A BRIEF HISTORY OF

INTERNATIONAL BANKING
Chapter 2

International Banking
by
Jane Hughes and Scott MacDonald
International Banking
 Linked to the development of world trade, the
process of urbanization, and the rise of the
nation-state.
 Essential prerequisites for international
banking is
 The rule of law
 Political stability
 Large-scale economies with depth and scope
to support major international banking hubs
Early Banking – first references

 Babylonian Empire (1728 – 1686 B.C.)

 Code of Hammurabi contains 150 paragraphs
pertaining to loans, interest, pledges and
guarantees, standardizing procedures.
Creation of Money
 Chinese probably invented money.
 Lydians in Anatolia (modern day Turkey) who
invented money in the west.
 A standardized unit of currency would simplify
transactions. (640 to 630 B.C.) they minted
coins.
 Money and sea travel throughout the
Mediterranean, Indian Ocean and the Far
East supported the growth of trade.
Roman Empire (1st Century AD)

 The power and breadth of the Roman Empire

controlled piracy and provided uniform,
formalized and predictable legal environment.
 Construction of sea ports and shipping
infrastructure underwrote the development of
trade further.
Importance of History

 Much of what we see today is the product of ‘history’

 You should see in this chapter how the evolution of
banks, trade, economic, political and social
development are all intertwined.
 The evolution of banking is inextricably linked to the
development of the global economy especially in trade,
industrial development and infrastructure.
 Reflect on the importance of confidence (a concept
introduced in chapter 1) and rule of law to the
extension of credit, the creation and trade of financial
instruments.
The History of Banking
Early Banking
- Principles of lending (1728 – 1686 B.C.) – the Code of
Mannurabi – a code containing 150 paragraphs that pertain
to loans, interest, pledges and guarantees.
- Creation of money (640 – 630 B.C.) – Lydians in ancient
Anatolia (Turkey) – a standardized coin made from electrum
(unit of commerce) to simplify transactions.
- Greco-Roman banking in support of trade involved smiths
and collectors, money changers and inspectors of currency.
- Roman Empire (1st Century AD) – again trade in a stable,
far-flung empire
- Italy (middle ages) – because of its central location, Italian
city-states emerged as the first international banking centers
using coins (florin in Forence 1252 and ducat in Venice)
Importance of Trade Fairs
 Trade fairs were safe, convenient meeting places
between northern and southern Europe…between
Italian and Flemish cities.
 A system of credit made the trade fairs work.
 Credit was used to settle large cross-border
transactions without the physical expense and risk of
transporting coined or uncoined bullion.
 Credit worked in the trade fair system because of the
rule of law that supported it as well as a healthy dose
of self-regulation.
The double-entry Bookkeeping
 Century 12-13th : The Italian merchants
introduced double-entry bookkeeping and
established the first international banking
networks
 Exchange banks  creation of commercial
credit and clearance of client obligations
by book transfer
 The Emergence of Banks

 Century 13-14th: Three types of banks emerged:

 Foreign exchange, deposits, loans to local
business
 Large merchant banks: finance international
commerce through Bills of Exchange
 Pawn banks: extend consumer credit secured by
personal assets
 Maritime insurance underwriting  risk
diversification
The Expansion 1350-1600, Antwerp

 In the early 1500s: Antwerp became the first

Europe’s financial hub
 The stock market in Antwerp is one of the two
world bourses
 Capital and credit available to royal
borrowers against guaranteed tax revenue or
other promises of repayment
 Ended by religious conflicts in the 1580s
 Amsterdam
 By 1600 the Dutch independence was
relatively secure
 Domestic political stability  trade flows
 More sophisticated financial infrastructure
was needed to trade financial instruments:
 Amsterdam Exchange Bank founded 1609
 In 1611, Amsterdam Stock Exchange
opened
 The Rise of London, 19th Century
 Bank of England founded 1694 by private
holders but controlling the nation’s finances
 Strong economic growth thanks to Industrial
Revolution, trade expansion and political
stability means long-term bonds and loans
could be issued
 Free trade and the gold standard
 HSBC founded in 1865 to finance trade from
China
The Evolution of the Eurocurrency
 Eurocurrencies are currencies that held
outside their home countries
 The Eurodollar market emerged in 1957:
large amounts of the dollar deposited in
foreign branches of US banks
 Politically, it is interrelated to the Cold War:
The Soviet Union and other bloc nations
transferred the dollars from New York to
Western Europe for fear of being frozen by
the US government
…
 Suez Crisis 1956  the birth of Eurodollar
market
 With the speculative attack pressure, British
government prohibits the use of pounds as in
trade credits for non-residents
 UK and other banks turn to the dollar 
active solicitation of dollar deposits by
Western European banks
 Take-off in 1960s, rapid growth 1973-82
The Evolution of the Eurobond Market
 Eurobond market develops in early 1960s
 issue of debt outside US in Eurodollar: first
issue by an Italian toll road authority, worth
USD15 m
 US restrictive monetary policy 1959 because
of concerns about large amounts of the
dollars outside US
 Interest Equalisation Tax 1963: dissuade
foreigners from borrowing in US bond markets
The Evolution of the Eurobond Market

 Commerce Department rules that US firms

investing abroad must raise funds outside
US, this stimulates further the development of
eurobond market
 Foreign Investment Restraint Programme
1965 and Foreign Credit Restraint
Programme 1966: tried to keep US bank
business onshore but US banks set up
subsidiaries in London (important for its
development)
The Evolution of the Eurobond Market

 In 1960s and 1970s, Eurobond market

became major alternative to issuing debt in
the US
 a way for banks to remain competitive
 US banks constrained by Glass-Steagall
(1933) which prohibited US commercial banks
to involve in securities
 Euroclear and CEDEL develop (clearing
houses)
The Evolution of the Eurobond Market
 Although virtually unregulated, market
employs self-imposed standards of practice
 Eurobonds usually listed in Luxembourg or
London
 issues are normally subject to UK law
 Confidence is underpinned by
 disclosure requirements of Luxemburg and UK
exchanges
 application of minimum standards set by the
Association of International Bond Dealers
(AIBD)
The Expansion of Int’l Banking
 The period from the late 1950s to 1982
 Major structural changes witnessed
 Euromarkets developments
 The growth of multinational firms and trading blocs
 Changing patterns in demand for finance
 New technologies and techniques like syndication
 Changes in regulations
 financial liberalisation
 Re-emergence of emerging market economies
in capital markets
 End of the Golden Age
 Oil crisis of 1973  recycling of petrodollars
Balance of Payments surpluses in OPEC states
recycled by international banks to EME
 Perceived problem of not enough funds
 Intense competition among international banks
 more credit to EME (in Latin America)
 Ends with the International Debt Crisis 1982-1992
Trends

 Deregulation of capital markets in both

industrialized and emerging nations
 The globalization of the market for
financial services
 The consolidation process
 The offshore banking activities
 Banking in the 2000s
 End of Debt Crisis in 1992 facilitated market
growth but Asian crisis in 1997-1998 caused
global market failure
 Regulators try to reduce systemic risk and
level playing field
 Banks have become more cautious: strategic
emphasis on profitability and asset quality
improvement
Banking in the 2000s

 Bank operation subject to new

capital adequacy rules
 Re-regulation
 Investment and commercial banking
 Securitization …
The International Financial Centre
 Primary centres: London, New York
service industrialised countries; no controls on
capital flows
 full array of products; advanced payments

systems
 flexible regulations and tax for non-residents

 Booking centres: Bahamas, Cayman Isles

 loans/deposits booked through shell branches
 weaker regulations and tax (secrecy, disclosure)
 low cost of entry to Euromarkets for small banks
The International Financial Centre
 Funding centres: Brussels, Rio de Janeiro
 inward financial intermediation - channel
funds from outside region
 Regulations and tax favourable for non-
residents
 Collection centres: Bahrain, Amsterdam
 outward financial intermediation - local
markets do not have sufficient investment
opportunities
 funds flow out of the region for higher returns
JP Morgan
What trend did J.P. Morgan discern early in the
1980s yet…not manage to take advantage of?

 The eventual repeal of the Glass Steagall Act and the trend
toward disintermediation (ie. the move to universal banking)
 Lew Preston observed that their traditional clients were
abandoning wholesale lending and defecting to the capital
markets.
 So…they decided to recreate the commercial bank as an
investment bank.
Rothschilds
Who were the Rothschilds and what innovations did they
initiate to support their banking activities?

 One of the most prominent German banking families in the mid-

1700s.
 The five sons of Mayer allowed the growth of their business to
Paris, Vienna, Naples, London and Frankfurt.
 They found that superior information could make the difference
between massive profits and losses.
 They constructed their own international intelligence network:
 Fast packets
 Agents
 Carrier pigeons
 Couriers
Key Concepts
 Bretton Woods Agreement
 International Monetary Fund (IMF)
 World Bank
 General Agreement on Tariffs and
Trade(GATT)[and now it’s successor the
World Trade Organization(WTO)]
 Eurocurrency and Eurobond Markets
 London Interbank Offered Rate (LIBOR)
 Universal banking