History and development of banking

Question 1

What are the main retial banking events?

Answer 1

• BC-1000: There is little known about banking during the dark ages
• 1100: Lombards become the first merchant bankers – financing farmers, crops exports and insurance
• 1565: Sir Thomas Gresham founds the Royal Stock Exchange as a centre for merchants and traders
• 1600’s: Goldsmiths diversify into finance after initially offering safe custody of valuables. The Bank of England founded to provide finance to the government and issue notes.
• 1700’s: Joint stock banks emerge
• 1844: The Bank Charter Act 1844: passed to restrict the powers of banks to create money
• 1900’s: era of legislation and consolidation
• 1979: The Banking Act 1979: BoE role formalised a licensing system introduced and administered by BoE.
• 1986: The Financial Services Act 1986: Consistent with government policy of withdrawing its role from financial markets, this act introduced a system of self-regulation for providers
• 1987: The Banking Act 1987: Reinforced BoE regulatory control and supervisory duties
• 1998: The Bank of England Act 1998: Reformed the BoE role. Transferred responsibility for regulation and supervision of banking sector to FSA
• 2000: The Financial Services and Markets Act 2000: Created a unified system of regulation.

Question 2

What are the main Building Society events?

Answer 2

• 1775: first BSoc
• 1836: Benefit Building Societies Act 1836: building societies were required to have their rules approved by a Certifying Barrister
• 1870: Over 2000 terminating and permanent societies in existence
• 1874: Building Societies Act 1874: Recognition of BSocs as corporate bodies having a legal personality separate from their members
• 1894: Building Societies Act 1894: Following collapse of largest society, Liberator, government passed this act to tighten controls on BSocs including a requirement that mortgages be fully secured and stricter reporting requirements.
• 1920’s: BSocs start having full time staff. Rationalisation of BSocs previous to this.
• 1950’s: BSocs prosper in housing boom following the war, and demand for mortgages increase which other financial institutions show little interest in.
• 1986: Building Societies Act 1986: Subject to member agreement, it allowed BSocs to forego mutual status and become a plc.
• 1997: Building Societies Act 1997: Built on the earlier act by simplifying regulatory requirements and reinforcing prudential controls.

Question 3

What is the main history of savings banks?

Answer 3

• The Post Office Bank was the main vehicle up until the 1960’s
• In the 1970’s National Giro Bank esablished an electronic payments platform

Question 4

What are the main events in the history of the Credit Union?

Answer 4

• 1864: First established in Germany

Question 5

What are cooperatives

Why have cooperatives increased market share in recent times?

Answer 5

• Owned by depositors and borrowers
• Their ethical syance has helped them increase market share, especially since the credit crises

Question 6

List the main events in the credit crises.

Answer 6

Pre-2007: Bull market in the USA characterised by massive growth in lending, fuelled by low interest rates. Market deteriorates as a consequence of some or all of the following:

• Significant increase in sub-prime lending from under-estimation of risk
• Sales of loans at initially attractive interest rates, created to lock borrowers into contracts that would ultimately be unaffordable
• A decline in mortgage underwriting standards
• The willingness of borrowers to release equity in real estate
• Predatory lending

Mid-2007: Securitisation was long established in the USA but newer to the UK. UK banks invested funds in mortgage-backed securities, and these securities became impossible to sell as markets became nervous. The downturn in the market in the USA drove up wholesale interest rates that in turn exposed many UK financial institutions to risk, as many had relied on the wholesale market for funding.

Autumn 2007: Northern Rock approaches BoE for emergency funding as it’s unable to get funds from conventional wholesale sources at sustainable interest rates. The publicity of this causes a run on the bank.

Mid-2008: £500 billion government rescue plan for RBS and Lloyds to restore stability. Several smaller banks and former BSocs encounter difficulty and their toxic assets are taken into public ownership. Financial institutions who were less reliant on wholesale markets were ~ okay.

The Credit Crises had a major impact on IBs. One reason is that IBs play a crucial role in assisting lenders to raise funds. Mortgage lenders create loans but they use investment banks to fund the debt by issuing bonds, the proceeds of which can be used for further lending. This is how securitisation works. However the demarcation between the role of primary lender and the investment bank was blurred when primary lenders took responsibility for securitisation and IBs became primary lenders. The USA had in fact attempted to segregate retail and investment banking in 1929 but these restrictions were removed in 1999 as part of a programme of deregulation. IBs took that opportunity to chase short-term profits that went sour with wholesale market conditions. Bear Stearns and Lehman Brothers collapsed whilst Goldman Sachs, Merrill Lynch and Morgan Stanley barely survived.

Question 7

What were the outcomes of the credit crisis?

Answer 7

• In return for government financial assistance, and to comply to EU requirements, Lloyds and RBS agreed to sell off some of their branches.
• Banks reappraised the risk-return relationship, moving towards more conservative policies
• Banks became more aware of downside risk, particularly wrt businesses with long standing overdraft arrangements
• Badly damaged banking industry reputation, and a loss of trust
• SMEs see reduced lending and those that collapse resent the fact that the banks didn’t lend to them despite banks being saved by the tax-payer.
• Accelerated reform: The Vickers report, Basel III and the FCA

Question 8

What were the main points in the Vickers Independent Commission?

Answer 8

• A competitive and innovative banking sector is crucial to maintaining the UKs position as a banking centre
• The Basel III reforms that increase capital adequacy and liquidity requirements do not go far enough
• Ring-fence retail from wholesale/investment activities though keep the benefit of having these services under the same umbrella. For example retail activities might be turned into a legally separate subsidiary of a company.
• Make switching current accounts easier