The Origins of National Financial Systems

Douglas J. Forsyth, Daniel Verdier, Douglas J. Forsyth, Daniel Verdier

• Publisher: Routledge
• Year: 2003
• ISBN:
  9781134417308
• Edition: 1
• Topic: Betriebswirtschaft
• Subtopic: Business allgemein

Since the nineteenth century, there has been an accepted distinction between financial systems that separate commercial and investment banking and those that do not. This comprehensive collection aims to establish how and why financial systems develop, and how knowledge of financial differentiation in the nineteenth century may afford insight into the development of contemporary banking structure.

This book poses a systematic challenge to Alexander Gerschenkron's 1950s thesis on universal banks. With contributions from leading scholars such as Ranald Michie and Jaime Reis, this well written book provides solid and intriguing arguments throughout.

1 Explaining cross-national variations in universal banking in nineteenth-century Europe, North America, and Australasia

Daniel Verdier

A universal banking system is defined as a system in which banks engage in both lending and the underwriting of securities. In contrast, a specialized banking system keeps the two activities under separate roofs. Universal banking is commonly believed to have existed before 1913 in Belgium, Germany, Austria, Italy, whereas specialized banking was mostly encountered in France and the Anglo-Saxon countries. The purpose of this chpater is to explain this variation.

In 1952, Alexander Gerschenkron offered what is still the most ambitious explanation for cross-national variations in banking systems in Europe. The more capital was needed in the shortest amount of time, the less could equity markets cope with the task of allocating long-term financial capital; instead, banks and state had to step in, causing cross-national variations in banking structures.

In this essay, I shift the emphasis away from the asset side of the banks’ balance sheets – loans and the demand thereof – to the liability side – deposits. I draw from Adam Smith’s famous argument that the division of labor is only limited by the extent of the market.¹ I argue that universal banking was a rational response to the segmentation of the deposit market. Wherever the deposit market was allowed to develop unshackled, banks tended to specialize. Market segmentation was a necessary but not sufficient cause for universal banking. A second condition had to be met in the form of the existence of a lender of last resort. Universal banking was less liquid than specialized banking. Its survival required a stabilizing agent in the form of a modern central bank. These two conditions (segmentation and central banking) in turn were two consequences of one single cause – the degree of centralization of the state. Segmentation was found along with decentralized state institutions, whereas central banking first appeared in centralized states. As a result, universal banking was most likely to emerge in states that were neither so centralized that local banks were displaced by center banks, nor so decentralized that there was no central bank.

I first lay out the background for the argument: the state of the deposit market in the first half of the century and how it changed in the second half. I then show the existence of a cross-sectional relation between state decentralization and market segmentation. I then argue, and show systematically, that market segmentation and central banking were two necessary and sufficient conditions for the emergence of universal banking. I survey the unexplained residual in the last section.

The deposit market during the first half of the nineteenth century

The market for individual deposits was separate from the payments system. The payments systems operated on the basis of the bill (acceptance and domestic bill of exchange) market and current bank accounts – in addition to bank notes. Professions involved in the exchange of goods and services had their current account credited whenever they discounted a bill and had it debited whenever they settled a debt due on a prior purchase. ² In contrast, the market for individual savings was controlled by savings banks. Savings accounts were opened by individuals, not businesses, and were always creditor – they could not be used to grant credit. Savings were kept out of the payments system until the middle of the century, earlier in Belgium and England (even earlier in Scotland).³

Initially, savings banks were non-profit organizations, created in the early 1800s by philanthropic individuals and local municipalities to instill the saving habit among the urban poor; savings banks invested their customers’ savings in mortgages and safe, government paper. The anticipation or consummation of crises raised the question of government guarantee and regulation. The answer reflected state structures. In Britain, France, and Belgium, the solution to the savings banks crisis came from the center. In Britain, the 1817 Statute provided for the mandatory deposit of all savings banks’ deposits in an account with the Bank of England (Horne, 1947; Moss, 1997). French and Belgian savings banks spontaneously invested all their deposits in rentes sur l’État. Anticipating the depreciation of this asset, however, the Caisse d’épargne de Paris petitioned and obtained the right in 1829 to re-deposit all its resources in a current account earning a fixed rate of interest with the Royal Treasury.⁴ The Belgian solution was more radical: the failed savings banks were allowed to be taken over by joint-stock banks.⁵

Similar setbacks in decentralized countries drew the opposite response. The banks were rescued by, and became the chasses gardées of, fiscally-strained local governments. They invested their profits in local government projects, and their resources (individuals’ deposits) in mortgages (local land). In some areas, they also held communal bonds among their assets. This was current practice in Italy and Prussia in the early part of the century.⁶ In Geneva, the cantonal Caisse d’Épargne held more city bonds than Confederal bonds until 1873 (Hiler, 1993: 188). In Austria, the savings banks were allowed to make short-term loans to towns (Albrecht, 1989: 77). In the United States, in the states of Massachusetts and Maryland, savings banks were prohibited from investing in bonds of other States (Vittas, 1997: 150). In Denmark, until the end of absolutist rule in 1848, the savings banks were forced to place their deposits at interest in the treasury; the following Liberal governments discontinued the practice, and savings resources were mainly invested in mortgages (Hansen, 1982: 590).

State custody was not favorable to the long-term expansion of the savings banks. State officials in Britain and France harbored mixed feelings; they benefited from managing the savings banks’ ample resources but had little control over operating costs. Support existed at the ideological level – succor the poor, combat poverty. But that principle in the end worked against the savings banks, for it denied them the possibility to become the banks of the petite bourgeoisie – which is where the money was. The British and French governments contained the development of savings banks, reducing the interest rates that these banks could pay to their depositors and capping the amount of each account.

Municipalities in decentralized countries proved better custodians of the long-term interest of the savings banks than the state in centralized countries. Having at heart the welfare of the local economy, local governments supported the savings bank administrators’ requests for an extension of their activities. Although in many cases the local imperative clashed with the central regulator’s ideological wishes, the decentralized nature of the regime insured that local wishes would in the end prevail.⁷

In sum, even though savings banks started off as local endeavor to succor the poor, by 1850 the local logic had dethroned the class logic in decentralized countries. Only in centralized countries did the philanthropic motive retain pride of place, albeit as a convenient justification for the central treasury’s lack of ambition for savings banks.

The rise of deposit-branch banking

The neat separation between the current account and savings markets was progressively questioned by a ubiquitous change in the payments system – the check and wire transfer dethroned the bill as principal instrument of the money market. The change rested on three related innovations – the joint-stock bank, the branch-bank network, and the individual deposit. Joint-stock banking, along with limited responsibility of shareholders, made it possible for banks to develop countrywide networks of branches, tap individual deposits five times at least over the size of the initial capital, and finance assets with individual deposits. Deposit banking took market share away from banknotes and coins, as checks and wire transfers reduced the amount of cash kept on hand for payments purposes. It also cut into the bill market, as banks no longer needed to rely on rediscounting to maintain adequate liquidity.

What made deposit banking irresistible, however, is not so much that it was more efficient than past modes of payments, but that it brought within the payments system three segments of the economy – the periphery, industry, and the petite bourgeoisie – until then excluded from it. The eighteenth-century bill market was centrally located in Amsterdam, London, Paris, New York, and so forth. This concentration reflected economies of scale but was also a source of discrimination against business located on the periphery, for which credit information was more difficult to obtain. The success met by the country branches of the Banque de France when it was forced by the government in the early half of the nineteenth century to extend its branch network to the countryside attests to the limits of the bill market mechanism at including the periphery within the money market.⁸ Although the British and Dutch money markets may be considered as having been able to overcome this problem, in most other countries, however, the countryside was left out of the money market.⁹

Deposit banking also brought industry into the payments system. Manufacturing had a slower inventory turnover than trade and thus required a type of financing that was not strictly dependent on the shipping of goods to purchasers. The solution was provided by the overdraft, an advance that the bank financed through deposits and that it could renew at its own discretion, without having to obtain the sanction of a third party, as such was the case with rediscounted bills of exchange.

Last, deposit banking brought the savings of the petite bourgeoisie into the payments system. As the benefits of industrialization began to penetrate deeper into the middle strata, the demand for deposits accounts, both short and long, grew (J. Wysocki, 1997: 22). Risk-averse and uninformed, these new strata at first took their newly-earned savings to the savings banks, which typically re-invested them in long-term placements such as mortgages and public debt, until private bankers understood that they could finance investment by tapping the vast store of popular savings. Bankers also saw in deposit-taking a way of improving profitability, as depositors typically earned less than bank shareholders.

The change was quick and ubiquitous. With the exception of North America, in which joint-stock banking was liberalized from the outset in the United States, 1821 in Canada, and the isolated case in Europe of three Scottish banks, joint-stock banking is a mid-nineteenth century occurrence. Joint-stock banks first flourished in Britain after the passage of legislation permitting it beyond a 65-mile radius of London from 1826 until 1833, and anywhere thereafter. Limited responsibility was granted in 1855. A parallel evolution occurred on the continent, charters being granted by governments sparsely before 1852 (the Belgian Société Générale and Banque de Belgique in 1822 and 1835 respectively, the Swedish Enskilda banks from 1824 on, Spanish banks in the 1840s), liberally after 1852, the founding date of the French Crédit Mobilier, which spawned dozens of imitations throughout the continent, and was completely freed sometime after 1860 (1863 in France and Italy, 1864 in Sweden, 1869 in Spain, 1870 in Germany, 1881 in Switzerland, and so on). In countries without note-issuing monopoly, the thus-chartered joint-stock banks were given the right to issue notes as well as collect deposits.

The rising importance of deposits created a liquidity problem for the banks. Deposits were short-term resources, since even an early-withdrawal penalty scheme would hardly stop a poorly informed, panic-prone depositor confronted with the danger of a bank run from cashing his savings rather than facing the risk of losing it all. The problem was compounded by the popularity of overdrafts. Overdrafts were better remunerated than bills, but they were easily renewed and could not be readily recycled through rediscounting at the central bank. Therefore, relying on more volatile resources (deposits) to finance less liquid assets (overdrafts), banks were caught in a liquidity squeeze, of which they became aware in the wake of a string of banking crises, during which deposits were withdrawn in exchange for coin and central bank notes. Hence, after each crisis in England and Wales, the most severe being the crash of the City of Glasgow Bank in 1878, the banks tended to maintain a higher proportion of very liquid assets. The crash of 1882 in France served to disqualify loans to industry in the eyes of Henri Germain, the director of the Crédit Lyonnais (Collins, 1991: 41; Bouvier, 1968: 221). Meanwhile, banks scrambled for “good paper,” that is, standard, short, and readily disposable assets, thereb...