1.      HISTORY OF BANKING AND FINANCE

 

The history of international finance has been closely associated with the development and evolution of money as well as of trade finance out of which modern merchant and investment banking emerged. The background to money can also be considered with credit and payment as these have always been intimately connected historically. International finance markets have been subject to continuous change and innovation which has included the development of many new forms of financial instruments and more recently new electronic money and funds transfer channels. The key functions of banks and other financial intermediaries have nevertheless remained the same over time. These are essentially based on the provision of deposit (or savings) facilities, loan (or credit), payment (paper based or electronic) as well as investment (bonds and equities) and insurance (and hedging) services.

 

(1)    BANKING

 

Banking began with the Italian merchant and financial families during the 13th and 14th centuries. The main financial centres were the Italian City states such as Lombardy and Florence, Venice and Genoa and other northern towns. The Italian bankers quickly emerged as the leading money changers, lenders and dealers in early bills of exchange and coins within Europe. The word bank is derived from the Italian 'banco' or bench on which the early bankers sat to conduct their business. Early coins were referred to as 'florins' (after Florence) with the UK florin not being abolished until the decimalisation of English coinage in 1971. The close connection is still clear with one of the oldest banking streets 'Lombard Street' being named after Lombardy. The oldest private bank in the world is claimed to be the Monte de Paschi in Sienna in 1472 with the Casa de San Giorgio having been set up in Genoa in 1407 as the first public clearing bank. Italian financiers had a close relationship with British royalty from an early stage. Money was often lent to the British crown generally to finance wars. Defaults were not uncommon such as when Edward III failed to repay outstanding debts to the Bardi and the Peruzzi in Florence in 1345.

 

(2)    INTERNATIONAL FINANCE

 

International finance generally developed through the great trade fairs that were held in the main mediaeval towns across Europe from the 13th and 14th centuries. While these originated in the northern Italian towns, they subsequently spread to other major European cities including Lyons and Geneva. They then moved north with the growing trade routes into Flanders and the Netherlands, Bruges and Antwerp. Important families included the Fuggers in Augsburg which developed from early wool trading to become the main financiers to the Hapsburg empire. The most common means of payment at such fairs was the ‘bill of exchange’ which was simply a transferable debt instrument drawn by a creditor (the drawer) on his or her debtor (the drawee) with the debt being directed to be paid to a third party (the beneficiary on the bill). The holder may then further transfer the benefit of the debt before repayment by special (named) or general (open) endorsement and signing with all signatories being liable on the bill subject to recovery against the ultimate drawee. The bill of exchange subsequently emerged as the dominant payment instrument in international finance until the early 20th century.

 

 

 

(3)    INTERNATIONAL TRADE AND MERCHANT FINANCE

 

The most important type of finance instrument apart from the bill of exchange was the promissory note which was simply a written undertaking (promise) to pay an agreed fixed amount by one party to another, either at an agreed time or on demand. Although often used by merchants and tradesmen in their dealings with each other, promissory notes were commonly used as a form of receipt issued by early custodians or goldsmiths. Goldsmiths were often used for custodian purposes for coins and other valuables due to the secure storage facilities maintained. Goldsmiths would then issue receipts which could be traded as early forms of money. Whether paper money originally developed out of the goldsmith's receipts directly or the promissory note is unclear and subject to dispute by historians. Some of the oldest banks in England are nevertheless derived from goldsmiths, such as Coutts Bank, which was set up as a goldsmith bank in 1692.

 

The first legal tender was issued by the Bank of Sweden in 1661. This had originally been set up as the Bank of Stockholm in 1656 although it had to be closed as a result of significant trading losses which led to its founder being imprisoned. The bank was reopened in 1668 and subsequently renamed the Riksbank. The Bank of Amsterdam had been set up in 1609. Other early banking institutions that subsequently developed into national central banks included the Bank of England which was set up by William Patterson, a Scottish merchant, in 1694 to fund the costs of continuing war debts with other European countries.

 

(4)    MERCHANT BANKNG

 

The earliest type of banking that emerged from merchants and trade fair activities is still referred to as ‘merchant banking.’ This includes the financing of trade, mainly through bills of exchange, and then more recently using letters of credit and other trade finance practices as well as raising finance for companies of governments through bond and securities issues and providing other corporate advice and services. A number of the great British and European banking names developed out of such early merchant bank practices including Barings and Rothschild's. ‘Commercial banking’ developed out of separate deposit taking activities and the acceptance of funds from business or individual clients which could then be on-lent in the form of loans and later over-draft or other credit facilities. Such banks emerged during the late 18th and 19th centuries although it was not until the consolidation of the smaller regional banks that took place from the middle of the 19th century and the introduction of limited company liability under the Limited Liability Act 1855 that the large modern commercial banks emerged as dominant market players.

 

Other more specialised institutions also arose to support trade finance and international trade especially with Acceptance Houses and Discount House. These are specialist banks that add their credit by accepting (signing or stamping) bills of exchange (trade bills) and other instruments which can then be sold (discounted) through a discount house (with the discount fee being calculated equal to the interest due on the remaining term of the bill before it matures and is paid). The discount houses would also emerge as the specialist counterparties in the UK dealing directly with the Bank of England in the primary Money Market or Discount market. This is the principal market through which the Bank conducts monetary policy which is essentially concerned with managing the volume and cost of credit in circulation within the financial system.

 

This is distinct from the Secondary Money Markets that developed in the late 1950s and early 1960s which deal in other wholesale financial instruments issued by wholesale issuers. The main secondary markets now consist of the 'Local Authority' bill market, the 'Sterling Certificate of Deposit' (essentially a security representing an underlying deposit) market, the general 'Certificate of Deposit', the 'Inter-Company' market and 'Inter-Bank' market.

 

(5)    INVESTMENT BANKING   

 

Investment banking is an American term which dates from the separation of commercial banking and securities businesses under the Glass Steagall provisions of the Banking Act 1933. This was adopted following the 1929 Stock Market Crash and ensuing Great Depression in the early 1930s and required the division of many large institutions or groups into separate deposit-taking banking and securities or investment firms. The securities business of J P Morgan, for example, was split off with Henry S Morgan and Harold Stanley setting up Morgan Stanley in 1935. A merged Chemical Bank and Chase Manhattan Bank would later acquire J P Morgan & Co in 1996 to create J P Morgan Chase which would, in turn, purchase the fifth largest Wall Street securities firm Bear Stearns in March 2008 for $230 million with the assistance of the Federal Reserve. Investment firms engage in securities trading and market making, underwriting, asset management, corporate advisory work and other activities such as foreign exchange, financial derivatives and commodities trading. The term investment banking is commonly used with merchant banking although merchant banks were strictly British banks specialising in trade finance which could also provide deposit-taking facilities for their clients.