History of Banking in the World

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Anupama Nair

The practice of lending and borrowing may be as old as the invention of money. Isn’t it fascinating to see what our ancestors did in financial transactions and how they did it without any technology that we have today! “To purchase grains from the market, buy and sell cattle, textiles, craftsmanship! No matter what their needs were, they were not much different from ours. 

Banking has been around since the first currencies were minted, may be even before that, in some form or other. Currency, especially coins, grew out of taxation. As empires expanded, functional systems were needed to collect taxes and distribute wealth. The history of banking began when empires needed a way to pay for foreign goods and services with something that could be exchanged easily. Coins of varying sizes and metals eventually replaced fragile, impermanent paper bills. Banking as a concept was born in ancient Mesopotamia in the 8th Century. The birth of money originated in ancient Babylon

Coins, however, had to be kept in a safe place, and ancient homes did not have steel safes or lockers. According to World History Encyclopedia, “wealthy people in ancient Rome, India and Greece kept their coins and jewels in the basements of temples”. The presence of priests or temple workers, who were assumed devout and honest, and armed guards added a sense of security. The recent incident at Padmanabha Swamy Temple in the Travancore Kingdom or present-day Trivandrum in Kerala is an example where unimaginable gold coins, ornaments, precious stones etc., were found hidden in vaults inside the temple. It is said the Maharaja had hid the wealth to protect it from the British East India Company.

Historical records from India, Greece, Rome, Egypt, and Ancient Babylon suggested that temples lent money in addition to keeping it safe. The fact that most temples also functioned as the financial centers of their cities is a major reason why they were ransacked frequently during wars. An example of this is the Somnath Temple in Gujarat that was attacked by Invaders 17 times. Coins could be hoarded more easily than other commodities, so a class of wealthy merchants took to lending coins, with interest, to people in need. Temples typically handled large loans to various Kings, and wealthy merchant money lenders handled the rest of the people.

The Romans, who were expert builders and administrators, removed banking from the temples and formalized it within distinct buildings. During this time, moneylenders still profited, similar to the loan sharks today, but most legitimate commerce and almost all government spending involved the use of an institutional bank.The Roman Empire eventually disintegrated, but some of its banking institutions lived on in the form of the papal bankers that emerged in the Holy Roman Empire and the Knights Templar during the Crusades. Small-time moneylenders that competed with the Church were often denounced for moneylending. Eventually, the various monarchs that reigned over Europe noted the strengths of banking institutions. As banks existed by the grace, and occasionally explicit charters and contracts, of the ruling kings, the royal powers began to take loans to make up for hard times when the royal treasury was almost empty, but on the king's terms. This easy financing led kings into unnecessary extravagances, costly wars, and arms races with neighboring kingdoms that would often lead to crushing debt.

The birth of Modern banking was in Italy, where there was trade practice between merchants and Jewish Moneylenders. Jews used to live in Moorish Spain and England. After the genocides of the Jews in England in 1200 AD, they settled down in Italy. In 1557, Philip II of Spain managed to burden his kingdom with so much debt as the result of several unnecessary wars  and it was the beginning of the world's first national bankruptcy. This occurred because 40% of the country's Gross National Product  (GNP) was going toward servicing the debt. The trend of turning a blind eye to the creditworthiness of big and influential customers continues to haunt banks even today. Vijay Mallya and Nirav Modi are apt examples.

Banking was already well-established in the British Empire when Adam Smith introduced the ‘Theory of the Wealth of Nations’ in March 1776. Authorized by his views of a self-regulated economy, moneylenders and bankers managed to limit the state's involvement in the banking sector and the economy as a whole. Bank notes were first issued in London in the 17th Century where they were used as receipts for deposit at the Goldsmith’s. These receipts soon became known as our modern money after the Promissory Note Act of 1704. This free-market capitalism and competitive banking found fruitful ground in the New World, where the United States of America was just about to get Independent from Great Britain on July 4 1776. The birth of USA signified the birth of a modern democratic country, when the world especially Asia, Australia and Africa was in the grasp of Imperialism

Initially, Smith's ideas did not benefit the American banking industry. The average shelf life for an American bank was mostly five years, after which most currency notes from the defaulted banks became worthless. These state-chartered banks could, after all, only issue banknotes against the gold and silver coins they had held in reserve. Alexander Hamilton, a former Secretary of Treasury, established a national bank that would accept member banknotes at par, thus floating banks through difficult times. “After a few stops, starts, cancellations, and resurrections, this national bank created a uniform national currency called Dollar and set up a system by which national banks backed their notes by purchasing Treasury securities, thus creating a liquid market. However, the average Americans in those days had already grown to distrust banks and bankers in general, and the state of Texas outlawed corporate banks till 1904!

Most of the economic duties that would have been handled by the national banking system, in addition to regular banking business like loans and corporate finance, was handled instead by large merchant banks because the national banking system was irregular. These banks included Goldman Sachs, Kuhn, Loeb and  Co., and J.P. Morgan. Originally, they relied heavily on commissions from sales of foreign bond  from Europe, with a small back-flow of American bonds trading in Europe. This allowed them to build the necessary capital. At that time, a bank was under no legal obligation to disclose its capital reserves, an indication of its ability to survive large, above-average loan losses. This mysterious practice meant that a bank's reputation and history mattered more than anything. While banks came and went, these family-held merchant banks had long histories of successful transactions. As large industries emerged and created the need for corporate finance, the amounts of capital required could not be provided by any single bank, and so initial public offerings (IPOs) and bond offerings to the public became the only way to raise the required capital.

The public in the United States, and foreign investors in Europe, knew very little about investing because a disclosure as we have today, was not legally enforced. Many issues were largely ignored, according to the public's perception of the guaranteeing banks. Consequently, successful offerings increased a bank's reputation and put it in a position to ask for more to underwrite an offer. By the late 1800s, many banks demanded a position on the boards of the companies seeking capital, and if the management proved lacking, they ran the companies themselves.

The collapse in the shares of a copper trust set off a panic, and stock sell-offs, which caused shares to plummet. There was no Federal Reserve Bank to take action then, to calm people down, and the responsibility  fell to John Pierpont Morgan to stop the panic. Morgan used his considerable clout to gather all the major players on Wall Street to exercise the credit and capital they controlled, just as the Federal Bank would do today. Ironically, this show of supreme power in saving the U.S. economy ensured that no private banker would ever again wield that power. As it had taken J.P. Morgan, a banker who was disliked by much of America along with Carnegie and Rockefeller, to save the economy, the government formed the Federal Reserve Bank in 1913. Although the merchant banks influenced the structure of the Central Bank, they were also pushed into the background by its formation.

Even after the establishment of the Central Bank, financial power and residual political power were concentrated on Wall Street. When World War I broke out, America became a global lender and replaced London as the center of the financial world by the end of the war. Unfortunately, a Republican administration after the War, put some unconventional shackles on the banking sector. The government insisted that all debtor nations must pay back their war loans, which traditionally were forgiven, especially in the case of Allied Powers (USA, UK, France and Russia) before any American institution would extend them further credit.

This slowed down world trade and caused many countries to become hostile toward American goods. When the stock market crashed on ‘Black Tuesday’ in 1929, the already sluggish world economy was knocked out. The Central Bank couldn't contain the crash and refused to stop the Depression or the Wall Street Catastrophe as it was called and the aftermath had immediate consequences for all banks. A clear line was drawn between banks and investors. In 1933, banks were no longer allowed to gamble with deposits, and Federal Deposit Insurance Corporation (FDIC) regulations were enacted to convince the public that it was safe to approach the banks. No one was fooled and the Depression continued. World War II may have saved the banking industry from complete destruction. World War II and the industriousness it generated stopped the downward spiral afflicting the United States and world economies.



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