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A BRIEF HISTORY OF INTERNATIONAL BANKINGChapter 2Business 4039: 

A BRIEF HISTORY OF INTERNATIONAL BANKING Chapter 2 Business 4039 International Banking by Jane Hughes and Scott MacDonald

International Banking: 

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: 

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: 

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): 

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: 

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: 

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: 

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.

JP Morgan: 

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: 

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: 

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

Question 1: 

Question 1 Who were the first people to develop modern banking techniques? Italian city-states

Question 2: 

Question 2 What was the contribution of the Fuggers to international banking?

Question 2 - answer: 

Question 2 - answer Who were the Fuggers and what important lesson in diversification was learned from their experience? One of the most prominent German banking families in the late Middle Ages (1487 – 1577) Gained control of the country’s silver production as collateral for loans. Developed letters of credit to provide liquidity to clients who faced multiple currencies and inefficient markets for currency exchange. The Fuggers became too closely aligned with Charles V who decided to borrow money to wage a series of wars against the Ottomans, French and German Protestants and they later found that even sovereign leaders are only as solvent as the underlying health of their economies. They learned an important lesson…diversify both sides of the balance sheet. In their case, they developed too much exposure to one political figure.

Question 3 : 

Question 3 What are the eurobond and eurodollar markets and how did they develop?

Question 3 - answer: 

Question 3 - answer What are the eurobond and eurodollar markets and how did they develop? Eurodollar market is an international money market focused on short-term credit flows Eurobond market is an international capital market dealing with long-term bonds (developed in the early 1960s) Significance of the eurodollar (eurocurrency) market: Serves as a source of short-term funds for the trade financing activities of international banks Facilitates foreign exchange transactions by banks An outlet for placing surplus funds Gave birth to LIBOR – London Interbank Offered Rate Outlet for recycled petrodollars in the early 1970s

Question 4: 

Question 4 What is Bretton Woods and what is its importance to international banking?

Question 4 - answer: 

Question 4 - answer What is Bretton Woods and what is its importance to international banking? Created in 1944 (after math of WW II) At this conference the allied nations created organizations that were designed to provide coordination of monetary policy among the major world economies Created were: IMF – promote international monetary cooperation by establishing and maintaining exchange rate stability World Bank – long-term loans for reconstruction – technical expertise to developing economies GATT – promote free international trade through tariff reduction and nondiscrimination The Bretton Woods system came to an end when Nixon took the US dollar off the gold standard in 1971. Surviving institutions: [IMF (G’7) and World Bank, and GATT is now WTO]

Question 5 : 

Question 5 How did the system of international banking evolve, starting with the Italians and eventually ending up with the Americans as the dominant force?

Question 6 : 

Question 6 International banking has through through several crisis. What has been the cause of these crises, such as the cases of Latin America in the 1980s or of Asia in the late 1990s?

Question 6 : 

Question 6 International banking has through through several crisis. What has been the cause of these crises, such as the cases of Latin America in the 1980s or of Asia in the late 1990s? Too much debt…and rapid decline in a country’s ability to service that debt are perhaps the too most common causes. (see table 2.2, page 21)