out its big banks in 1983 but succeeded in selling off the government's share in some of them. The only republic in the region to support a privately owned banking system is Lebanon. Until the Civil War broke out in 1975, Lebanon was the financial center and trading entrepôt for much of the Middle East. Its Bank Control Commission regulates the eighty or so commercial banks on behalf of the Banque du Liban, the country's central bank, and remains a model in the region for the professional supervision of banks.
Like Lebanon, the monarchies that survived the revolutions sweeping the Arab world in the 1950s and 1960s tended to conserve their banks as well as their ruling families, and they encouraged local businesspeople to gain control of the banks in the 1970s and 1980s, usually continuing a close association with their foreign founders. Until 2003, for instance, Citibank not only had a 30 percent interest in the Saudi American Bank but also a management contract. The leading Moroccan banks, despite the Moroccanization of commerce in 1973, have kept close ties with the French banks that founded them. In Jordan, the Arab Bank deserves special mention: Founded by Abd al-Hamid Shoman in Jerusalem in 1930, the bank survived the creation of Israel in 1948 and Jordan's subsequent takeover of the West Bank and East Jerusalem. It is not only the oldest locally owned bank but also one of the largest international ones to be based in an Arab country. The other large international players, such as Arab Banking Corporation, are based in the Persian Gulf states (see Table 1). Bahrain, a money-market center for offshore international banking since the mid 1970s, became the center for Islamic finance in the twenty-first century as well.
Many Muslims tend to distrust banks, either out of a general distrust of public institutions or because they object to interest on religious grounds. The banking systems that preserved continuity with their foreign origins tended to be more in touch with local depositors than the public sector monopolies that broke with the foreign banks. The percentage of money held in banks, rather than as cash under people's mattresses, was high in the Gulf Cooperation Council (GCC) city states and also in Israel, Lebanon, Turkey, and Iran—countries that had delayed or never gotten around to nationalizing their respective banking systems.
The small size of a country may ease the penetration of banks into household finance, but the banks of large countries like Turkey and Iran also substantially outperformed those in all Arab countries except Lebanon. Lebanon had always encouraged commercial banking, which became its virtual
|Country||Bank||Capital (US $m)||Total assets (US $m)||Capital assets ratio (%)||Return on assets (%)|
|Syria||Commercial Bank of Syria||730||66,215||1.1||0.2|
|Bahrain||Arab Banking Corporation||2,110||26,586||7.94||0.6|
|Saudi Arabia||National Commercial Bank||2,275||26,569||8.56||na|
|Egypt||National Bank of Egypt||1,027||22,631||4.54||0.61|
|Saudi Arabia||Saudi American Bank||2,243||20,623||10.87||2.91|
|Saudi Arabia||Riyad Bank||2,139||17,933||11.93||2.01|
|Bahrain||Gulf International Bank||1,236||15,232||8.11||0.61|
|Kuwait||National Bank of Kuwait||1,421||14,551||9.77||2.52|
|Saudi Arabia||Al Rajhi Banking & Investment Corporation||1,794||13,816||12.99||2.98|
|Saudi Arabia||Saudi British Bank||1,055||11,194||9.42||1.98|
|Saudi Arabia||Arab National Bank||887||10,785||8.23||1.2|
|Saudi Arabia||Al Bank Al Saudi Al Fransi||1,075||10,683||10.06||2.11|
|Egypt||Banque du Caire||358||9,422||3.8||0.39|
|U.A.E.||National Bank of Dubai||1,133||8,893||12.74||1.38|
|U.A.E.||National Bank of Abu Dhabi||878||8,782||10||1.96|
|Libya||Libyan Arab Foreign Bank||445||8,769||5.08||1.52|
|Qatar||Qatar National Bank||1,294||7,797||16.6||1.86|
|Kuwait||Kuwait Finance House||685||7,674||8.93||2.26|
|U.A.E.||Abu Dhabi Commercial Bank||1,035||7,241||14.3||2.35|
|Algeria||Banque Extérieure d'Algérie||244||7,116||3.43||0.11|
|Saudi Arabia||Saudi Hollandi Bank||550||6,721||8.18||1.96|
|Morocco||Crédit Populaire du Maroc||536||6,716||7.99||1.63|
|U.A.E.||Emirates Bank International||1,075||6,406||16.78||2.38|
|Egypt||Bank of Alexandria||322||6,225||5.18||0.55|
|Algeria||Banque Nationale d'Algérie||312||5,944||5.25||0.6|
|Algeria||Crédit Populaire d'Algérie||273||5,557||4.91||0.02|
|Kuwait||Commercial Bank of Kuwait||618||5,503||11.22||2.12|
|Lebanon||Banque de la Méditerranée||470||4,659||10.09||0.64|
|Morocco||Banque Commerciale du Maroc||441||4,313||10.23||2.14|
|Morocco||Banque Marocaine du Commerce Extérieur||449||4,199||10.7||1.11|
|U.A.E.||Dubai Islamic Bank||310||4,175||7.41||1.02|
|Egypt||Commercial International Bank (Egypt)||351||4,143||8.47||2.43|
|Bahrain||Ahli United Bank||542||4,103||13.22||1.34|
|Saudi Arabia||Saudi Investment Bank||594||4,073||14.59||1.99|
|Kuwait||Al-Ahli Bank of Kuwait||518||3,859||13.42||1.18|
|U.A.E.||Union National Bank||401||3,613||11.11||1.83|
|Kuwait||Bank of Kuwait & the Middle East||445||3,519||12.64||1.47|
|Bahrain||Bank of Bahrain & Kuwait||299||2,929||10.21||1.52|
|Egypt||Misr International Bank||232||2,910||7.99||1.92|
|Bahrain||National Bank of Bahrain||330||2,868||11.5||1.68|
|Egypt||Arab International Bank||405||2,746||14.75||0.38|
|Tunisia||Société Tunisienne de Banque||235||2,668||8.8||1.17|
|Oman||National Bank of Oman||245||2,472||9.89||-0.64|
|Egypt||Suez Canal Bank||166||2,450||6.77||0.94|
|Jordan||The Housing Bank for Trade and Finance||362||2,410||15.01||1.76|
|Tunisia||Banque Nationale Agricole||243||2,242||10.84||0.97|
|Country||Bank||Capital (US $m)||Total assets (US $m)||Capital assets ratio (%)||Return on assets (%)|
|Table by GGS Information Services, The Gale Group.|
|Egypt||Faisal Islamic Bank of Egypt||77||2,221||3.45||0.39|
|U.A.E.||Commercial Bank of Dubai||333||2,002||16.63||2.94|
|Jordan||Jordan National Bank||98||1,910||5.12||-0.03|
|Tunisia||Banque Internationale Arabe de Tunisie||156||1,810||8.62||1.55|
|Oman||Oman International Bank||229||1,749||13.08||0.38|
|Lebanon||Bank of Beirut & the Arab Countries||78||1,682||4.64||0.79|
|U.A.E.||Arab Bank for Investment & Foreign Trade||336||1,573||21.35||0.7|
|Egypt||National Bank for Development||95||1,567||6.05||0.89|
|Egypt||Egyptian American Bank||116||1,537||7.56||1.06|
|Egypt||National Société Générale Bank||125||1,487||8.41||2.27|
|Qatar||Commercial Bank of Qatar||182||1,431||12.71||1.94|
|Morocco||Crédit du Maroc||128||1,417||9.04||1.13|
|Saudi Arabia||Bank Al-Jazira||185||1,365||13.53||1.12|
|Jordan||Jordan Islamic Bank for Finance & Investment||76||1,280||5.9||0.15|
|Bahrain||Shamil Bank of Bahrain||258||1,242||20.8||1.69|
|Qatar||Qatar Islamic Bank||102||1,213||8.4||1.52|
|Tunisia||Banque du Sud||101||1,079||9.35||1.55|
|Jordan||Bank of Jordan||75||1,040||7.18||2.52|
|Egypt||Arab African International Bank||142||1,029||13.84||1.01|
|Tunisia||Banque de Tunisie||116||945||12.28||2.59|
|U.A.E.||First Gulf Bank||141||938||15.08||1.79|
|Bahrain||United Gulf Bank||214||931||23.01||0.43|
|Bahrain||Bahrain International Bank||176||888||19.78||-5.29|
|Egypt||Cairo Barclays Bank||64||877||7.3||1.49|
|Oman||Oman Arab Bank||100||832||12.01||2.14|
|Jordan||Jordan Kuwait Bank||76||804||9.44||1.78|
|U.A.E.||National Bank of Fujairah||151||718||21.1||2.66|
|Bahrain||Bahraini Saudi Bank||88||595||14.82||2|
|U.A.E.||National Bank of Sharjah||188||557||33.8||3.73|
|Egypt||Delta International Bank||108||544||19.88||5.9|
|U.A.E.||Bank of Sharjah||93||525||17.78||2.6|
|Egypt||Société Arabe Internationale de Banque||85||500||16.89||2.1|
|U.A.E.||United Arab Bank||117||484||24.08||4.04|
|U.A.E.||National Bank of Umm Al-Qaiwain||126||466||27.04||3.45|
|Bahrain||Albaraka Islamic Bank||62||260||23.83||1.06|
government during the anarchy of 1975 through 1990. Turkey systematically encouraged a Turkish private sector after 1924, and Iran delayed its revolutionary attack on privately owned banks until 1979, when the banks had already acquired substantial control over the country's money—a control that would be recovered in the 1990s (see Table 2).
Under the gun of international debt workouts after 1982 (but this time by international financial institutions rather than the nineteenth-century imperialists), most of the commercial banking systems in the region were partially liberalized in the 1990s. In the predominantly state-owned banking systems of Algeria, Egypt, and Tunisia, liberalization meant adding a satellite private sector, whereas reform in the monarchies tended to strengthen privately owned oligopolies in defense of their respective ruling families. The different regimes of the Middle East and North Africa were able to parry the international pressures for reform so as to reinforce rather than undermine their enduring authoritarian
|Table by GGS Information Services, The Gale Group.|
traits. Neither in Egypt nor Tunisia, for example, were the patronage operations of their respective state banks seriously threatened, nor has the Moroccan private sector escaped a business oligopoly that is partly owned by the Makhzan (royal treasury). But foreign competition may pose new challenges under measures that break down national barriers to financial services.
One response to global economic pressures is Islamic finance, designed to attract the savings of people who distrust conventional banks. Islamic banking emerged officially for the first time in Dubai in 1974, and two Saudi entrepreneurs, Prince Muhammad al-Faisal (son of the late King Faisal ibn Abd al-Aziz Al Saʿud) and Shaykh Salih Kamil, then projected such banks to over twenty countries, including the United Kingdom and Denmark, in the subsequent decade. In some of the less developed countries, such as Sudan and Yemen, the Islamic banking movement made important inroads. The Faisal Islamic Bank of Sudan enabled Hasan al-Turabi to cultivate new business networks that supported his seizure of power in 1989 (but then deserted him in 1999 when his military allies removed him). The wealthy Gulf countries, however, fuel most of the steady growth of these new institutions. In Saudi Arabia in particular, conventional banks have opened up Islamic windows to satisfy customers who reject interest as a matter of Islamic principle but who are eager to receive legitimate returns on investment. Most of the savings attracted by Islamic banks are just as likely, however, to be reinvested abroad, in the United States or Europe, as those of the conventional banks.
The international crackdown on money laundering after 11 September 2001 adversely affected Islamic banks because the Al-Baraka group of Shaykh Salih Kamil was confused with a company called AlBaraka in Somalia, which transferred workers' remittances but was also suspected by the U.S. Treasury of being associated with international terrorists. The United States, however, has put only one very marginal Sudanese Islamic bank on its blacklist, and the Islamic banks not only recovered after the shock of 11 September but increased their share in the wealthy Gulf markets to well over 10 percent of their respective commercial banking assets.
see also faisal ibn abd al-aziz al saʿud; lebanese civil war (1975–1990); nasser, gamal abdel; turabi, hasan al-.
Bistolfi, Robert. Structures économiques et indépendance monétaire. Paris: Editions Cujas, 1967.
Davison, Roderic H. Essays in Ottoman and Turkish History, 1774–1923. Austin: University of Texas Press, 1990.
Fieldhouse, D. K. Economics and Empire, 1830–1914. London: Weidenfeld and Nicolson, 1973.
Henry, Clement M. The Mediterranean Debt Crescent: Money and Power in Algeria, Egypt, Morocco, Tunisia, and Turkey. Gainesville: University Press of Florida, 1996.
Henry, Clement M., and Wilson, Rodney, eds. The Politics of Islamic Finance. Edinburgh, U.K.: Edinburgh University Press, 2004.
Landes, David. Bankers and Pashas: International Finance and Economic Imperialism in Egypt. Cambridge, MA: Harvard University Press, 1958.
Snider, Lewis W. Growth, Debt, and Politics: Economic Adjustment and the Political Performance of Developing Countries. Boulder, CO: Westview, 1996.
Udovitch, Abraham L. Partnership and Profit in Medieval Islam. Princeton, NJ: Princeton University Press, 1970.
Warde, Ibrahim A. Islamic Finance in the Global Economy. Edinburgh, U.K.: Edinburgh University Press, 2000.
Clement Moore Henry
A bank deals in money and money substitutes; it also provides a range of financial services. In a formal sense, it borrows or receives “deposits” from firms, individuals, and (sometimes) governments and, on the basis of these resources, either makes “loans” to others or purchases securities, which are listed as “investments.” In general, it covers its expenses and earns its profits by borrowing at one rate of interest and lending at a higher rate. In addition, commissions may be charged for services rendered.
A bank is under an obligation to repay its customers’ balances either on demand or whenever the amounts credited to them become due. For this reason, a bank must hold some cash (which for this purpose may include balances at a bankers’ bank, such as a central bank) and keep a further proportion of its assets in forms that can readily be converted into cash. It is only in this way that confidence in the banking system can be maintained. In its turn, confidence is the basis of “credit.” Provided its promises are always honored (for example, to convert notes into gold or deposit balances into cash), a bank can “create credit” for use by its customers—either by issuing additional notes or by making new loans (which in turn become new deposits). A bank is able to do this because the public believes the bank can and will without question honor these promises, which will then be accepted at their face value and circulate as money. As long as they remain outstanding, these promises continue to constitute claims against that bank and can be transferred by means of checks or other instruments from one party to another. In essence, this is what is known as “deposit banking.” With some variations, it is the accepted basis of commercial banking as practiced in the modern world. Indeed, deposit banking cannot be said to exist as long as the assets held by a bank consist only of cash lodged by depositors. Once the accounts of banks begin to show more deposits than cash, part of these deposits must represent loans that have been made by a banker to his customers, that is, deposits created by the banking system.
Although no adequate documentation exists prior to the thirteenth century, banking is known to have a longer history. However, many of the early “banks” dealt primarily in coin and bullion, much of their business being concerned with money-changing and the supply of lawful foreign and domestic coin of the correct weight and fineness. A second and important group consisted of merchant-bankers who dealt not only in goods but also in bills of exchange, which provided for the remittance of money and the payment of accounts at a distance, without shipping actual coin. This was possible because many of these merchants had an international business and held assets at a number of points on the trading routes of medieval Europe. For a consideration, a merchant would be prepared to accept instructions to pay out money through an agent elsewhere to a named party, the amount of the bill of exchange to be debited by the agent to the merchant-banker’s account. In addition to the consideration paid, the merchantbanker would also hope to make a profit from the exchange of one currency for another. Since there was the possibility of loss, any profit or gain was not regarded as usurious. There were also techniques for making concealed loans by supplying foreign exchange at a distance but deferring payment for it until a later date. The interest charge was camouflaged by fluctuations in the rate of exchange between the date of ordering goods and the date of payment for them.
The acceptance of deposits was another early banking activity. These might relate either to the deposit of money or valuables merely for safekeeping or for purposes of transfer to another party or to the deposit of money in current account. A balance in current account might also represent the proceeds of a loan granted by the banker. Indeed, by oral agreement between the parties, recorded in the banker’s journal, a loan might be granted merely by allowing a customer to overdraw his account. In all these instances, a banker was held liable to meet on demand the claims of his depositors.
By the seventeenth century English bankers had begun to develop a depositbanking business, and the techniques evolved there and in Scotland were in due course to prove highly influential elsewhere. As men of wealth and reputation, the London goldsmiths already kept money and other valuables in safe custody for customers. They also dealt in bullion and foreign exchange and this led to their acquiring and sorting coin for profit. In order to attract coin for sorting, they offered to pay a rate of interest and, in this way, began to supplant as deposit bankers their great rivals the “money scriveners.” These were notaries who had come to specialize in bringing together borrowers and lenders and had themselves been accepting deposits.
It was soon discovered that when merchants deposited money with a goldsmith or scrivener they tended, as a group, to maintain their deposits at a fairly steady level; the goldsmith was able to “depend upon a course of Trade whereby Money comes in as fast as it is taken out.” In addition, customers preferred to leave their surplus money with the goldsmith and to hold only enough for their everyday needs. Hence, there was likely to be a fund of idle cash that could be lent out at interest to those who could use such money to advantage.
Invention of the check. There had also grown up a practice whereby the customer could arrange for the transfer to another party of part of his credit balance with his banker by addressing to him an order to this effect. This was the origin of the modern check (the earliest known example in England is dated 1670). It was but a short step from making a loan in specie to permitting customers to borrow by issuing checks. One technique was to debit a loan account with the full amount borrowed and immediately to credit an equivalent amount to a current account against which checks could be drawn. Alternatively, the customer might be permitted to overdraw his account. In the former case, interest was charged on the full amount placed to the debit of the loan account; in the latter, interest was charged only on the amount actually borrowed. But, in both cases, the customer was permitted to borrow by issuing checks in payment for goods or services. The checks represented claims against the bank, which had a corresponding claim against its customer.
Bank notes. Another means whereby a bank could create claims against itself was by issuing notes. If the volume of notes so issued exceeded the amount of specie or bullion held, additional money would have been created. The amount that was issued depended on the banker’s calculation of the possible demand from his customers for specie; the public would accept such notes only because of the banker’s known integrity. The evidence suggests that in London the goldsmith bankers were developing the use of the bank note at about the same time as the check, although the first bank notes in Europe were issued in 1661 by the Bank of Stockholm (later to become the Bank of Sweden). Some commercial banks are still permitted to issue their own notes, but most such issues have now been taken over by the central bank.
In Britain the check proved to be such a convenient means of payment that gradually the public came to prefer the use of checks for the larger part of their monetary transactions, using coin (and, later, notes) for the smaller kinds of payments. In consequence of this development, the banks grew bold and accorded their borrowers the right to draw checks far in excess of the amount of cash actually held. In other words, the banks were then creating “money”—claims that were generally accepted as means of payment. This money came to be known as “bank money” or “credit.” If bank notes are excluded, this money consists of figures in bank ledgers and is money only because of confidence in the ability of the banks to honor their liabilities when called upon to do so.
When a check is drawn and passed to another party in payment for goods or services, the check will usually be paid into another bank account, although certain checks may be cashed by direct presentation. If the check has been drawn by a borrower (and assuming that the overdraft technique is employed), the mere act of drawing and passing the check will create a loan as soon as the check is paid by the borrower’s banker. Because every loan so made tends to return to the banking system as a deposit, deposits will tend, for the system as a whole, to increase (and to decrease) approximately to the same extent as loans. If the money lent has been debited to a loan account and the amount of the loan has been credited to the customer’s current account, a deposit will be created immediately.
Negotiable instruments. In England, where the mercantile courts had greater scope than on the Continent, one of the most important factors in promoting the development of banking was the legal recognition of the negotiability of credit instruments. When orders of payment were first introduced in Europe they were certainly nonnegotiable, but in England many such orders were drawn in terms similar to those of a bill of exchange and, when the doctrine of negotiability had been established and accepted by the Courts of Common Law, the check was explicitly defined as a bill of exchange and recognized as a negotiable instrument. This helps to explain some of the differences between banking arrangements in Continental Europe and in Britain, as well as in countries influenced by British traditions. In particular, Continental limitations on the negotiability of an order of payment stood in the way of the extension of deposit banking based on the check that became such a feature of British development in the eighteenth and early nineteenth centuries. Meanwhile, Continental countries were developing a system of Giro payments, whereby transfers were effected on the basis of written instructions to debit the Giro account of the payer and to credit that of the payee.
Despite the above differences, the various banking systems have many similarities. This may be attributed to the fact that all banks trade in a type of “commodity” (money and money substitutes) that has particular characteristics. Thus, in all banking institutions (with the partial exception of those in the U.S.S.R. and those based on the same system), there is some emphasis on the need for liquidity (or the ease with which assets can be converted into cash without substantial loss) and on margins of safety in lending. Even where certain of the commercial banks are state owned (for example, in Australia, Egypt, France, and India), this has remained true.
It is more interesting, therefore, to establish why banking systems in the several countries do differ from one another, sometimes in quite material respects. The problems that face banks are much the same the world over but there is considerable variety in the solutions that are put forward to resolve them. Hence, it is in the details of organization and technique that one tends to find the differences. Yet there is a tendency for the differences to become less pronounced because of growing efficiency in international communication and the disposition to emulate practices that have proved successful elsewhere. Those differences that survive are largely the result of influences deriving from the economic and sociopolitical environment. These similarities and differences can be discussed in terms of: (a) the structure of commercial banking systems; and (b) the varying emphases in the types of business that are done by banks in different countries.
Although one must be careful not to oversimplify, it is possible to classify banking structures as falling within one or another of certain broad categories. For example, “unit banking” still describes fairly accurately the commercial banking arrangements that obtain over large areas in the United States, which has nearly fourteen thousand banks and not very many more bank branches. In a number of other countries it is more usual to find a small number of commercial banks, each of which operates a highly developed network of bank branches. In England and Wales, for example, only 11 banks (5 much larger than the rest) do nearly all the domestic banking business through more than 11,500 branches and agencies. Between these two extremes, there are many instances of “hybrid” systems, where the services of banks that are national in scope are supplemented by those that restrict their activities to either a region or a locality. Examples of such banking systems would be those of France and India. Although these hybrid systems are slowly changing their character (banks are tending to become fewer in number and individually larger, often with networks of branches), so far they have remained different enough from the two other main types of banking systems to warrant separate classification.
Unit banking—the United States
Over large areas of the United States, bank organization is still passing through a phase of structural development that many other countries went through some decades ago. This is not to deny that there has been much experimentation in the evolution of the American banking system, but its development has been subject to constraints that have certainly influenced the path that was chosen. For example, the United States has a federal form of government with a constitution that permits both federal and state legislatures to pass laws to regulate banking. A bank can, therefore, be subject to the banking laws of its own state as well as to those passed by the federal Congress. Some states permit branch banking (sometimes subject to restrictions); others prohibit it. Of itself, this has cut across any integrating forces operating on a nationwide basis. Thus the constitutional arrangements, reinforced by the political influence of small local bankers, provided the legal framework that encouraged the establishment and retention of a large number of unit banks. It must be emphasized that it was not federalism as such but the division of powers within the federation that constituted the barrier to concentration. In Australia, which also has a federal constitution, the federal government has exclusive power to legislate for all banking except that conducted by banks owned by a state government and operating within the state, and for the most part the laws relating to banks have been applied nationally. As it happens, there have been no legal impediments to the spread of branch banking in Australia, and this system is in fact well developed.
The initial establishment of a large number of banks in the United States was due to the scarcity of capital in relation to profitable opportunities for investment as the frontiers of settlement were pushed rapidly westward by the early pioneers. To satisfy the heavy demand for loans and for a medium of exchange, banks sprang up across the country. At this time, too, communications between the frontiers of settlement and the established centers of commerce and finance were still undeveloped. It was only with the coming of the railroads that east-west traffic expanded at all rapidly. Steady territorial expansion also converted the United States into a country of immense distances; there was an obvious need for a large number of banks to serve the diverse and rapidly expanding demands of a growing and constantly migrating population.
As long as communications remained imperfect, therefore, it is not difficult to explain the existence of large numbers of competing institutions. But why the subsequent failure of bank mergers or amalgamations to produce a concentration of financial resources in the hands of large banking units serving local needs through a network of branches? The retention of a primarily unit-banking system long after the barriers of distance had been broken down can be attributed in part to the federal constitution; disinclination to change was further strengthened by the widespread distrust of monopoly and the deep-rooted fear that a “money trust” might develop. There was wide acceptance of a political philosophy that emphasized the virtues of individualism and free competition. Moreover, restrictions on branching, bank mergers, and holding companies were a feature of both the state and federal banking laws. However, in parts of the United States bank branches are already numerous (especially in California, where branching is statewide; also in New York, although there the area covered by a branch network is restricted) and, despite regulation, a large number of bank mergers have been approved.
The demand for larger banking units is generally a concomitant of economic growth, with which may often be associated a rapid increase in population and its aggregation in industrial centers. A prior condition not only of growth but also of the integration of an economy and its financial institutions (without which larger units could scarcely emerge) is the development of adequate transport facilities and communications. Without efficient communications, banks could not clear checks drawn on other banks and effect their remittances easily and quickly. Branch banking is not necessarily a function of growth, but in England it was associated with it. Again, good communications were a prerequisite, in order to control branches at a distance. The Scots, for example, who from the establishment of the Bank of Scotland in 1695 favored the establishment of branches, were not initially very successful—primarily because of poor communications and the difficulty of moving adequate supplies of coin. It was not until after the Napoleonic Wars that these banks began to expand their branches with vigor. The banks then sought to overcome their difficulties by appointing as “agents” to take charge of their branches local men of standing and repute, for whom banking was often merely a sideline. Only much later, as communications improved, was responsibility for authorizing advances gradually shifted from the “agent” to the head office.
By the 1830s in England, the stream of industrial progress was running fast and already the size of the business unit was growing. A large number of small private banks were proving inadequate to meet the needs of an industrial structure no longer capable of financing itself. Bigger industrial units required financial units with greater resources, whether for lending or in the form of the more extensive connections essential to the provision of an increasing range of services. Small banks, unable to stand the strain of these enlarged demands, often became overextended and failed. This was the economic basis for the growth in bank size that was encouraged by legislation, beginning in 1826, permitting joint-stock ownership. The more widely spread proprietary, less exposed to the vagaries of human frailty, was a much more important influence on growth than limited liability, which at first—and until after the failure of the City of Glasgow Bank in 1878—was regarded with some suspicion.
Although most of the early joint-stock banks tended for some time to remain localized in their business, joint-stock ownership, latterly with limited liability, furnished the basis for the subsequent growth of the English banks in both resources and geographic coverage. These developments, which assisted in attracting deposits and in spreading the banking risk over a wider range of industries and areas, were undoubtedly encouraged by the competitive spirit and desire for personal power. They were greatly accelerated by the bank amalgamation movement that began during the nineteenth century and came to fruition during the first two decades of the twentieth century, giving Britain substantially the kind of banking system that it has today.
Different again from the unit banking of the United States and the primarily branch-banking systems of, for example, Britain, Australia, Canada, New Zealand, and South Africa are the hybrid banking systems. These are characterized by a small number of banks with branches throughout the country that hold the larger part of total deposits; the balance of deposits are lodged in a relatively large number of small banks. Although there are differences of degree and the long-term trend would seem to be toward concentrating bank deposits in fewer institutions, it has been found in many instances (for example, in France, Germany, Italy, the Netherlands, and India) that the number of the small banks decreases rather slowly. In Japan, where there is a small number of large city banks with branch networks and a larger number of local banks, there was a small increase in the total following World War ii and then virtual stability.
It is pertinent to inquire why the decrease should be slow and what obstacles exist to impede integration. Their precise character will vary from country to country; only a few examples can be offered here. These will be drawn from France and India. Frenchmen, for example, are individualists; this is reflected in the large number of small businesses that still exist and in the continuing demand for the small banking unit that can provide a more individual and personal service than the larger bank. Again, particularism is still strong in some parts of France; this manifests itself in support for local institutions. Moreover, the local banker can often attract business simply because of his special knowledge of the local industries and people; this enables him to accept risks that the big banks will decline. Also, in the past, the larger institutions in France preferred to open their own branches in new areas rather than to absorb local and regional banks.
In a less developed country like India, where a relatively large number of small banks still exists, there are other kinds of impediments. India is primarily an agricultural country, with an economic and social structure based largely on villages. These are often separated by both distance and poor communications. Integration of banking, based as it is on the spread of new ideas and institutions, is also impeded by the great barriers of ignorance and illiteracy; some degree of literacy is an obvious prerequisite for operating a bank account. In addition, there are the barriers of language and caste, as well as the difficulties that arise from joint family ownership (for example, when providing security for a bank loan). Again, habits of thrift are not easy to inculcate until incomes can be lifted sufficiently to provide a margin for saving. Hence the still strong preference for the indigenous banker with his flexible methods, and even for the moneylender. Both have existed for centuries. The indigenous banker, who is also a merchant, offers genuine banking services—accepting deposits (when available) and remitting funds; making loans quickly and with a minimum of formality; and, by means of the hundi (an indigenous credit instrument in promissory note form), financing a significant, if decreasing, part of India’s domestic trade and commerce.
It is hoped that the moneylender in India will gradually be displaced, however, by the development of a network of rural credit cooperatives, although in some areas progress has been very slow. In addition, as an act of policy and over a period of years, a progressively larger number of “pioneer” bank branches have been opened in rural areas, initially by the semipublic Imperial Bank of India and more recently by its nationalized successor, the State Bank of India. Meanwhile, many of the smaller banks that tend to serve the persons or concerns that initially sponsored them have begun to disappear.
Norway provides an interesting example of the effects on banking structure of physical geography. Almost everywhere the country is mountainous, and overland transport (especially in winter) is often difficult. Although airlines and telecommunications are beginning to knit the country together more effectively, it will be some time before improved communications can break down the particularisms that favor the continued existence of the local banks.
Yet in all these countries there is already evidence of much integration as a result of the steady growth in the size of branch networks, as well as in the share of total business done by the more important banks. Regional and local banks have been absorbed, a process that has been quickened by the need for larger resources than can be mustered by the smaller banks. In France, regional and some local banks have become associated with an institution in the capital. In India small banks have amalgamated on a regional basis, usually with the active encouragement of the Reserve Bank of India, which has hoped thereby to impart a greater degree of strength and stability to the Indian banking system. India has also encouraged the progressive extension of “pioneer branches,” a technique that has also been employed in Pakistan. In all these countries (as in the United States) there is widespread use of bank correspondents. Indeed, when banking systems are either of a unit or hybrid type, institutions must carry a rather higher proportion of total funds as balances with correspondents than do branch-banking institutions, in order to compensate the correspondent for providing a range of services that otherwise could be supplied only by setting up a local branch.
It remains to inquire into the degree to which there are variations in the types of business done by commercial banks in different countries and to establish the reasons for such differences. The essential characteristics of banking business can be most readily understood within the framework of a simple balance sheet.
The main liabilities are capital (including reserve accounts) and deposits—domestic and foreign—whether of corporations, firms, private individuals, other banks, or (sometimes) governments; whether repayable on demand (that is, sight or current accounts) or after the lapse of a period of time (time, term, or fixed deposits, but also including on occasion savings deposits).
The most important assets items are: cash, (which may be in the form of credit balances with other banks—for example, with the central bank or with correspondents); liquid assets, such as money at call and short notice, day-to-day money, short-term government paper (for example, Treasury bills and notes), and commercial bills of exchange, all of which may be readily converted into cash without risk of substantial loss; investments or securities (medium-term and long-term government securities, including those of local authorities such as states, provinces, or municipalities; also, in certain countries, participations and shares in industrial concerns); advances and loans to customers of all kinds, but primarily those in trade and industry, including in some countries term and mortgage loans (discounts, that is, discounted commercial bills of exchange, may sometimes be shown here, instead of under liquid assets); and premises, furniture, and fittings (usually written down to quite nominal figures).
A bank balance sheet must also include an item to cover contingent liabilities (for example, on bills of exchange whether “accepted” or endorsed by the bank); this will be exactly balanced by a “contra” item on the other side, representing the customer’s obligation to the bank (for which the bank might also have taken security). Virtually all banks of any size nowadays provide acceptance credits (sometimes called bankers’ acceptances), primarily to finance external trade. As the acceptor of a bill, a bank lends its name and reputation to it and thereby ensures the readier discount of paper that might otherwise have been difficult to place. A bank endorsement may serve a similar purpose.
Deposit banks, as their name suggests, operate largely on the basis of their deposits. These consist of borrowed money (and therefore liabilities), but insofar as an increase in deposits provides a banker with additional cash (an asset), this increase in cash will supplement his loanable resources. Capital and reserve accounts, which are the other important liability item, now serve primarily as the ultimate cover against losses (for example, on loans and investments). But they usually represent only a small part of the total liabilities of deposit banks. In the United States, the capital accounts are also significant as they provide the statutory basis of a bank’s lending limit to the individual borrower. However, those institutions concerned with investment banking (for example, the French banques d’affaires), a proportion of whose loans and industrial investment is likely to be long-term and therefore less liquid, must necessarily depend to a rather greater extent on their own capital resources.
For the banking system as a whole, an increase in deposits may arise in two ways: (a) if the banks increase their loans they will either transfer the money borrowed to a current account and create a new deposit directly or they will accord the borrower a limit up to which he may draw checks, which when they are deposited by third parties create a new deposit; or (b) the growth in deposits may stem from enlarged government expenditure financed by the central bank—claims on the government equivalent to cash will be paid into the commercial banks as deposits and their ownership thereby transferred from their initial recipients to the banks themselves. In the first case, as bank deposits increase, there is a related increase in the potential liability to pay out cash; in the second, the increase in deposits with the commercial banks will be accompanied by a corresponding increase in bank holdings of money claims equivalent to cash.
For the individual bank, an increase in its loans may result in a direct increase in deposits, either by transfer to a current account (as above) or by transfer to another customer of the same bank. Again, there will be an increase in the potential liability to pay out cash. But an increase in loans by another bank (including central bank loans to the government) may result in increased deposits with the first bank matched by a corresponding claim to cash (or its equivalent). Thus, the individual bank can generally expect that an increase in deposits will result in some net acquisition of cash or in a corresponding claim for receipt of cash from a third party. It is in this sense that an accretion to deposits provides the basis for further bank lending.
Except in countries where banks may still be small and insecure, the banks as a whole can usually depend on current account debits being offset very largely by the related credits, although an individual bank may from time to time experience marked fluctuations in its deposit totals. Further inertia may be added to the deposit structure by accepting money contractually for a fixed term or repayable only subject to notice. Nevertheless, at the banker’s discretion, funds may in fact be withdrawn prior to due date. Alternatively, a bank may lend against the security of such a deposit. Overdependence on foreign deposits, which tend to be more volatile than those of domestic origin, may have the opposite effect, since rumors from a distance are apt to prompt precipitate action.
Indeed, at all times, confidence in the banks is the true basis of stability. This is greatly enhanced where there exists a central bank prepared to act as “lender of last resort.” Deposit insurance (as in the United States and India) is another means of maintaining confidence as it protects the small depositor against loss in the event of a bank failure. This was also the ostensible purpose of the “nationalization” of bank deposits in Argentina from 1946 to 1957. The recipient bank acted merely as the agent of the government-owned and government-controlled central bank, all bank deposits being guaranteed by the state.
Cash and liquidity requirements. The essence of the banker-customer relationship is the banker’s undertaking to provide his customers with cash on demand or after an agreed period of notice. Hence the necessity to hold a cash reserve and to maintain a “safe” ratio of cash to deposits. This ratio may be established by convention (as in England) or by statute (as in the United States and elsewhere). In either case, the choice has been based on experience. However, where a minimum cash ratio is imposed by law a bank’s assets will in fact be impounded and, in the absence of any revision of the required ratio, be unavailable to meet sudden demands for cash by the bank’s customers. Indeed, the necessity to provide some dayto-day flexibility is one reason why required ratios are often based on the averaged cash holdings of an institution over a legally specified period.
One of the first bankers to publicize the importance of maintaining an adequate proportion of deposits in cash (or other liquid form) was George Rae; this was in 1875. Whatever the amount of cash held (short of covering demand deposits 100 per cent), no bank could meet depositors’ claims in their entirety if all customers were to exercise fully their rights to demand cash. If that were a common phenomenon, it would not be possible to base banking on the receipt of deposits. But for the most part the public is prepared to leave its surplus funds on deposit with the banks, confident that their money will be repaid as required. Nevertheless, there are occasions when unexpected demands for cash may exceed what might reasonably have been anticipated. A banker must, in consequence, always hold part of his assets in cash and a proportion of the remainder in assets that without significant loss can be quickly converted into cash. In theory, even his less liquid assets should be self-liquidating within a reasonable time.
While no banker can safely ignore the necessity to maintain adequate reserves of liquid assets, some tend to emphasize instead the desirability of limiting the sum of loans and investments to a certain percentage of deposits (say, to 70 per cent). They would feel “uncomfortable” if their loandeposit ratio were to run for any length of time at too high a level; investments are often regarded as something of a residual. But whichever ratio were adopted as a guide to action would matter little, since the effects would be much the same.
There are three main ways in which a bank’s assets may be mobilized: (a) loans may be “callable” (repayment may be demanded immediately or at short notice); (b) securities may be sold in an organized market; or (c) paper representing investments or loans may be discounted at the central bank or submitted as security for an advance. However, any precipitate calling in of loans would so disrupt the delicate nexus of debtor-creditor relations as to exaggerate the loss of confidence liable to occasion a run on the banks. So would heavy selling of marketable assets, with sharply falling prices and consequent losses. Ready cash may be obtainable only at a high price. Either the banks must maintain cash reserves and liquid assets at a high level, or there must exist a “lender of last resort” (for example, a central bank) able and willing (albeit subject to conditions) to provide the banks with cash, when required, in exchange for or against the security of eligible assets. In either event, liquid assets (including cash) are an essential component of the bank balance sheet, and, indeed, in some countries the commercial banks may be required to maintain a minimum liquid asset ratio. This is common, for example, in western European countries and also applies in effect to the English, Australian, and Canadian banks. In Asia, the requirement is usually limited to cash reserve ratios only, although Malaysia is an exception. A minimum liquid assets ratio has also been prescribed for commercial banks by several of the new African central banks (for example, in Ghana and Nigeria) and in Jamaica. At the same time, a central bank resorts to such requirements nowadays less as a means of maintaining appropriate levels of commercial bank liquidity than as a technique for influencing directly the lending potential of the banks.
The commercial banks rightly regard their investments (often consisting largely of medium-term government securities, but also sometimes including industrial shares and participations) as rather less liquid than money-market assets (such as call money and treasury bills). Nevertheless, by staggering their maturities, they are able to ensure that a portion of their holdings is regularly approaching redemption, thereby constituting a secondary liquid reserve. Following redemption at maturity, the banks usually reinvest all or most of this money by purchasing longerterm securities that in due course themselves become increasingly shorter-term. (In Britain, the average maturity of a bank investment portfolio is about five years; it is usually rather less in the United States.) But selling before maturity is also quite common—in order to vary the spread of maturities, or to restore a bank’s liquidity, or to expand loans. Because market conditions may be variable and longer maturity dates give less opportunity to avoid loss by holding securities to maturity, banks tend for balance-sheet purposes to “write down” the value of their investments (and other assets) and thereby to create “hidden reserves.” The essential difference between money-market assets and bank investments is that as a rule the liquidity of investments depends primarily on marketability (although sometimes it depends on the readiness of the government or its agent to exchange its own securities for cash), whereas the liquidity of money-market assets depends partly on marketability and partly on eligibility at the central bank. For this reason, money-market assets are more liquid.
Long-term finance. Where special investment banks exist (like the French banques d’affaires, although these also undertake a sizable deposit banking business, especially for firms in which they hold shares or any other kind of capital interest), or where the commercial banks are accustomed to finance long-term industrial developments (as in West Germany), it is no more than ordinary business prudence both to operate on the basis of relatively large capital funds (plus long-term deposits) and to value the relevant investments most conservatively. The risk of error and therefore of loss tends to increase with the period of the commitment, which after the initial technical investigation may begin as an interim credit to be converted later into a participation. Since one of the functions of these banks (which frequently organize themselves in consortiums or syndicates) is to “nurse” investments until a venture is well established, it may be necessary to hold such participations for long periods. Then, if in the bank’s judgment market conditions are deemed favorable, the original investment can be converted into marketable securities by arranging an issue of shares to the public. Nevertheless, even assuming the ultimate success of the issue, a bank may on occasion be obliged to hold such shares for long periods before being able to liquidate the bulk of its holdings and begin the process all over again. In fact, a banque d’affaires will often retain a sufficient percentage of a firm’s shares to ensure a degree of continuing control.
In contrast with Continental tradition, the long-term provision of industrial finance is usually referred in the countries of the British Commonwealth (including the United Kingdom) to specialist institutions, with the commercial banks providing part of the necessary capital. Except in the United States, where the banks are active competitors for this business, installment credit (hire-purchase finance) is also provided in most countries largely by specialist houses. In Japan, the long-term financial needs of industry are met partly by special industrial banks (which supplement their capital with the proceeds of debenture issues) and partly by the ordinary commercial banks (on the basis of the large volume of time deposits they attract).
Since World War II, term lending has been systematically developed in the United States, largely for the purpose of financing industrial re-equipment and growth. This policy owes its origin to the poor loan demand of the 1930s, when the banks sought to induce additional borrowing, especially at times when stock markets were unfavorable for new issues, by offering finance for a period of years. These loans, the majority of which have an effective maximum maturity of little more than five years, are subject to a formal agreement between the customer and (usually) a group of lending banks, sometimes in cooperation with other institutions, such as insurance companies. More recently, banks in several other countries (including Britain and Australia) have instituted term loans to finance exports and capital expenditure, both in industry and in agriculture.
Loans and advances. Yet even in countries where commercial banks do lend long-term to industry, it is the self-liquidating loans and advances that constitute the core (and often the most profitable part) of earning assets. Traditionally, much of this accommodation is of the “seed-time to harvest” kind, that is, provision of working capital, although there may be some temporary financing of fixed capital development pending arrangements to raise long-term finance elsewhere. Overdrafts, whereby a borrower may overdraw his account (or go into debit) up to an agreed limit, are the common means of bank lending in the United Kingdom and in a number of other countries. In theory they are temporary but usually renewable annually or repayable after due and reasonable notice has been given; in practice they may run on for long periods, depending on the character of the business being financed. The advance is reduced or repaid when credits are paid into the account, and recreated when new checks are drawn. The “cash credit” employed in India and Pakistan to finance the holding of stocks is similar. Even in countries where the overdraft predominates (for example, in Britain and the Netherlands), the method of debiting a loan account for credit to a current account may sometimes be used; checks are drawn on the current account, with interest payable on the whole amount of the loan (itself usually for a fixed period) instead of only on the amount actually overdrawn.
Elsewhere (for example, on the Continent and in the United States and Japan), bank finance is often made available short-term on the basis of discountable paper—commercial bills or promissory notes, often subject to a line of credit similar to an overdraft limit. This accommodation is also self-liquidating as it matures, although such paper may be renewable at the discretion of the lender. If eligible for rediscount at the central bank, it becomes virtually a liquid asset, unlike a bank advance or loan. Under both systems, finance may be made available with or without formal security, depending on the reputation and financial strength of the borrower. In many countries the customer may seek finance (and other services) from a number of banks (to protect their own interests these institutions will usually freely exchange information about joint credit risks), but in Britain and in the Netherlands the tendency is for all but the largest concerns to use the services of a single institution to meet the bulk of their banking needs.
Finally, we must consider the relations between the commercial banks and other types of financial intermediary that undertake quasi-banking business. In the days of “cloakroom” banking (lending out mainly such money as had in fact been deposited in cash), banks were not in any important sense “creators of money,” except to the extent of their note issues. In a similar way, installment credit (or hire-purchase) finance companies, mortgage banks, and building societies (or savings and loan associations) in effect lend out only what they receive and, since money deposited with them usually and with little delay finds its way back to the banks themselves, the existence of such intermediaries cannot seriously affect the level of bank deposits. Other institutions, such as local governmental and other authorities, collect savings to spend; these, again, reappear in bank accounts. Yet, although they may not “create money” in the same way as the commercial banks, nonbank financial intermediaries can be the means of activating otherwise idle balances (accumulated from savings in earlier periods) and can thereby add to the intensity of the use made of monetary assets. In large measure what they do is merely gather savings together and direct these (by lending them) into the hands of those who will use them. In this event they lend no more than savers decide to place with them from their current income receipts. Only to the limited extent that these intermediaries invest in government securities may deposits be lost to the banking system, just as when commercial undertakings buy treasury bills. However, during times of credit restriction, when bank lending has been significantly curtailed, the nonbank financial intermediaries have been able to increase their share of the types of loans also made by the banks. In that way they seriously compete with the latter for business that once lost is difficult to regain. In addition, the competition for new loan business has certainly been intensified by the growth of lending institutions other than banks, and in a number of countries banks have been forced either to acquire capital interests in finance companies or themselves to develop installment credit or hire-purchase business.
J. S. G. Wilson
American Bankers Association 1962 The Commercial
Banking Industry. A monograph prepared for the Commission on Money and Credit. Englewood Cliffs, N.J.: Prentice-Hall.
Beckhart, Benjamin H. (editor) 1954 Banking Systems. New York: Columbia Univ. Press.
Commission on Money and Credit 1961 Money and Credit: Their Influence on Jobs, Prices and Growth. Englewood Cliffs, N.J.: Prentice-Hall.
Crick, W. F. (editor) 1965 Commonwealth Banking Systems. Oxford: Clarendon.
Great Britain, Committee on Finance and Industry 1931 a Report. Papers by Command, Cmd. 3897. London: H.M. Stationery Office. → Commonly known as the Macmillan Report.
Great Britain, Committee on Finance and Industry 1931b Minutes of Evidence Taken Before the Committee. Vol. 1. London: H.M. Stationery Office.
Great Britain, Committee on the Working of the Monetary System 1959 Report. Papers by Command, Cmd. 827. London: H.M. Stationery Office. → Commonly known as the Radcliffe Report.
Great Britain, Committee on the Working of the MONETARY SYSTEM 1960a Minutes of Evidence. London: H.M. Stationery Office.
Great Britain, Committee on the Working of the Monetary System 1960b Principal Memoranda of Evidence. 3 vols. London: H.M. Stationery Office.
Jacoby, Neil H.; and Saulnier, R. J. 1947 Business Finance and Banking. National Bureau of Economic Research, Financial Research Program. Princeton Univ. Press.
Plumptre, Arthur F. W. 1940 Central Banking in the British Dominions. Toronto Univ. Press; Oxford Univ. Press.
Reserve bank of India, Committee of Direction of the All-India Rural Credit Survey 1954 All-India Rural Credit Survey. Bombay. → Volume 1: The Survey Report. Parts 1 and 2. Volume 2: The General Report. Volume 3: The Technical Report.
Sayers, Richard S. (editor) 1952 Banking in the British Commonwealth. Oxford: Clarendon.
Sayers, Richard S. (editor) 1962 Banking in Western Europe. Oxford: Clarendon.
[U.S.] Board of Governors of the Federal Reserve System 1941 Banking Studies. Baltimore: Waverly.
BANKING.THE RISE OF THE BIG BANKS
NATIONAL BANKING SYSTEMS
BANKING AND ECONOMIC DEVELOPMENT
THE FIRST WORLD WAR AND ITS
THE BANKING CRISIS OF THE 1930S
SUPERVISION AND REGULATION
WARTIME CONTROLS AND
THE EMERGENCE OF THE EUROMARKETS
COOPERATION AND COMPETITION IN
TOWARD THE TWENTY-FIRST CENTURY
Throughout the twentieth century, banks have played a major role in Europe's economy, society, and politics. As companies banks have counted among the largest, while as financial intermediaries they have contributed decisively, though sometimes controversially, to economic development. Yet banking has displayed different features in each European country. For if a broad definition of a bank can easily be provided (taking deposits on the one hand and granting credit on the other), there have been multiple variations on this theme, in terms of type of banking activity (commercial or investment bank), ownership (private, joint stock, or state-owned), size (small, medium-size, large), and geographical expansion (local, regional, national, multinational). The combination of these different characteristics has varied between countries, contributing to their distinctive banking architecture, as well as over time.
By 1914 national banking systems had adopted their distinctive features, which were not entirely to disappear with the transformations of financial activities occurring in the course of the twentieth century, especially from the 1960s. Despite national idiosyncrasies, two main models have been dominant across Europe: the British model of deposit banking complemented by a more active capital market, and the German model of universal banking, with France combining some elements of the two. This entry will thus mainly concentrate on these three cases, Europe's three leading economies, while paying attention, when necessary, to other national experiences.
By the eve of the First World War, the effects of the banking revolution of the nineteenth century—the emergence of the large joint-stock bank—were being fully felt, though in different degrees, in all European countries. The phenomenon was most pronounced in England, where twelve banks, based in London with a national or regional network of branches, controlled two-thirds of the country's deposits. The three largest—Lloyds, Midland, and Westminster—were among the world's top five, together with Crédit Lyonnais of France and Deutsche Bank of Germany (see table 1). Such powerful institutions were the result of an amalgamation movement starting in the mid-nineteenth century and leading to the complete disappearance of the private country banks and of most regional banks. The level of concentration was also high in France, with more than half of the resources of the registered banks in the hands of the four largest. Unlike England, however, over two thousand local banks survived in France, and although their importance cannot be assessed quantitatively, as they did not publish their balance sheet, recent historical research has revealed that they played a major role in supporting small and medium-size enterprises. The situation was still different in Germany, where the nine big Berlin banks collected barely 12 percent of the country's banking resources. There were still several hundred local and regional joint-stock banks, whose joint resources were more or less equal to those of the big banks, as well as a good thousand private banks that were not included in the Reichsbank's statistics. But the bulk of the deposits lay elsewhere: almost 75 percent was in the hands of savings banks, mortgage banks, banking cooperatives, and other specialized banks. Alongside the big banks, old established private banks—the haute banque, to use the evocative French terminology—had managed to retain an influential position, especially in international finance, thanks to their prestige and networks of relationships. Their position was particularly strong in London, then the world's financial center, less so in Paris and Berlin.
The strength of the London merchant banks—the English version of the haute banque, with such famous names as N. M. Rothschild, Baring Brothers, Morgan Grenfell, Schroders, or Kleinwort—was partly the result of the highly specialized nature of the English banking system. While German banks were specialized by type of customer (large companies for the big banks, small and medium-size firms for the local and regional banks, and so on), the English banking system was specialized by functions. However, in all countries central banks were starting to establish their role as lenders of last resort in order to ensure the stability of the financial system.
In Britain banking basically meant deposit banking. The golden rule of deposit banks, or clearing banks as they are usually called, was not to tie up in long-term investments the money deposited with them on a short-term basis. Assets thus had to be as liquid as possible, with self-liquidating bills of exchange being especially popular. Investments were in consols—the British national debt—or in other highly liquid securities, not in industrial securities; advances were granted on a short-term basis, whether in the form of loans (granted for a fixed sum and for a given period) or of overdrafts (which customers could use as they required, up to a limit agreed upon beforehand with the bank). For their long-term
|Total assets (£ millions)|
|Crédit Lyonnais (France)||113|
|Deutsche Bank (Germany)||112|
|Midland Bank (United Kingdom)||109|
|Lloyds Bank (United Kingdom)||107|
|Westminster Bank (United Kingdom)||104|
|Société Générale (France)||95|
|Comptoir National d'Escompte de Paris (France)||75|
|National Provincial Bank (United Kingdom)||74|
|Dresdner Bank (Germany)||72|
|Société Générale de Belgique (Belgium)||72|
|Barclays Bank (United Kingdom)||66|
|Parr's Bank (United Kingdom)||52|
|Union of London and Smiths Bank (United Kingdom)||49|
requirements, companies could raise money on the capital markets, traditionally more developed than in continental Europe, though clearing banks did not issue securities on behalf of customers, a task left to company promoters.
International credit was provided by the merchant banks that accepted, or upon which were directly drawn, bills of exchange, generally for three months, which constituted the main instrument for financing international trade. These bills were negotiable instruments, and well before they reached their maturity dates they were discounted by other specialized banking firms, the discount houses, which then resold them to commercial banks. Merchant banks were also specialized in the most prestigious financial activity of the day, issuing loans on behalf of foreign companies and governments. In addition to being specialized by functions, banking was divided between international and national financial activities. Though more involved in the latter, the clearing banks provided the cash credit, in the form of day-today loans, to discount houses that discounted the bills of exchange accepted by the merchant banks, thus making the whole wheel of international trade financing turn. Finally, the overseas banks were English banks, insofar as their capital and management were English and their registered office was usually in London, but their sphere of activity was in the British Empire or abroad. Their goal was to finance trade with the regions in which they were established and to obtain exchange facilities. Among them were the Hong Kong and Shanghai Banking Corporation, the London and River Plate Bank, the Standard Bank of South Africa, and several others, all independent companies and not subsidiaries of big commercial banks.
In Germany, by contrast, universal banks undertook all types of operations: they collected deposits, granted short-term commercial credit as well as medium- and long-term industrial credit, discounted bills of exchange, and acted as brokers and as issuing houses. Bankers were also massively represented on the boards of other, especially industrial, companies. The German big banks were thus involved in both national industrial financing and large international banking and financial transactions, especially in issuing foreign loans. The French banking system is usually seen as standing roughly halfway between the British and German models. On the one hand, the French big commercial banks followed the principles of the English joint-stock banks, while more risky industrial financing was left to another type of bank, the banque d'affaires (banks akin to investment banks, mainly dealing in securities and holding controlling stakes in other companies), whose most famous representative was the Banque de Paris et des Pays-Bas. Overseas banks were also part of the German and French banking systems, though they were less numerous and had smaller networks of foreign branches than their British counterparts and, unlike the latter, were often subsidiaries of the large commercial banks. Elsewhere, Belgium, Switzerland, Italy, and Austria were close to the German model, Holland and the Scandinavian countries to the British one.
There have been intense debates about the respective merits of these systems, in the first place the British and the German ones, particularly with respect to their contribution to economic development. A long historiographical tradition holds that the financial sector contributed to Britain's relative economic decline in the three or four decades before the First World War. British banks have been criticized for their reluctance to provide long-term industrial finance and the London capital market for directing overseas funds that could have been more beneficially invested in the British economy. A similar criticism has been directed at the French banks, especially as far as their preference for foreign investments is concerned. Such criticisms are not surprising given that Britain and France were the two largest capital exporters (with respectively 18.3 and 8.7 billion dollars of assets in foreign countries in 1913 out of a total of 44 billion dollars, as against 5.6 billion for Germany) and experienced slower economic growth than Germany during the three decades preceding the First World War. The German banking system, for its part, has often been seen as working in the long-term interest of the manufacturing industry, while some authors, most famously Rudolf Hilferding in Das Finanzkapital, published in 1910, have stressed the power of the banks, in particular the control they were in a position to exert over industry and, ultimately, over the entire German economy.
Historical evidence reveals a picture often at odds with such analyses. French banks have been absolved from the sin of "failing" industry. Recent research has shown that British banks were more involved in industrial finance than they had been credited for and that large industrial companies were able to make effective use of the flexibility of the capital markets. And German industrial companies have been shown to have been far more independent from the banks than Hilferding and his followers had assumed. As for capital exports, they barely affected the economies of centrally located countries. In the end, finance held a stronger position in Britain, as a result of the international position of the City of London, than in Germany, where the banks' power and prestige ultimately lay in their support of the country's industrialization.
Banking prospers in times of peace, not in times of war. Indeed, for most bankers and financiers the First World War meant a marked decrease in their activities owing to disruptions in the trading of goods, services, and capital among countries, as well as to growing state intervention in economic and financial affairs. A large number of services traditionally offered by the banks were henceforth superfluous, like commercial credit or issuing syndicates, since governments at war tend to pay companies up front or borrow directly from savers. The London merchant banks, cornerstone of the international credit mechanism prior to 1914, suffered from the slump in their accepting and issuing businesses, while the commercial banks had to adjust to the part played from then on by financing the growing needs of the state: the assets of all big European banks mainly comprised Treasury bonds and similar stocks at that time.
However, despite the disruptions caused by war and monetary disorders in the early 1920s, the trend toward the strengthening of the large joint-stock banks and increased banking concentration continued during the 1920s. This trend was particularly strong in Britain, where the amalgamation movement reached its peak in 1918, before the war was over. Five mergers took place in that year, involving the country's ten largest banks and resulting in the formation of five huge banks that immediately came to be known as the "Big Five"—Barclays, Lloyds, Midland, National Provincial, and Westminster—and controlled 90 percent of the country's deposits. The "Big Five" emerged as the largest banks in the world, far ahead of their German and French counterparts (in 1929 the largest British bank was nearly four times larger than the largest German or French one), which encountered more difficulties in the early postwar years. French banks suffered from the devaluation of the franc and the absence of significant mergers. As for German banks, even though they expanded by taking over provincial banks, they were weakened by the devastation of war and hyperinflation: in 1924 the commercial banks' capital was valued at 30 percent of its prewar gold value, their assets at only 21 percent. However, they strengthened their position within the German banking system, with their share of the total assets of all German banks reaching 33 percent in 1929, a level not to be surpassed until the 1980s.
Business conditions somewhat altered in the 1920s. In Britain the clearing banks, with their enormous financial means, increasingly competed with the merchant banks in the accepting and issuing activities. Moreover, the former became involved in long-term industrial finance, though this policy was somewhat forced upon them rather than deliberately chosen. During the boom of 1919–1920 they granted large overdrafts, particularly to heavy industry, which with the downturn of the 1920s often had to be converted into frozen loans and nursed for the remainder of the period. In France the big banks had to face growing competition from the main provincial banks (Crédit du Nord, Société Nancéienne de Crédit, and others). And as Germany became a capital-importing country (having been stripped of its foreign assets and required to pay reparations by the Treaty of Versailles), the big banks and the leading private banks played an active role in these transfers, borrowing on a short-term basis abroad and then lending on a long-term basis to German companies, a risky strategy in the event of the influx of foreign capital coming to a stop. Furthermore, they had to deal with competition from foreign banks, especially American, which granted credit directly to German companies and took charge of issuing securities on their behalf on the New York market.
The Wall Street crash of October 1929 and the ensuing slump soon affected banking. The big Italian banks—Banca Commerciale Italiana, Banca di Roma, and Credito Italiano—went through serious difficulties in 1930 and were rescued in secrecy by the Bank of Italy and the Italian government, which undertook a thorough transformation of the banking system, leading, in particular, to the nationalization of the banks and the end of universal banking. In May 1931 the Credit-Anstalt in Vienna went bankrupt, and the crisis then moved to Berlin. On 13 July 1931 the Danat Bank, weakened by the collapse of the large textile trust company Nordwolle, closed its doors, provoking a run of depositors on the other banks, which decided to only pay 20 percent of the sums that their clients wanted to withdraw, in other words to suspend their payments. The German banks were initially penalized by the interruption, following the crash, of foreign capital inflows into Germany, on which the entire credit mechanism hinged. Then, with the prolongation of the crisis and international tensions, especially surrounding the payment of reparations, they had to contend with massive withdrawals of foreign funds. Finally, in July 1931, they were no longer able to obtain refinancing from the Reichsbank, whose gold and currency reserves shrank below their statutory minimum. The intervention of the German government put an end to the panic. It ordered the immediate closure of all banks for two days, during which the Dresdner Bank also declared itself bankrupt, and introduced exchange controls on 15 July. With state backing, the Reichsbank set up the Akzeptund Garantiebank to obtain credit for commercial banks and savings banks. Furthermore, the government undertook major restructuring of the big banks, resulting in their near nationalization; they were denationalized, however, during the Third Reich.
From Germany, the crisis moved to England. The big banks held out well, with no major English bank having to close its doors during this period. The merchant banks were hit harder by the contraction in international trade and especially the introduction of exchange controls in Germany, and some of the smaller houses had to be wound up. The real crisis was a crisis of the pound sterling, whose convertibility in gold was suspended by the British government on 21 September 1931—a turning point in monetary history, with the end of the gold standard, rather than in banking history.
The French banks were not spared. Between October 1929 and September 1937, 670 French banks became insolvent, the vast majority of them small local and regional banks. Among the big banks, the Banque Nationale de Crédit (BNC), the country's fourth-largest deposit bank, collapsed in 1931 and was built up again the following year, with help from the state, under the name of Banque Nationale pour le Commerce et l'Industrie (BNCI). The Banque de l'Union Parisienne, one of the main banques d'affaires, shaken by the crises in Germany and central Europe, experienced very serious difficulties that brought it to the brink of bankruptcy in 1932, but it was saved by the joint intervention of the Banque de France and the main Parisian banks.
Small countries were also affected by the crisis, including safe havens such as Switzerland, then Germany's fourth-largest creditor. The large Swiss banks suffered badly from the effects of German banking crisis, with their assets more than halving between 1930 and 1935. Only the two largest banks—Swiss Bank Corporation and Crédit Suisse—avoided large reductions of capital, while one of them—the Banque d'Escompte Suisse, Geneva—collapsed in 1934 and another—the Schweizerische Volksbank, Berne—was only saved by the intervention of the federal government.
The depression of the 1930s interrupted the forward march of the big banks that had started fifty years earlier, reinforcing the public and para-public banks. The shift was most spectacular in France, where by the late 1930s the share of the publicly owned institutions, in the first place the savings banks, far outstripped those of the commercial banks: between 1930 and 1937 deposits held by the former rose from 67 to 113 billion francs, while those held by the latter actually fell from 87 to 67 billion. In Germany, the share of the savings banks in the total assets of all banks increased from 31 percent in 1929 to 43 percent in 1938, while those of the commercial banks fell from 33 to 15 percent. Despite their rapid growth, savings banks and building societies never reached such a dominant position in Britain: by 1933 their assets represented 37 percent of those of the clearing banks, up from 17 percent in 1920.
The bank bankruptcies and the crisis of confidence in financial institutions led governments to intervene in financial affairs, with the aim of ensuring the stability of both the financial system and the economy. Moreover, state regulation was encouraged by the prevailing ideology and growing distrust toward market mechanisms. The main issue was the risks involved in universal banking. Mention must be made here of the United States, the first country to legislate and the one that went the furthest in this field, in particular with the Glass-Steagall Act (from the names of the two promoters of the Banking Act passed in 1933), which decreed the complete separation of commercial banking activities (raising funds and loans) from investment banking activities (issuing, distributing, and trading securities). Similar measures were taken in a number of European countries, notably Belgium, where two decrees passed in 1934 and 1935 (and in fact largely inspired by bankers anxious to restore confidence) abolished universal banking and subjected all institutions having banking status to control by a new body, the Banking Commission. From then on, the SociétéGénérale de Belgique, Europe's oldest universal bank, founded in 1822, concentrated all of its commercial banking activities in a new institution, the Banque de la SociétéGénérale, later known under the name of Générale de Banque.
The universal bank survived in Germany, though its abolition was debated. The banking law of December 1934, enacted under the Nazis, attributed the crisis to individual failings rather than to any shortcoming of the system and made do with strengthening bank supervision and introducing some restrictions on long-term deposits and on banks' representation on the supervisory boards of other companies. But even though universal banking survived, the government considerably strengthened its hold over financial institutions. Other laws, of a more sinister nature, also transformed the banking landscape in Germany by excluding Jews from economic life.
In Switzerland the federal banking law of 1934 did not abolish universal banking, and its only effect was the Swiss Confederation's very mild interference in banking affairs arising from the establishment of a Federal Banking Commission to supervise the system. The law was above all famous for its Article 47 relating to banking secrecy. This article made those who were subject to it—bank employees, managers, directors, auditors, and supervisors—liable to fines or up to six months' imprisonment if they divulged information on the trend of the business market and, above all, the names of a bank's clients.
England, for its part, steered clear of the trend toward greater regulation of the banks, probably because there had not been any bank bankruptcies during the 1930s, and because the financial system was more specialized than elsewhere and effectively monitored by the Bank of England. France too left things as they were until 1941, when the Vichy government introduced a law, upheld and completed in 1944, that controlled and regulated banking activities that until then had been open to any newcomers. Henceforth, banks had to be registered according to their type of activity, with a clear distinction between banques d'affaires and deposit banks, as well as between banks and other specialized institutions such finance companies and discount houses.
All banks, in all countries, were affected by the Second World War. As in the First World War, contributing to the war effort meant, as far as their business operations were concerned, a shift from commercial to government lending. Everywhere, including in the neutral countries, their assets became dominated by government securities. In Britain, by August 1945 government paper and cash amounted to over 82 percent of the deposits of the London clearing banks. The figure was just under 50 percent at Deutsche Bank, as well as at the Swiss Bank Corporation.
However, these were but temporary effects, even though banks did not return to fully normal business conditions until the early 1950s. More fundamental changes affected German and French banks. In Germany, the Allies' determination to decentralize the German economy led to the decision to divide each of the three big banks (Deutsche, Dresdner, and Commerz) into regional banks. The Deutsche Bank, for example, was succeeded in 1948 by ten separate institutions. Such measures, inspired by American banking legislation, were clearly at odds with German, and more generally European, banking traditions. They met with strong resistance from the German banking community, which immediately set about working toward reunification. As soon as 1949 bank representatives made proposals for a first regrouping on a wider regional basis, taking advantage of Britain's disagreement with the decentralization projects and the favorable conditions presented by the Cold War. The number of successor banks had already been reduced to three by 1952, and complete reunification took place in 1957 for Deutsche and Dresdner and the following year for Commerz. During this period the credit banks progressively returned to their traditional business practices, in particular their close links with large industrial companies, through both advances and interlocking directorships.
In France the main transformation was the complete control established by the state over the mechanism of credit. The Banque de France and the major deposit banks (Crédit Lyonnais, Société Générale, Comptoir National d'Escompte, Banque Nationale pour le Commerce et l'Industrie) were nationalized in 1945, to be added to a public sector already including the Caisse des Dépôts et Consignations (the recipient of most of the assets of the savings banks). However, the nationalized banks did not lose their corporate identity, while the banques d'affaires, including the Banque de Paris et des Pays-Bas, remained in private hands. The nationalized banks played only a modest role in the country's economic reconstruction and modernization and contented themselves with collecting short-term deposits and supporting Treasury issues. They hardly extended their network of branches and were happy to avoid competition in a cartelized sector. With the state now in the driving seat, it was the Treasury that financed the first of France's many five-year economic plans and the Caisse des Dépôts that financed local communities.
In Britain, only the Bank of England was nationalized in 1946, though the Big Five were under strict official control. They received precise instructions from the Treasury concerning not only their liquidity ratios but also their lending priorities, especially as far as manufacturing investment and the support of exports were concerned, leading John Maynard Keynes to comment that the clearing banks hardly needed to be nationalized. Official controls also had the effect of curbing competition. Despite their giant size, the Big Five were content to operate a price cartel that set interest rates and to remain strictly within the limits of deposit banking. Merchant banks, for their part, were working in a much less congenial economic environment: New York had become the world's undisputed financial center, the dollar was the main trading and reserve currency, and the pound suffered from not being fully convertible on current account until 1958. While they resumed their traditional activities, merchant banks increasingly turned their attention to domestic issues, preparing the ground for their later dominance of the field of corporate finance.
In the late 1950s and early 1960s, the emergence of the Euromarkets—Eurodollars, then Eurobonds and syndicated Eurocredits—marked a turning point in the history of international finance. As truly international capital markets, separate from the United States financial system and unregulated, they gave a new impetus to international capital flows.
Eurodollars are dollars deposited outside the United States. From the early 1950s, they started to accumulate in Europe, especially in London, partly because of the Cold War (the Soviet Union and Eastern European countries preferred to deposit their dollars in Europe rather than in the United States for fear of their being blocked in case of international tension) but mainly as a result of the United States' overseas investment—in the first place by multinational companies but also in foreign aid, as well as the country's growing payment deficit. Banking regulations also played their part, in particular the so-called Regulation Q, which dated back to the Banking Act of 1933 and enabled the Federal Reserve System to put a ceiling on the rate of interest that banks paid on domestic bank deposits. As British banks were able to offer a higher rate, funds were attracted to Britain, especially those earned overseas by American multinationals. With the ban on the use of sterling instruments for financing third-party trade imposed by the British government following the sterling crisis of 1957, London banks, unwilling to lose customers, began to use these dollars instead. The Eurodollar market was born. With the return to external convertibility of European currencies in 1959 and the relaxation of exchange controls on capital account from the early 1960s, the Eurodollar market was soon to provide world credit on an unprecedented scale, with banks as the main operators and deals usually for very large amounts. Eurodollars were mainly used in the interbank market (banks placing funds at other banks), usually, though not exclusively, for short periods. From 1.5 billion dollars in 1959, it reached 25 billion ten years later and over 130 billion in 1973.
The emergence of Eurodollars signaled the rebirth of the City of London, whose standing had been suffering from the pound's decline. The City soon established itself as the home of this new market, taking advantage of its long experience of international finance and its large pool of skilled personnel. The merchant banks' early role in initiating the market also helped to determine its location, together with the Bank of England's flexible system of control. Since the end of the war, major international financial operations could only be undertaken from New York. With the use of the Eurodollar, and to a lesser extent other Euro-currencies, such operations could once again be carried out from London. This was especially the case with one of the City's specialties: international issues.
The Eurodollar market led to the development of the Eurobond market—foreign dollar bonds issued in Europe—which provided longer-term loans than was usual with Eurodollars. The first Eurobond issue took place in London in 1963—a fifteen-million-dollar, 5.5 percent six-year loan to Autostrade Italiane, with the state-owned holding company IRI as guarantor, floated by S. G. Warburg and Co. Eurobonds quickly proved very popular, especially as they were bearer bonds and were not subject to withholding tax. And with the introduction later in 1963 of the Interest Equalization Tax by the American authorities (a tax on purchases of foreign securities by U.S. residents to check the outflow of capital), American multinationals increasingly borrowed outside the United States. From 258 million dollars in 1963, the Eurobond market grew to 4.2 billion dollars in 1973, catching up with the traditional foreign bonds (denominated in the currency of the country where they are issued) and overtaking them in the 1980s.
In addition to short-term Eurodollar deposits and long-term Eurobonds, medium-term loans (three to ten years) were also granted to industrial corporations, as well as to governments and public authorities. They usually took the form of syndicated loans (the funds were made available by a syndicate of thirty to forty international banks organized by a lead institution) with floating interest rates. From a mere two billion dollars in 1968, syndicated loans reached over twenty billion dollars in 1973 and played a major role in the recycling of "petrodollars" (dollars accumulated by oil-producing countries in the wake of the oil price increases of the 1970s) during the rest of the decade.
The emergence of the Euromarkets heralded a new era in multinational banking (banks owning at least one branch in a foreign country). Major changes took place in three main areas: the location of foreign branches, the type of operations undertaken abroad, and the home country of the banks involved. Multinational banks shifted their attention from developing countries, where British overseas banks, in particular, had been active since the mid-nineteenth century, to the world's major financial centers: London, far and above, as home of the Euromarkets; New York, the world's leading financial center; but also Paris, Frankfurt, Luxembourg, Zurich, and others. These banks were much more involved in wholesale banking (transactions with other financial institutions and large companies involving huge deposits) than in retail banking. And the leading players, at least until the mid-1970s, were American banks, with their formidable expansion abroad, especially in Europe, being perceived as an "invasion" by some contemporaries. For if American banks did not pioneer Eurodollar transactions—the first such loans were granted by London merchant banks and British overseas banks—they were quick to join and soon captured the bulk of the market in dollars traded outside their home country. British multinational banks had to undergo a profound restructuring, and, with the exception of French banks (which had retained a network of foreign branches, mostly in France's colonial empire), other European banks only started to move abroad in the 1970s and did not form major multinational banking groups before the globalization of the 1980s.
International expansion might have been the order of the day, yet it was a costly and risky proposition, especially if it meant entering new markets requiring a large capital basis. In order to face the "American challenge," European banks, including British banks, chose to cooperate. The innovation of the 1960s was the formation of banking "clubs," designed to extend the services of their members throughout Western Europe without the need for direct representation in other countries. Closer collaboration was also encouraged by the formation in 1958 of the European Economic Community and the prospect of rapid monetary integration: there is no doubt that the founders of these "clubs" saw them as a first step toward pan-European mergers. Cooperation also included launching several joint ventures in various parts of the world. By the early 1970s four such clubs had been established: Associated Banks of Europe Corporation (ABECOR), Europartners, European Banks International Company (EBIC), and Inter Alpha. They included most leading European banks, each with no more than one bank per country—for example, Amsterdam-Rotterdam Bank, Deutsche Bank, SociétéGénérale de Banque, and Midland Bank were members of EBIC, later joined by SociétéGénérale and Creditanstalt-Bankverein. Consortium banks represented another form of international cooperation. They were joint ventures that enabled their shareholders to share the risks and the profits involved in operating in the Euromarkets. Most of them were based in London (there were as many as twenty-eight in 1974), some established by members of the banking clubs, several others including American and other non-European banks.
Despite significant achievements, cracks started to appear from the mid-1970s, and the entire cooperative project eventually collapsed in the following decade, usually through one bank buying its partners' share in the joint ventures. This eventual
|Market capitalization ($ millions)|
|HSBC (United Kingdom)||97,967|
|Royal Bank of Scotland (United Kingdom)||69,356|
|HBOS (United Kingdom)||40,013|
|Barclays (United Kingdom)||38,433|
|BNP Paribas (France)||36,607|
|Santander Central Hispano (Spain)||29,872|
|Lloyds TSB (United Kingdom)||29,194|
|Banco Bilbao Vizcaya Argentaria (Spain)||27,561|
|Deutsche Bank (Germany)||26,844|
|ABN Amro (Netherlands)||24,332|
|Société Générale (France)||23,108|
|Crédit Suisse (Switzerland)||22,080|
|Crédit Lyonnais (France)||20,295|
failure occurred in part because a pan-European merger was no longer on the agenda, as European monetary union became an increasingly remote prospect in the wake of the monetary upheavals of the 1970s; because conflicts of interest between members increased; and especially because the partners wished to build their own international networks and be represented in their own name in the major financial centers.
Five interrelated trends have characterized the course of European banking since the 1970s. The first has been the gradual liberalization and deregulation of financial institutions and markets, leading to the despecialization of banking activities, among other effects. In both Britain and France, commercial banks have become akin to universal banks, offering a variety of services, usually through subsidiary companies. Such services ranged from wholesale banking (competing for the deposits of large customers) to retail banking (credit cards, consumer credit, mortgage financing), as well as those usually associated with investment banks (corporate financial advice, capital issues facilities, etc.). A second trend has been toward increased financial disintermediation (companies raising funds through the capital markets rather than bank borrowing), forcing banks to offer a wider range of products and to combine with nonbank financial institutions. This development has not eradicated the differences between "bank-based" and "market-based" banking systems, and the debates on their respective merits have been reminiscent of those related to the British and German models in the early twentieth century.
A third trend has been the unprecedented role played by innovation, made possible by the formidable development of information technology and resulting in the continual appearance of ever more sophisticated financial products—derivatives (financial instruments based on dealings in an underlying asset, such as bonds, equities, commodities, currencies, and indices representing financial assets), with futures, options, and swaps being the most important among them. A fourth trend has been toward increased competition. With the relaxation of state regulation, the end of cartel agreements, and the technological revolution in banking, competition intensified or simply resumed, not only within commercial banking but also from outside the traditional world of banking, with savings banks and other public and semipublic institutions beginning to provide their customers with a complete, or near complete, range of banking services. On the other hand, international competition has stiffened in the major international financial centers with the globalization of financial activities, especially in London, where there were 481 foreign banks in 2000, as against 242 in Frankfurt and 187 in Paris. A fifth trend has been a renewed consolidation movement, in other words the domination of the banking system by a handful of giant institutions. Megamergers and acquisitions have played a role in the process: Algemene Bank Nederland (ABN) and Amsterdam-Rotterdam Bank (AMRO) in 1991, Midland and the Hong Kong and Shanghai Banking Corporation (HSBC) in 1993; Union Bank of Switzerland (UBS) and Swiss Bank Corporation (SBC) in 1998; Banque National de Paris (BNP) and Paribas, and Santander and Banco Central Hispanoamerico (BCH), in 1999; National Westminster and the Royal Bank of Scotland in 2000. Interestingly, these mergers have taken place within a national context. So far, and despite the advent of the single European currency in 1999, no merger between major European banks of different countries has yet taken place, even though they have all acquired other banks abroad, in the first place in the United States. In the event, the group of the fifteen largest commercial banks in Europe in 2003 (table 2) looked different than ninety years earlier, especially in the decline of the German banks and the progress of the Spanish and Swiss ones, though not radically so, with most changes being due to mergers rather than the advent of newcomers. The top position held by the HSBC Group (the second-largest bank in the world after Citigroup, of the United States), present in seventy-seven countries, is a reflection of the degree of internationalization of banking and finance at the turn of the twenty-first century.
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Banks and Banking
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.
Cameron, Rondo. Banking in the Early Stages of Industrialization. New York, 1967.
Cameron, Rondo, ed. Banking and Economic Development. New York, 1972.
Cameron, Rondo, and V. I. Bovykin, eds. International Banking, 1870–1914. New York, 1991.
Kindleberger, Charles P. A Financial History of Western Europe. 2nd ed. New York, 1993.
Pohl, Manfred, and Sabine Freitag, eds. Handbook on the History of European Banks. Aldershot, U.K., 1994.
Sylla, Richard, Richard Tilly, and Gabriel Tortella, eds. The State, the Financial System, and Economic Modernization. Cambridge, U.K., 1999.
Banks and Banking
BANKS AND BANKING
Authorized financial institutions and the business in which they engage, which encompasses the receipt of money for deposit, to be payable according to the terms of the account; collection of checks presented for payment; issuance of loans to individuals who meet certain requirements; discount ofcommercial paper; and other money-related functions.
Banks have existed since the founding of the United States, and their operation has been shaped and refined by major events in U.S. history. Banking was a rocky and fickle enterprise, with periods of economic fortune and peril, between the 1830s and the early twentieth century. In the late nineteenth century, the restrained money policies of the U.S. treasury department, namely an unwillingness to issue more bank notes to eastern-based national banks, contributed to a scarcity of cash in many Midwestern states. A few states went so far as to charter local banks and authorize them to print their own money. The collateral or capital that backed these local banks was often of only nominal value. By the 1890s, there was a full-fledged bank panic. Depositors rushed to banks to withdraw their money, only to find in many cases that the banks did not have the money on hand. This experience prompted insurance reforms that developed during the next fifty years. The lack of a regulated money supply led to the passage of the Federal Reserve Act in 1913 (found in scattered sections of 12 U.S.C.A.), creating the Federal Reserve Bank System.
Even as the banks sometimes suffered, there were stories of economic gain and wealth made through their operation. Industrial enterprises were sweeping the country, and their need for financing was seized upon by men like J.P. Morgan (1837–1913). Morgan made his fortune as a banker and financier of various projects. His House of Morgan was one of the most powerful financial institutions in the world. Morgan's holdings and interests included railroads, coal, steel, and steamships. His involvement in what we now consider commercial banking and securities would later raise concern over the appropriateness of mixing these two industries, especially after the stock market crash of 1929 and the ensuing instability in banking. Between 1929 and 1933, thousands of banks failed. By 1933, President franklin d. roosevelt temporarily closed all U.S. banks because of a widespread lack of confidence in the institutions. These events played a major role in the Great Depression and in the future reform of banking.
In 1933, Congress held hearings on the commingling of the banking and securities industries. Out of these hearings, a reform act that strictly separated commercial banking from securities banking was created (12U.S.C.A. §§ 347a, 347b, 412). The act became known as the glass-steagall act, after the two senators who sponsored it, carter glass (DVA) and Henry B. Steagall (D-AL). The Glass-Steagall Act also created the federal deposit insurance corporation (FDIC), which insures money deposited at member banks against loss. Since its passage, Glass-Steagall has been the law of the land, with minor fine-tuning on several occasions.
Despite the Glass-Steagall reforms, periods of instability have continued to reappear in the banking industry. Between 1982 and 1987, about 600 banks failed in the United States. Over one-third of the closures occurred in Texas. Many of the failed banks closed permanently, with their customers' deposits compensated by the FDIC; others were taken over by the FDIC and reorganized and eventually reopened.
In 1999, Congress addressed many concerns on many involved in the financial industries with the passage of the Financial Services Modernization Act, Pub. L. No. 106-102, 113 Stat. 1338, also known as the Gramm-Leach Act. The act rewrote the banking laws from the 1930s and 1950s, including the Glass-Steagall Act, which had prevented commercial banks, securities firms, and insurance companies from merging their businesses. Under the act, banks, brokers, and insurance companies are able to combine and share consumer transaction records as well as other sensitive records. The act went into effect on November 12, 2000, though several of its provisions did not take effect until July 1,2001. Seven federal agencies were responsible for rewriting regulations that implemented the new law.
Gramm-Leach goes beyond the repeal of the Glass-Steagall Act and similar laws. One section streamlines the supervision of banks. It directs the federal reserve board to accept existing reports that a bank has filed with other federal and state regulators, thus reducing time and expenses for the bank. Moreover, the Federal Reserve Board may examine the insurance and brokerage subsidiaries of a bank only if reasonable cause exists to believe the subsidiary is engaged in activities posing a material risk to bank depositors. The new law contains many more similar provisions that restrict the ability of the Federal Reserve Board to regulate the new type of bank that the law contemplates. The Gramm-Leach Act also breaks down barriers of foreign banks wishing to operate in the United States by allowing foreign banks to purchase U.S. banks.
Categories of Banks
There are two main categories of banks: federally chartered national banks and state-chartered banks.
A national bank is incorporated and operates under the laws of the United States, subject to the approval and oversight of the comptroller of the currency, an office established as a part of the Treasury Department in 1863 by the National Bank Act (12 U.S.C.A. §§ 21, 24, 38, 105, 121, 141 note).
All national banks are required to become members of the Federal Reserve System. The Federal Reserve, established in 1913, is a central bank with 12 regional district banks in the United States. The Federal Reserve creates and implements national fiscal policies affecting nearly every facet of banking. The system assists in the transfer of funds, handles government deposits and debt issues, and regulates member banks to achieve uniform commercial procedure. The Federal Reserve regulates the availability and cost of credit, through the buying and selling of securities, mainly government bonds. It also issues Federal Reserve notes, which account for almost all the paper money in the United States.
A board of governors oversees the work of the Federal Reserve. This board was approved in 1935 and replaced the Federal Reserve Board. The seven-member board of governors is appointed to 14-year terms by the President of the United States with Senate approval.
Each district reserve bank has a board of directors with nine members. Three nonbankers and three bankers are elected to each board of directors by the member bank, and three directors are named by the Federal Reserve Board of Governors.
A member bank must keep a reserve (a specific amount of funds) deposited with one of the district reserve banks. The reserve bank then issues Federal Reserve notes to the member bank or credits its account. Both methods provide stability in meeting customers' needs in the member bank. One major benefit of belonging to the Federal Reserve System is that deposits in member banks are automatically insured by the FDIC. The FDIC protects each account in a member bank for up to $100,000 should the bank become insolvent.
A state-chartered bank is granted authority by the state in which it operates and is under the regulation of an appropriate state agency. Many state-chartered banks also choose to belong to the Federal Reserve System, thus ensuring coverage by the FDIC. Banks that are not members of the Federal Reserve System can still be protected by the FDIC if they can meet certain requirements and if they submit an application.
The Interstate Banking and Branching Efficiency Act of 1994 (scattered sections of 12U.S.C.A.) elevated banking from a regional enterprise to a more national pursuit. Previously, a nationally chartered bank had to obtain a charter and set up a separate institution in each state where it wished to do business; the 1994 legislation removed this requirement. Also, throughout the 1980s and the early 1990s, a number of states passed laws that allowed for reciprocal interstate banking. This trend resulted in a patchwork of regional compacts between various states, most heavily concentrated in the New England states.
Types of Banks
The term bank is generally used to refer to commercial banks; however, it can also be used to refer to savings institutions, savings and loan associations, and building and loan associations.
A commercial bank is authorized to receive demand deposits (payable on order) and time deposits (payable on a specific date), lend money, provide services for fiduciary funds, issue letters of credit, and accept and pay drafts. A commercial bank not only serves its depositors but also can offer installment loans, commercial long-term loans, and credit cards.
A savings bank does not offer as wide a range of services. Its primary goal is to serve its depositors through providing loans for purposes such as home improvement, mortgages, and education. By law, a savings bank can offer a higher interest rate to its depositors than can a commercial bank.
A savings and loan association (S&L) is similar to a savings bank in offering savings accounts. It traditionally restricts the loans it makes to housing-related purposes including mortgages, home improvement, and construction, although, some S&Ls have entered into educational loans for their customers. An S&L can be granted its charter by either a state or the federal government; in the case of a federal charter, the organization is known as a federal savings and loan. Federally chartered S&Ls have their own system, which functions in a manner similar to that of the Federal Reserve System, called the Federal Home Loan Banks System. Like the Federal Reserve System, the Federal Home Loan Banks System provides an insurance program of up to $100,000 for each account; this program is called the Federal Savings and Loan Insurance Corporation (FSLIC). The Federal Home Loan Banks System also provides membership options for state-chartered S&Ls and an option for just FSLIC coverage for S&Ls that can satisfy certain requirements.
A building and loan association is a special type of S&L that restricts its lending to home mortgages.
The distinctions between these financial organizations has become narrower as federal legislation has expanded the range of services that can be offered by each type of institution.
Bank Financial Structure
Banks are usually incorporated, and like any corporation must be backed by a certain amount of capital (money or other assets). Banking laws specify that banks must maintain a minimum amount of capital. Banks acquire capital by selling capital stock to shareholders. The money shareholders pay for the capital stock becomes the working capital of the bank. The working capital is put in a trust fund to protect the bank's depositors. In turn, shareholders receive certificates that prove their ownership of stock in the bank. The working capital of a bank cannot be diminished. Dividends to shareholders must be paid only from the profits or surplus of the bank.
Shareholders have their legal relationship with a bank defined by the terms outlined in the contract to purchase capital stock. With the investment in a bank comes certain rights, such as the right to inspect the bank's books and records and the right to vote at shareholders' meetings. Shareholders may not personally sue a bank, but they can, under appropriate circumstances, bring a stockholder's derivative suit on behalf of the bank (sue a third party for injury done to the bank when the bank fails to sue on its own). Shareholders also are not usually personally liable for the debts and acts of a bank, because the corporate form limits their liability. However, if shareholders have consented to or accepted benefits of unauthorized banking practices or illegal acts of the board of directors, they are not immune from liability.
The election and term of office of a bank's board of directors are governed by statute or by the charter of the bank. The liabilities and duties of bank officials are prescribed by statute, charter, bylaws, customary banking practices, and employment contracts. Directors and bank officers are both responsible for the conduct and honorable management of a bank's affairs, although their duties and liabilities are not the same.
Officers and directors are liable to a bank for losses it incurs as a result of their illegal, fraudulent, or wrongful conduct. Liability is imposed for embezzlement, illegal use of funds or other assets, false representation about the bank's condition made to deceive others, or fraudulent purchases or loans. The failure to exercise reasonable care in the execution of their duties also renders officials liable if such failure brings about bank losses. If such losses result from an error in judgment, liability will not be imposed so long as the officials acted in good faith with reasonable skill and care. Officers and directors will not be held liable for the acts of their employees if they exercise caution in hiring qualified personnel and supervise them carefully. Civil actions against bank officials are maintained in the form of stockholders' derivative suits. Criminal statutes determine the liability of officers and directors for illegal acts against their bank.
The powers and duties of a bank are determined by the terms of its charter and the legislation under which it was created (either federal or state regulations). A bank can, through its governing board, enact reasonable rules and regulations for the efficient operation of its business.
Deposits A deposit is a sum of money placed in an account to be held by a bank for the depositor. A customer can deposit money by cash or by a check or other document that represents cash. Deposits are how banks survive. The deposited money establishes a debtor and creditor relationship between the bank and the depositor. Most often, the bank pays the depositing customer interest for its use of the money until the customer withdraws the funds. The bank has the right to impose rules and regulations managing the deposit, such as restrictions governing the rate of interest the deposited money will earn and guidelines for its withdrawal.
Collections A primary function of a bank is to make collections of items such as checks and drafts deposited by customers. The bank acts as an agent for the customer. Collection occurs when the drawee bank (the bank ordered by the check to make payment) takes funds from the account of the drawer (its customer who has written the check) and presents it to the collecting bank.
Checks A check is a written order made by a drawer to her or his bank to pay a designated person or organization (the payee) the amount specified on the check. Payment pursuant to the check must be made in strict compliance with its terms. The drawer's account must be reduced by the amount specified on the check. A check is a demand instrument, which means it must be paid by the drawee bank on the demand of, or when presented by, the payee or the agent of the payee, the collecting bank.
A payee usually receives payment of a check upon endorsing it and presenting it to a bank in which the payee has an account. The bank can require the payee to present identification to prove a relationship with the bank, before cashing the check. It has no obligation to cash a check for a person who is not a depositor, since it can refuse payment to a stranger. However, it must honor (pay) a check if the payee has sufficient funds on deposit with the bank to cover the amount paid if the drawer of the check does not have adequate funds in his or her account to pay it.
A certified check is guaranteed by a bank, at the request of its drawer or endorser, to be cashable by the payee or succeeding holder. A bank is not obligated to certify a check, but it usually will do so for a customer who has sufficient funds to pay it, in exchange for a nominal fee. A certified check is considered the same as cash because any bank must honor it when the payee presents it for payment.
A drawer can revoke a check unless it has been certified or has been paid to the payee. The notice of revocation is often called a stop payment order. A check is automatically revoked if the drawer dies before it is paid or certified, since the drawer's bank has no authority to complete the transaction under that circumstance. However, if the drawer's bank does not receive notice of the drawer's death, it is not held liable for the payment or certification of that drawer's checks.
Upon request, a bank must return to the drawer all the checks it has paid, so that the drawer can inspect the canceled checks to ensure that no forgeries or errors have occurred, in adjusting the balance of her or his checking account. This review of checks is usually completed through the monthly statement. If the drawer finds an error or forgery, it is her or his obligation to notify the bank promptly or to accept full responsibility for whatever loss has been incurred.
Bank liabilities A bank has a duty to know a customer's signature and therefore is generally liable for charging the customer's account with a forged check. A bank can recover the loss from the forger but not from the person who in good faith and without knowledge of the crime gave something in exchange for the forged check. If the depositor's negligence was a factor in the forgery, the bank can be excused from the liability.
A bank is also responsible for determining the genuineness of the endorsement when a depositor presents a check for payment. A bank is liable if it pays a check that has been materially altered, unless the alteration was due to the drawer's fault or negligence. If a bank pays a check that has a forged endorsement, it is liable for the loss if it is promptly notified by the customer. In both cases, the bank is entitled to recover the amount of its loss from the thief or forger.
A drawee bank that is ordered to pay a check drawn on it is usually not entitled to recover payment it has made on a forged check. If, however, the drawee bank can demonstrate that the collecting bank was negligent in its collection duties, the drawee bank may be able to establish a right of recovery.
A bank can also be liable for the wrongful dishonor or refusal to pay of a check that it has certified, since by definition of certification it has agreed to become absolutely liable to the payee or holder of the check.
If a bank has paid a check that has been properly revoked by its drawer, it must reimburse the drawer for the loss.
Drawer liabilities A drawer who writes a check for an amount greater than the funds on deposit in his or her checking account is liable to the bank. Such a check, called an overdraft, sometimes results in a loan from the bank to the drawer's account for the amount by which the account is deficient, depending on the terms of the account. In this case, the drawer must repay the bank the amount lent plus interest. The bank can also decide not to provide the deficient funds and can refuse to pay the check, in which case the check is considered "bounced." The drawer then becomes liable to the bank for a handling fee for the check, as well as remaining liable to the payee or subsequent holder of the check for the amount due. Many times, the holder of a returned, or bounced, check will impose another fee on the drawer.
Loans and Discounts A major function of a bank is the issuance of loans to applicants who meet certain qualifications. In a loan transaction, the bank and the debtor execute a promissory note and a separate agreement in which the terms and conditions of the loan are detailed. The interest charged on the amount lent can differ based on many variables. One variable is a benchmark interest rate established by the Federal Reserve Bank Board of Governors, also known as the prime rate, at the time the loan is made. Another variable is the length of repayment. The collateral provided to secure the loan, in case the borrower defaults, can also affect the interest rate. In any case, the interest rate must not exceed that permitted by law. The loan must be repaid according to the terms specified in the loan agreement. In case of default, the agreement determines the procedures to be followed.
Banks also purchase commercial papers, which are commercial loans, at a discount from creditors who have entered into long-term contracts with debtors. A creditor sells a commercial paper to a bank for less than its face value because it seeks immediate payment. The bank profits from the difference between the discount price it paid and the face value of the bond, which it will receive when the debtor has finished repaying the loan. Types of commercial paper are educational loans and home mortgages.
Many banks are replacing traditional checks and deposit slips with electronic fund transfer (EFT) systems, which utilize sophisticated computer technology to facilitate banking and payment needs. Routine banking by means of EFT is considered safer, easier, and more convenient for customers.
Many types of EFT systems are available, including automated teller machines; pay-by-phone systems; automatic deposits of regularly received checks, such as paychecks; automated payment of recurring bills; point-of-sale transfers or debit cards, where a customer gives a merchant a card and the amount is automatically transferred from the customer's account; and transfer and payment by customers' home computers.
When an EFT service is arranged, the customer receives an EFT card that will activate the system and the bank is legally required to disclose the terms and conditions of the account. These terms and conditions include the customer's liability and the notification process to follow if an EFT card is lost or stolen; the type of transactions in which a customer can take part; the procedure for correction of errors; and the extent of information that can be disclosed to a third party without improper infringement on the customer's privacy. If a bank is planning to change the terms of an account—for example, by imposing a fee for transactions previously conducted free of charge—the customer must receive written notice before the change will be effective.
Banks must send account statements for EFT transactions on a monthly basis. The statements must have the amount, date, and type of transaction; the customer's account number; the account's opening and closing balances; charges for the transfers or for continuation of the service; and an address and telephone number for referral of account questions or mistakes.
EFT transactions have become a highly competitive area of banking, with banks offering various bonuses such as no fee for the use of a card when the account holder meets certain provisions such as maintaining a minimum balance. Also, the rapid growth of personal and home office computing has increased pressure on banks to provide services on-line. Several computer software companies produce technology that can complete many routine banking services, like automatic bill paying, at a customer's home.
Banks have a wide range of options available for notifying a customer that a check has been directly deposited into her or his account.
If a customer has arranged for automatic payment of regularly recurring bills, like mortgage or utility bills, the customer has a limited period of time, usually up to three days before the payment is made, in which to order the bank to stop payment. When the amounts of such bills vary, as with utility bills, the bank must notify the customer of the payment date in sufficient time so that there will be enough funds in the account to cover the debt.
If the customer discovers a mistake in an account, the bank must be notified orally or in writing after the erroneous statement is received. The bank must investigate the claim.
Often, after several days, the customer's account will be temporarily recredited with the disputed amount. After the investigation is complete, the bank is required to notify the customer in writing if it concludes that no error occurred. It must provide copies of its decision and explain how it reached its findings. Then the customer must return the amount of the error if it was recredited to his or her account.
A customer is liable if an unauthorized transfer is made because an EFT card or other device is stolen, lost, or used without permission. This liability can be limited if the customer notifies the bank within two business days of the discovery of the misdeed; it is extended to $500 if the customer fails to comply with the notice requirement. A customer can assume unlimited liability if she or he fails to report any unauthorized charges to an account within a specified period after receiving the monthly statement.
A customer is entitled to sue a bank for compensatory damages caused by the bank's wrongful failure to perform the terms and conditions of an EFT account, such as refusing to pay a charge if the customer's account has more than adequate funds to do so. The customer can also recover a maximum penalty of $1,000, attorneys' fees, and costs in an action based upon violation of this law.
The expansion of the internet in the mid 1990s allowed banks to offer many more electronic services to their customers. Although this form of business with banks is certainly convenient, it has also caused a considerable amount of concern regarding the security of transactions conducted in this manner. Although laws designed to prevent fraud in traditional banking also apply to electronic banking, identifying individuals engaged in fraud can be more difficult when electronic transactions are concerned. On the federal level, the Electronic Funds Transfers Act, 15 U.S.C.A. §§ 1693a et seq., provides protection to consumers who are the subject of an unauthorized electronic funds transfer.
The Gramm-Leach-Bliley Financial Modernization Act, PL 106-102 (S 900) November 12, 1999. also modified federal statutory provisions related to electronic banking. Under this act, banks must now disclose the fees they charge for use of their automated teller machines. If the consumer is not provided with proper fee disclosure, an ATM operator cannot impose a service fee concerning any electronic fund transfer initiated by the consumer. Furthermore, the act requires that possible fees be disclosed to a consumer when an ATM card is issued.
Interstate Banking and Branching
In late 1994, the 103d Congress authorized significant reforms to interstate banking and branching law. The Interstate Banking Law (Pub. L. No. 103-328), also referred to as the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994, provided the banking industry with major legislative changes. The Interstate Banking Act was expected to accelerate the trend of bank mergers. These mergers are a benefit to the nation's largest banks, which will likely see savings of millions of dollars resulting from streamlining.
Adler, Joseph. 1995. "Banking without Glass-Steagall? Look Overseas." American Banking Association Journal (May).
Bunditz, Mark. 2002. Consumer Banking and Payments Law. Boston: National Computer Law Center.
Lovett, William A. 2001. Banking and Financial Institutions in a Nutshell. St. Paul, Minn.: West. Timberlake, Richard H., Jr. 1993. Monetary Policy in the United States: An Intellectual and Institutional History. Chicago: Univ. of Chicago Press.
Banks and Banking
Banks and Banking
The banking sector of the economy can be viewed bottom-up or top-down. The top-down view shows central banks overseeing financial activities for the entire nation. Beneath them full-service national commercial banks conduct business. At the bottom of the system are small full-service community banks and specialized savings and loan institutions. Other specialized institutions, some regional, some local, fill in the fabric of banking. These include trusts and credit unions. Of greatest interest to the small business is the local community bank or the local branch of a national commercial bank.
THE FEDERAL RESERVE
Our central bank, the U.S. Federal Reserve, operates through 12 regional banks. The Fed, as it is known, provides services like check clearing; more importantly, it regulates the banking sector and sets monetary policy by managing credit and the money supply. Its principal aim is to hold inflation in check. The Fed uses three major tools to do this job. First, it sets the rate at which banks can borrow from the Federal Reserve. High rates discourage and low rates encourage economic activity. Second, under law the Federal Reserve sets "reserve requirements." The nation's banks must place a portion of their deposits with the Federal Reserve, e.g., 20 percent; they may only lend out the remainder. If the Fed increases the reserve requirement, that takes money out of the economy. Lowering reserve requirements makes money available. Third, the Federal Reserve engages in open market operations that indirectly affect reserves. It either sells or buys Treasury securities on the open market. Holding a Treasury bill is, in effect, a savings: it takes money out of circulation. Thus the Fed sells securities to "cool" and buys securities to "heat up" a sluggish economy. The Fed thus decreases or increases the money supply. Such activities are reflected in interest rate levels which, of course, affect the small business. In this manner even a very small business feels the activity of the Fed's activities.
Full-service commercial banks accept deposits from customers; the interest paid on such deposits is relatively low, but the funds up to a maximum of $100,000 are insured by the Federal Deposit Insurance Corporation, an entity created by Congress in 1933 to restore faith in the banking system during the Depression. The bank places a portion of its deposits with the Fed (the "reserve requirement," see above) and lends the rest to others at a higher rate of interest—be these loans to purchase cars, homes, or to finance business activities. Commercial banks also generate revenues from services such as asset management, investment sales, and mortgage loan maintenance. By their very nature, banks are conservative. Most of their lending is secured. So-called "investment bankers" that finance start-ups are not to be confused with commercial banks. They are other types of financial entities. A commercial bank may operate an investment banking business, but not as part of its regulated activities. Small businesses should not look to banks to obtain start-up capital.
Most commercial banks are operated as corporate holding companies that own one or several banks. Because of regulatory constraints, banks that are not associated with holding companies must operate under restrictions that often put them at a disadvantage compared with other financial institutions. Holding companies are often used as vehicles to circumvent legal restrictions and to raise capital by otherwise unavailable means. For instance, many banks can indirectly operate branches in other states by organizing their entity as a holding company. Banks are also able to enter, and often effectively compete in, related industries through holding company subsidiaries. In addition, holding companies are able to raise capital using methods from which banks are restricted, such as issuing commercial paper. Multibank holding companies may also create various economies of scale related to advertising, bookkeeping, and reporting.
Commercial banking in the United States has been characterized by: 1) a proliferation of competition from other financial service industries, such as mutual funds and leasing companies; 2) the growth of multibank holding companies; and 3) new technology that has changed the way that banks conduct business. The first two developments are closely related. Indeed, as new types of financial institutions have emerged to meet specialized needs, banks have increasingly turned to the holding company structure to increase their competitiveness. In addition, a number of laws passed since the 1960s have favored the multibank holding company format. As a result the U.S. banking industry had become highly concentrated in the hands of bank holding companies by the early 1990s.
Electronic information technology, the third major factor in the recent evolution of banking, is evidenced most visibly by the proliferation of electronic transactions. Electronic fund transfer systems, automated teller machines (ATMs), and computerized home-banking services all combined to transform the way that banks conduct business. Such technological gains have served to reduce labor demands and intensify the trend toward larger and more centralized banking organizations. They have also diminished the role that banks have traditionally played as personal financial service organizations. Finally, electronic systems have paved the way for national and global banking systems.
THRIFTS AND OTHER BANK-LIKE INSTITUTIONS
Savings banks, savings and loan associations (S&Ls), and credit unions are known as thrift institutions or simply as "thrifts." Like commercial banks, they are depository institutions but, under law, deal with individuals rather than businesses. Small businesses are unlikely to do business with thrifts.
Trust companies act as trustees, managing assets that they transfer between two parties according to the wishes of the trustor. Trust services are often offered by departments of commercial banks. Insurance companies and pension funds, which are really outside the banking sector strictly viewed, fulfill some bank-like functions such as the management of savings. They typically invest their assets but are not good sources of small business financing.
BANKS AND SMALL BUSINESSES
Small business is the fastest-growing segment of the American business economy. As a result, more and more commercial banks are creating special products and programs designed to attract small business customers. The small business owner looking for funds is best advised to seek out a local community bank. Tom Henderson, writing in Crain's Detroit Business, sums up the situation: "Name changes and consolidations among the area's biggest banks capture headlines, but industry and government analysts say the activity also creates big opportunities for community banks. Those banks continue to carve out a niche by providing loans and lines of credit to small and medium-sized businesses." Citing a 2004 report by the Federal Deposit Insurance Corporation, Henderson says that "small banks have an advantage in small-business lending because it requires 'local expertise that is both characteristic of community banks and more favorable to some small-business borrowers, such as new or young firms with limited credit history.'"
There are a number of factors a small business owner should consider when selecting a bank, including its accessibility, compatibility, lending limit, loan approval process, general services provided, and fees charged. Perhaps the best way to approach banks is to obtain referrals to business representatives or loan officers at three to five banks. This approach aids the small business owner by providing a recommendation or association from a known customer, and also by providing the name of a specific banker to talk to. The company's accountant, business advisors, and professional contacts will most likely be good sources of referrals.
The next step in forming a positive banking relationship is to arrange for a preliminary interview at each bank to get a feel for its particular personnel and services. It may be helpful to bring a brief summary of the business and a list of questions. The small business owner should also be prepared to answer the bankers' questions, including general information about the business, its primary goods/services, its financial condition, its banking needs, and the status of the industry in which it operates. All of these queries are designed to solicit information that will enable the institution to evaluate the small business as a potential client. After all the face-to-face meetings have taken place, the small business owner should compare each bank to the list of preferred criteria, and consult with his or her business advisors as needed. It is important to notify all the candidates once a decision has been made.
Ideally, a small business's banking relationship should feature open communication. Consultants recommend regular appointments to keep the banker updated on the business's condition, including potential problems on the horizon, as well as to give the banker an opportunity to update the small business owner on new services. The banker can be a good source of information about financing, organization, and record keeping. He or she may also be able to provide the small business owner with referrals to other business professionals, special seminars or programs, and networking opportunities.
The Federal Reserve Bank of St. Louis. "In Plain English: Making Sense of the Federal Reserve." Available from http://www.stls.frb.org/publications/pleng/default.html. Retrieved on 4 January 2006.
Henderson, Tom. "Banking on Small Business; Increased Lending to Small Business Lays the Groundwork for Growth of Community Banking." Crain's Detroit Business. 12 December 2005.
Koehler, Dan M. Insider's Guide to Small Business Loans. PSI Research, 2000.
Hillstrom, Northern Lights
updated by Magee, ECDI
Banking is the name given to the activities of banks. The word bank is derived from the Italian banca, which means bench. Moneylenders in Northern Italy originally did business in open rooms or areas, with each lender working from his own bench or table. In the modern era banks are financial firms that simultaneously issue deposits, make loans, and create money.
A deposit is issued when a household or a business brings cash or currency to a bank in exchange for an equivalent amount of stored value, which can either be used to meet payment obligations or saved for future expenditure needs. Loan making is a form of credit. Credit comes into being when one economic unit (the creditor) authorizes another (the debtor) to acquire goods prior to paying for the goods received. A bank makes a loan when it authorizes a borrower to make expenditures on the bank’s account up to a contractually agreed maximum level, in exchange for repayment of these advances later in time. Loans are usually made for expenditure purposes that are agreed on in advance (for example, the purchase of housing or of education services). Borrowers are normally authorized to use loan funds for a certain period of time and are required to repay the amount of the loan plus some amount of interest, which reflects the cost of the loaned funds. Common types of loans are workingcapital loans, used by businesses primarily for buying supplies and making wage payments, and mortgage loans, which provide long-term funds (often for a duration of thirty years) for purchasing residences.
There are two principal types of bank deposits. Demand deposits are used primarily to handle transaction needs. They are completely liquid, as they can be withdrawn at will and without notice by the deposit holder. Time deposits are used primarily to store savings. They are less liquid than demand deposits, as they are normally contracted for fixed time periods (often six months or one year). In compensation for this loss of liquidity, those holding time deposits receive compensation in the form of (higher) interest payments.
The process of making loans may create money. A financial institution creates money in making loans when it creates demand deposits that can be spent by its borrowers. These borrowers did not possess these deposits before receiving loans, nor were these deposits taken from any of the bank’s deposit customers. The ability to create money by making loans makes banks’ behavior procyclical: Their loan making tends to expand when the economy is growing, further accelerating growth, and to slow when the economy does.
Banking is heavily regulated for two reasons. First, maintaining an orderly economy requires maintaining reliable transaction processes and financial markets, and banks are at the heart of these processes and markets. Second, banks are a source of instability within the economy. The default risks inherent in loan making interact with banks’ ability to expand the money supply through loan making. In a worst-case scenario, unsound bank loan making (or choices of other assets) can weaken an economy and subject it to bank or currency runs, and/or expose an economy to stagnation, deflation, and even recession.
Banking has always been a heavily regulated field of activity. For one, banks typically require a bank charter issued by regulators. Moreover, every economy normally has a central bank, which attempts to control money and credit growth and which is responsible for rescuing the banking system in times of acute crisis. Regulation is especially important at the beginning of the twenty-first century, because banks’ behavior in loan making has changed so much over time. From the 1930s to the 1960s, banks were relatively cautious. They made loans up the amount of their excess reserves, that is, the amount of currency on hand beyond that needed to meet its deposit customers’ normal withdrawal demands. Over time, banks became more aggressive in finding funds to lend. Banks evolved the practice of liability management, in which they set targets for asset and loan growth and reach those targets by borrowing reserves, primarily from other banks in the interbank market.
Banks have also become more aggressive in loan making, as a result in part of their deepening links to financial centers such as Fleet Street and Wall Street. Since the late 1970s, banks have competed to make loans in hot markets, including overseas borrowers. This has led to severe crises of loan repayment and refinancing, the most spectacular cases being the Latin American debt crisis of the 1980s and the East Asian financial crisis of 1997–1998 (Stiglitz 2003). Despite these recurring crises, banks continually push into new areas of loan making, searching for new ways to earn revenue. In the 1990s and 2000s, banks have increasingly extended personal credit (often via credit cards), and have gotten involved in such nonbanking activities as derivatives and options, mutual funds and insurance.
The recurring problems in loan markets have made banking behavior a central topic in economic research. One key question is why lending booms and busts occur; another is why borrowers default (that is, are unable to repay loans according to their contractual obligations). Economists focusing on the first question have emphasized that banks are driven by competition to overlend in boom periods, leading to rising financial fragility (more debt obligations relative to available income), which eventually triggers a downturn (Minsky 1982). Economists addressing the second question focus on the distribution of information in credit markets; they emphasize that borrowers may seek to cheat lenders, and that banks may not accurately determine which potential borrowers are competent and which are not (Freixas and Rochet 1997). Banks can avoid default by extracting timely information about borrowers, their competence, and their intentions. Yet the social neutrality of the criteria that banks use to decide which borrowers are creditworthy has been called into question. Economic studies have generated substantial evidence that banks sometimes treat racial minorities, residents of minority and lower-income communities, and even disadvantaged regions unfairly in their credit-market decisions (Austin Turner and Skidmore 1999).
SEE ALSO Financial Markets; Loans; Overlending
Austin Turner, Margery, and Felicity Skidmore, eds. 1999. Mortgage Lending Discrimination: A Review of Existing Evidence. Washington, DC: Urban Institute.
Freixas, Xavier, and Jean-Charles Rochet. 1997. The Microeconomics of Banking. Cambridge, MA: MIT Press.
Minsky, Hyman. 1982. Can “It” Happen Again? Armonk, NY: M. E. Sharpe.
Stiglitz, Joseph E. 2003. Globalization and Its Discontents. New York: Norton.
Gary A. Dymski
Monarchs had borrowed from merchants and landowners for centuries. By the late 17th cent., constitutional changes, particularly the growth of parliamentary power over government expenditures, required a more regulated framework. The Bank of England, founded in 1694, gave the government and other users of credit access to English funds. Similar developments occurred in Scotland and Ireland. These banks remained without serious competition until the later 18th cent., when expanding commercial and manufacturing activities gave scope to merchants, brewers, and landowners to establish banks based on their own cash reserves. These commercial banks took deposits, made loans, usually for limited periods, and issued promissory notes whose value was backed by bullion in the vaults combined with a fiduciary issue which depended on the likely scale of withdrawals. Errors of judgement sometimes occurred and ‘runs on the bank’ took place when depositors feared for the security of their money and demanded its return.
Fluctuations in the value of money because of the return to a gold-based currency after the end of the Napoleonic wars (1815) precipitated a series of crises. To stabilize the currency the government eventually introduced the 1844 Bank Charter Act, which gave the Bank of England two functions, that of supervising the note issue as part of the currency and that of monitoring the activities of the banking system. Regulatory powers were put in place in 1845 to control banking in Scotland and Ireland.
From their earliest days, banks required loyal staff who did not accept bribes, steal money, or give information about accounts to unauthorized persons. Literate and numerate staff received high salaries, retirement pensions, and various privileges including holidays and social facilities. Their work required systematic record keeping which grew in volume and complexity during the 19th cent. when cheques replaced banknotes for many business transactions. In 1773 banks established the London Clearing House to process cheques rapidly.
In the 19th cent., overseas trade and the expanding British empire reinforced the place of London as a centre of merchant banking. The probity, knowledge, and skills of these specialist bankers attracted business from foreign firms and governments seeking loans in Britain. Some British firms employed merchant banks to arrange their supply of capital finance. This usually involved share or bond issues which were traded on the stock markets. Such arrangements made possible the rapid development of railways, heavy engineering, mines, and large commercial developments. Many of these merchant banks survive, including Rothschilds, Lazard Brothers, Baring, Kleinwort Benson, and Schroders. Internal commerce and trade were funded mainly by a larger number of separate local banks which, after the middle of the 19th cent., became consolidated into a much smaller number of banks covering much of England. Numbers continued to diminish so that by 1980 banking was dominated by four companies: Barclays, Lloyds, Midland, and National Westminster.
London's dominance as the banking centre, not only of Britain but of the financial world, was not challenged until the 20th cent. with the growth of competing international economies such as the USA and Japan. None the less, London remains a major centre of merchant banking.
Within Britain, banking has been characterized, largely because of technological innovation, by an increasingly sophisticated provision of traditional banking services and an expansion of services associated with consumer credit. The business of safeguarding and lending money is often arranged through machine-readable cards and continuous access by telephone. Since the Financial Services Act of 1986, banks face more competition with many banking services being provided by building societies, trustee savings banks, and the Post Office.
Ian John Ernest Keil
Banks and Banking
Banks and Banking
Authorized financial institutions and the business in which they engage, which encompasses the receipt of money for deposit, to be payable according to the terms of the account; collection of checks presented for payment; issuance of loans to individuals who meet certain requirements; discount of commercial paper; and other money-related functions.
Watters v. Wachovia Bank, N.A.
The federal government regulates federally chartered banks, while the states have the authority to regulate state chartered banks. States that seek to regulate federally chartered banks are prohibited through the doctrine of preemption, which recognizes the constitutional authority to completely control areas such as interstate commerce. Despite this apparently clear demarcation in state and federal bank regulatory powers, the state of Michigan challenged a ruling that it could not regulate a subsidiary of a national bank that had originally been states chartered. The U.S. Supreme Court, in Watters v. Wachovia Bank, N.A., __U.S.__, 127 S.Ct. 1559, __L.Ed.2d __ (2007), ruled that a national bank's mortgage business, whether conducted by the bank itself or through the bank's operating subsidiary, was subject only to federal regulation.
The State of Michigan banking laws required mortgage lenders were subsidiaries of national banks to register with the state's Office of Insurance and Financial Services (OIFS) and submit to state supervision. From 1997 to 2003, Wachovia Mortgage was registered with OIFS, paying an annual fee and opening its books and records for inspection by OIFS examiners. In 2003 the company became a wholly owned subsidiary of Wachovia Bank, a federally chartered bank with corporate headquarters in North Carolina. Soon after the acquisition Wachovia Mortgage notified OIFS that it was surrendering its mortgage lending registration. As an operating subsidiary of a national bank it contended that the state's registration and inspection requirements were preempted. Linda Watters, the commissioner of OIFS, responded in a letter, advising Wachovia Mortgage it would not be authorize to conduct further mortgage lending in Michigan.
Wachovia Mortgage and Wachovia Bank filed suit in Michigan federal district court, asking it to prohibit Watters from enforcing Michigan's registration prescriptions. They argued that under federal banking law, the Office of the Comptroller of the Currency (OCC) was the only entity that had supervisory authority over Wachovia Mortgage. Watters countered by claiming that Wachovia Mortgage was not itself a national bank and thus the state was not preempted from regulating it. In addition, Watters claimed the Tenth Amendment prohibited OCC's exclusive oversight of lending activities conducted through national bank operating subsidiaries. The district court sided with Wachovia, deferring to OCC's determination that an operating subsidiary is subject to state regulation only to the extent that the parent bank would be if it performed the same functions. The district court also rejected Watter's Tenth Amendment claim. The Sixth Circuit Court of Appeals affirmed the district court.
The Supreme Court, in a 5 to 3 decision (Justice Clarence Thomas did not participate because members of his family were employed by Wachovia Bank), upheld the Tenth Circuit ruling. Justice Ruth Bader Ginsburg, writing for the majority, noted that the National Bank Act (NBA), first enacted in 1864, established a system of national banking that was still in force. One provision stated that "No national bank shall be subject to any visitorial powers except as authorized by Federal law." 12. U.S.C.A. §484(a). Visitorial powers include the power to regulate and the authority to examine bank records and books. In addition, Justice Ginsburg cited prior cases where the Court made clear that "federal control shields national banking from unduly burdensome and duplicative state regulation." These facts were buttressed by an NBA provision that authorized national banks to engage in mortgage lending, subject to OCC regulation.
Though Michigan law did exempt national banks from OIFS oversight, Watters argued that state regulation survived preemption when the institution was a national bank's operating subsidiary. Because Wachovia Mortgage had been chartered under state law, it was not an operating subsidiary but merely an "affiliate" of the national bank. Such affiliates could be regulated by both the OCC and the state. Justice Ginsburg rejected this argument. Since 1966 the OCC had recognized the authority of national banks to do business through operating subsidiaries. In 1999 Congress defined and regulated financial subsidiaries, distinguishing national bank affiliates from operating subsidies as defined by the OCC. The latter were subject to the same terms and conditions that govern national banks. The OCC regulations, which treated national banks and their operating subsidiaries as a single economic unit, were reasonable. Therefore, the Court must defer to the OCC's interpretation. As to the Tenth Amendment, Justice Ginsburg found Watters' claim meritless. If a power is delegated to Congress in the Constitution, the Tenth Amendment "expressly disclaims any reservation of that power to the States."
Justice John Paul Stevens, in a dissenting opinion joined by Chief Justice John Roberts and Justice Antonin Scalia, contended that Congress had not enacted a law that immunized "national bank subsidiaries from compliance with nondiscriminatory state laws regulating the business activities of mortgage brokers and lenders." Therefore, the OCC did not have the power to preempt state law through its regulations.