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History of banking r1


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History of banking r1

  1. 1. Prof. Dr. John JA BurkeSecurities and Banking Law for Foreign Direct Investment in EmergingMarketsHISTORY OF BANKING
  2. 2. Sources of Funds Type Debt Capital Equity Capital Informal Sources Loans from owners Retained earnings Informal external Loans from family, Investments by sources and friends, trade informed credit, brokers participants Financial Lending by Some Joint Stock intermediaries financial Companies institutions [banks] Public Markets Bond issues Stock IssuesSource: P. Temin, Financial Intermediation in the Early Roman Empire, MIT
  3. 3. Banks Credit intermediaries  Banks are financial institutions that accept deposits and make loans  Banks obtain funds by borrowing [taking deposits] and acquire assets through lending or purchase of securities  Deposits are bank liabilities  Loans are bank assets
  4. 4. Interest Rate Spread Pay no or low percentage interest on liabilities [the deposits]  Demand deposits: 0  Savings: low interest rate  Time: Higher rate [Money is committed] Charge higher rate of interest on assets loans] Spread is earnings
  5. 5. Financial Systems Facilitate pooling of funds  Aggregation of household wealth  Fund indivisible or efficient-scale enterprises Without “pooling” firm size would be constrained by wealth of single or few households Banks solve problem of information asymmetry Assume risk of non-payment
  6. 6. Agricultural Societies: RomanEmpire Banks are unnecessary Large landholders have excess income [savers] Large landholders also are investors  Intermediation therefore is unnecessary No asymmetric information
  7. 7. Institutions: Solve Asymmetry Merchants  Engaged in repetitive transactions with other merchants  Merchant that pays bills on time is quite likely to pay a loan on time Brokers  Bring lenders and borrowers together  Find people who want to lend  Find people who want to borrow
  8. 8. Progression of Financial Sytem Internal sources of capital  No financial system at all Informal external sources  Limited financial system Financial intermediation  Very good financial system Public capital markets  Advanced industrial financial system
  9. 9. History Most advanced capital markets were located in Amsterdam and London Merchant banking  E.g., 1500’s Medici Family in Italy, Fuggers in Germany  Wealthy merchants would extend credit to their customers and to governments  Private loans, involving only the capital of the merchant (no depositors) Activity was in certain cases so profitable that it overshadowed their trading activity and became their main business.
  10. 10. Contemporary Merchant Banks Merchant banks today classically defined as investment banks.  Fortis is a current example of the classical European merchant bank (rare)  Merchant/Investment banks were organized as partnerships In U.S., investment banks started in this same vein, such as Morgan Stanley, Goldman Sachs  Use their own capital to finance corporate underwriting Today, many investment banks are public firms, so they now risk outside investor money (although not depositors)
  11. 11. Merchant Banks Value of Reputation  Merchant banks are successful only as far as their reputation Credit works only if counterparties are credible Credit markets prefer reputations with longer life than an individual, hence the family unit Longer lived reputations include corporations and government entities
  12. 12. The Bill of Exchange The bill of exchange is a specialized type of negotiable instrument commonly used to expedite foreign money payments in any type of international transaction Purpose: 1. Act as a substitute for money; 2. Act as a financing or credit device 12
  13. 13. Bills of Exchange are Governed Today US = Uniform Commercial Act England = Bills of Exchange Act More than 20 countries = 1930 Convention on Bills of Exchange and Promissory Notes 13
  14. 14. Brief Requirements of a Bill of Exchange1. An unconditional order in writing;2. Addressed by one person to another;3. Signed by the person giving it;4. With the requirement that the person to whom it is addressed pay on demand or at a fixed or determinable future time;5. A sum certain in money;6. To or to be in order of a specified person, or to bearer 14
  15. 15. Negotiation is defined Negotiation is the transfer of an instrument from one party to another so that the transferee (called a holder) takes the legal rights in the instrument Purchase and sale of bills of exchange facilitated credit intermediation 15
  16. 16. BE: How it Works 4 1 Exporter Bill of Exchange Bank 2 3 $97,000 Bill of Exchange Signed BillGoods$100,000 6 Importer Assumptions: Bill of Exchange 3 months to pay the bill Bank buys at discount
  17. 17. Slight Variation: Interpose a Bank Exporter Discount Sale Bank ReturnExporter asks banks to accept the bill Presents for $100,000Bank accepts because it will be repaid 100 000 in 3 months Accepts Importer Accepting Bank Accepting Bank recovers from Importer or better its bank
  18. 18. Back to Original Merchant Banks Merchant would issue a promissory note  Bill obligatory  Merchants borrowed on their good names  Bill could be sold in England  Would not travel far because holder had to go to borrower for re-payment
  19. 19. Historical Route • Rome1 • Internal and Informal Sources of Capital • Italy and France2 • Precursors of Merchant Banking • Amsterdam and London3 • Financial Intermediation • US4 • Global • Complex capital markets5