1.1 The Origins of Banking
The practice of banking predates the introduction of standardized currency in the form of coins. Coins evolved from measures of weight. The earliest known coins date back to the seventh century B.C. and were in circulation in the Lydian kingdom, which is part of present day Turkey. Ancient Greek and Babylonian temples functioned as the world’s oldest banks. Banking declined in importance after the spread of Christianity as charging interest was viewed as immoral, but was revived in the middle ages to raise funds for the Crusades with the aid of the Templars and the Hospitallers.
Italy evolved into the birthplace of modern banking. The first known foreign exchange contract occurred in Genoa in 1156 when two brothers borrowed in Genoese pounds and repaid the amount in bezants in Constantinople. Accountants working for the House of Medici in Florence developed the double-entry book-keeping method for recording credits and debits. Banca Monte dei Paschi di Siena, founded in 1472 in Siena, is currently the oldest operating bank in the world. The bank originated as a monte pio or mount of piety, which was a charitable pawn agency run at the behest of the Magistracies of the Republic of Siena. The institution was specifically intended for the poorer segments of the population at a time of particular hardship for the local economy. The scope of the institution rapidly evolved, especially following the charters of 1568 and 1624, and the institution became a bank in the classical sense of the word. It began accepting deposits and the Medici Grand Duke even started providing state guarantees to the depositors on their money by entailing the income from the pasture lands held by the state, though he asked to be indemnified by the residents of Siena for any losses incurred by him. The bank also started expanding its market to progressively larger areas of Tuscany.1 It is currently one of the largest banks in Italy, with over two thousand branches and more than five million customers. Florence and Venice were other early centers of Italian banking. Though none of the oldest banks in either city have survived through the ages, the Acciaiuoli, Bardi, Medici and Peruzzi families were well-known for the immense power they wielded that stemmed from their banking wealth.
The second oldest continuously operating bank is the Berenberg Bank, officially known as the Joh. Berenberg, Gossler & Co. KG, based in Hamburg, Germany. It was founded in 1590 by the Flemish Berenberg family that had descended from the brothers Hans and Paul Berenberg, who fled Antwerp and came to Hamburg as Protestant refugees when the Dutch Protestants were given the choice to either convert to Catholicism or leave the country. The Berenberg Bank soon became a significant player in the field of trade, dealing in manufactured goods from Germany, silks and velvet from Italy, and colonial products from Portugal. It gradually became very successful as a merchant bank specializing in commercial loans and investment banking, financed the industrial revolution in the Hamburg area, and was extensively involved with trade with southern Europe, Scandinavia and Russia, and with North America later in the nineteenth century.2 A significant share of the bank is owned by the family to this day.
Excluding central banks, the third spot is occupied by the oldest British bank, C. Hoare & Co. This is a private bank established by Sir Richard Hoare in 1672, with its headquarters in London. Sir Hoare started out as a goldsmith and, taking advantage of the secure premises and piles of cash, subsequently began lending money to his customers with interest; banking was hence a natural evolution. While other smaller banks were all acquired by larger ones, C. Hoare & Co. is the sole survivor among the more than 750 private deposit banks that were established during the seventeenth and eighteenth centuries in England and Wales.3 The bank currently offers savings accounts and provides mortgages, other loans, and tax and estate planning services. Like Berenberg Bank, C. Hoare & Co. remains in the hands of the founding family.
1.2 The Pioneers in Central Banking
1.2.1 The Netherlands
The Bank of Amsterdam (Amsterdamsche Wisselbank in Dutch) is considered to be the forerunner of modern central banks. It was established in 1609 in Amsterdam when it was part of the Republic of the Seven United Provinces; the United Provinces had formed when Netherlands had seceded from Spanish rule in the late sixteenth century. It performed some of the activities associated with modern central banks. This was a time when Europe was fractured into many small states whose currency typically traded at a discount, and the Bank of Amsterdam accepted deposits in these myriad currencies and credited the depositors in what was known as “bank money,” which traded at a premium. The bank closed its doors as a result of providing large and risky loans to the local government of Amsterdam and the Dutch East India Company and committing other financial improprieties in 1819, just a few years after the creation of the Kingdom of the Netherlands in March of 1815.
1.2.2 Sweden
The oldest central bank in the world in the modern sense of the term is Sveriges Riksbank (often referred to as Riksbanken in Swedish and Bank of Sweden in English), which is the central bank of Sweden. A Dutch merchant named Johan Palmstruch established a bank named Stockholms Banco in Stockholm in 1657 after obtaining a charter from King Charles X Gustav during his brief but eventful reign. One of Palmstruch’s brainwaves was to use the money deposited by account holders to finance loans that were made by the bank. This is a mainstay of modern banking, but back then deposit banking and loan banking were separate activities. Stockholms Banco itself had originated as two separate charters, an exchange bank that opened its doors in 1657 and a loans bank that started operating in 1659. The two were later merged by Palmstruch, who was the general manager. Palmstruch had another major contribution to the field of banking. Sweden did not have a single unified currency at the time; the riksdaler was issued in both copper and silver. Silver appreciated in value relative to copper over time, which caused the exchange rate between the two to fluctuate. Copper currency especially depreciated in value in the year 1660. Some of this copper currency was rectangular plate money that was huge and heavy; the ten riksdaler piece weighed around 45 pounds (or 20 kilos). Silver coins were hoarded by the Swedes, whereas copper coins were bulky. This prompted Palmstruch to issue the first European banknotes. Issuance of these notes, known as kreditivsedlar, began in 1661. The notes were easy to carry and freely transferrable, and as a result they quickly replaced the cumbersome dalers in transactions.
The downfall of Stockholms Banco was due to its issuance of far too many banknotes without securing them with the requisite collateral. The Swedish parliament decided to intervene in what was the first banking crisis in Sweden. Palmstruch was convicted by the Svea Court of Appeals of financial mismanagement; his death sentence, however, was subsequently commuted. On September 17, 1668, the charter of Stockholms Banco was transferred to the Bank of the Estates of the Realm (Riksens Ständers Bank in Swedish), whose name was changed to Sveriges Riksbank in 1866. The bank instituted a silver standard to stabilize the economy. To lower the chances of successful counterfeiting, Riksbank opened its own paper mill for printing bank notes in Tumba, a southwestern suburb of Stockholm, in 1755.4 The paper was handmade and included unique watermarks and embossed stamps. The notes themselves were printed in Stockholm, and included the motto “Hinc robur et securitas” (From here, strength and security). Counterfeiting carried the ultimate penalty of death by hanging. The Riksbank also oversaw the establishment of the first savings banks in Sweden in the 1820s and the first mortgage institutions in the 1830s.5
1.2.3 United Kingdom
The royal charter for establishing the Bank of England was granted on July 27, 1694. England needed money to shore up its military in the backdrop of the War of the Grand Alliance (or the Nine Years’ War) with King Louis XIV of France. England’s First Lord of the Treasury, Fellow of Trinity College at Cambridge and close friend of physicist and mathematician Sir Isaac Newton, Charles Montagu devised the Bank of England Act of 1694 (also known as the Tonnage Act) as
An Act for granting to theire Majesties severall Rates and Duties upon Tunnage of Shipps and Vessells and upon Beere Ale and other Liquors for secureing certaine Recompenses and Advantages in the said Act mentioned to such Persons as shall voluntarily advance the summe of Fifteene hundred thousand pounds towards the carrying on the Warr against France.6
The stated goal was to raise £1,200,000 at an eight percent interest. The subscribers would be rewarded by incorporation as The Governor and Company of the Bank of England. This worked exactly as Montagu had hoped; the requisite funds were raised in less than two weeks and the bank, sometimes referred to as the Old Lady of Threadneedle Street, established a firm foothold. The bank’s first governor was Sir John Houblon, who at various times was also the sheriff of London, the mayor of London and a director of the British East India Company.
In its earliest form, the Bank of England had limited functions. It gradually acquired much of broad regulatory powers and its standing as the lender of the last resort in the country over the course of the following two centuries. The Bank Charter Act of 1844 played an especially important role. It was passed by the parliament during the prime ministership of Sir Robert Peel, who is better known for introducing Britain to t...