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In this final part of the blog, we will look at the factors that made banking the behemoth it is today – industrial revolution, globalization, and the rise of technology.

The industrial revolution and globalization

In the early 18th century, as agriculture stepped aside to bring industrial revolution in the spotlight, the need for capital increased further.

We can forever argue on what factors caused the growth of Industrial revolution in England, but from 1750, which is normally seen as the starting date of industrialization, the growth of the banking industry and the industrial revolution became entangled.

Before 1750, the economy was run on not just cash, but on gold, copper and other metals. After 1750, the entrepreneurs of England, Belgium, Germany, and France among other nations required not only an easy form of money, especially up front, but also needed an effective and efficient mechanism for their day to day transactions. Credit was also becoming a norm.

The traditional money lender could not provide this. Moreover, as pointed out earlier, the rise of Protestantism had created a new set of bankers – the Christian family bankers. Both these factors created an increase in demand for the banking industry and led to the rise of specialist banks with the knowledge of certain industries.

For example, in England, in 1750, there were three tiers of banks – the Bank of England was the first tier, the private banks, which were around thirty, formed the second tier and the local regional banks formed the third tier. By 1800, the number of private banks had increased to seventy and the number of regional banks doubled in 25 years.

The same story was repeated in countries like Belgium, Germany, and Italy.

In Belgium, the first country to follow England in the Industrial Revolution, banks such as Société Générale and Banque de Belgique became universal banks and where their growth was critical in the growth on Industrial Revolution in Belgium.

Germany is often cited as the best example of bank-driven development. Germany experienced rapid industrialization between 1850 and 1880 and the German Industrial Credit Banks played a critical role in this growth. The major banking players in Germany also witnessed an increase in their profits and more players stepped in. Between 1850 and 1870, 259 firms were incorporated as credit banks and most of these banks were profitable.

Italy, which witnessed a rapid surge in industrialization between 1890 and the first world war, also followed a similar path and the banking industry also grew rapidly.

While the banks in Europe focused on providing short-term loans, the banks in the US during these times focused on long-term loans. This led to the formation of a new form of banks – the investment banks. The US witnessed the rise of large investment banks who participated in the industrial growth in the latter part of the 19th century. Large scale projects were majorly financed by these investment banks in the US.

Two global wars and the world’s greatest depression followed the period of rapid industrialization.

Globalization followed world wars. The World Bank and the IMF were established. Banks acted as the catalysts for the modern society and the national banks grew beyond their national boundaries. Economies and banks became interconnected. Some followed a local strategy, some followed a global strategy, and some followed a truly glocal strategy.

Banking activities expanded in three phases – the first phase, which ran through the 1960s, was characterized by the euro-dollar market expansion which brought into limelight several European banks; the second phase, which happened during the 1970s, brought forth the importance of the Middle East through the rise of the oil economy and the third phase, which happened in the 1980s, was characterized by financial globalization, brought to the fore the US investment banks, the English merchant banks, and the Japanese banks.

The three phases not only helped banks expand but also forced banks to adopt new strategies. Many banks merged, some collapsed, but many new banks and financial institutions were born. Perhaps, the seeds of the financial crisis of 2007-08 were sown in these times as banks, which were driven by the need for greater and continued profits, started to follow riskier business models. It is interesting to think whether the financial crisis would have happened if the banks had not passed through any one of these stages. Hindsight is indeed a great teacher.

In the later stages of globalization, as the prevalence of technology increased in the banking industry, new kinds of banks emerged; countries fought with each other, not through weapons, but through economic policies driven by their central banks; competition increased between banks which meant that there was pressure on CEOs to adopt far riskier propositions to win a greater market share and increase profits and regulation, controls and compliance standards increased across the globe.

And one day, the Titanic hit the iceberg. 2008 happened.

In the US alone, 465 banks collapsed from 2008 to 2012. This fact alone is enough to showcase the impact of globalization on banking.

Perhaps, no other sector was impacted by the industrial revolution and globalization than the banking industry. The cornerstone of the modern economy is capitalism. Capitalism drove the two forces – industrial revolution and globalization and as noted before, banks were the circulatory system for capitalism.

From 1750, as the world transformed radically due to these two forces, the banking industry also grew. These two forces also resulted in the creation of another revolution which has catapulted the banking industry to the next level.

The rise of technology

Today, Amazon processes millions of transactions every year. Billions of dollars are spent on online shopping. It is hard to imagine that three decades ago, the idea of shopping through a hand-held device, was not just a dream, but out of the imagination of 99.99% of people across the world.

The world before 1750 was further different from what it was three decades ago. Speed was associated with horses, the difference engine invented by Charles Babbage was more than 70 years away, no one expected a message to be sent across from Europe to the US in a day and the Australian continent was not discovered by the Europeans.

But, with the birth of the Industrial Revolution, another wheel was also set in motion.

When Thomas Malthus observed in his Malthusian theory in 1798 that population would rise to such a level that the resources of the world would be insufficient, and this could lead a catastrophe, he had forgotten to accommodate the biggest thing had driven humanity till then – the human ingenuity and the increase in productivity per resource.

The wheel that was set in motion with the birth of the Industrial Revolution was the wheel of technology which built on the continuous urge for humans to produce more with the same set of resources and to find newer ways to do it.

As entrepreneurs focused on increasing profits, one thing became clear. Without the application of science, the productivity of resources can’t be increased and without increased productivity, profits cannot be increased. Technology can be defined as the application of science for practical purposes, and that is what the industrial revolution and later globalization did.

So, technology in banking did not start with internet banking or mobile banking. It started much before.

Probably, Western Union, who pioneered the concept of e-money in 1860 and electronically transferred e-money in 1871 through telegram were the earliest adopters of technology in banking.

But, the use of technology slowed down in the next forty years only to be revived by the bank’s move to automate many of its operational activities through technology. This was done by the increase in their scale of operations and the need to reduce operational costs.

The era after the second world war saw an increased focus on technology. This was driven primarily by the enormous benefits that banks foresaw from leveraging the technology invented for the world war.

The first credit card, which was a precursor to the Diners card was invented by John Biggins in 1946. It was called Charge-It.

Banks started to invest heavily in computers from the 1950s. In fact, many large banks brought mainframe computers to process a large set of transactions. In 1957, the CNEP, one of the four banks that merged to form BNP, bought Bull Gamma 60, the largest computer in Europe at that time. In the late 1950s, the Magnetic Ink Character Recognition or MICR was introduced propelling the way forward for cheques to be cleared faster.

1967 was a truly ground-breaking year for banks and technology as Barclays introduced the first ATM, a revolutionary piece of technology that propelled access to cash and access to banks further. Now, a bank at every block was a possibility.

1980 saw the bank coming to us through another channel as telephone banking was introduced. I am sure most of you would appreciate the benefits of phone banking.

Around the mid-1990s, some intelligent people working in a bank saw the possibility of the internet for expanding their operations and gradually, all the banks embraced this new wonder-kid with open arms. And the rest they say is history.

Today, with blockchain, big data analytics, artificial intelligence, and many more technological innovations, banks are far from the dull data storing dust-filled offices they were in the early 80s or 90s.

Globalization created a need for banks to reach out to a large set of the market in a relatively short frame of time. Banks used technology to cover this distance in an exponential way. If the industrial revolution and globalization were the airplanes on which the banking industry rode, then technology is now the rocket on which the banking industry is riding. Technology has not only enabled banking to become more efficient and reach new markets, but also helped in the creation of new models, new products, new services, and even new organizations.

The bank of today is a result of all these forces. In hindsight, even if one of these forces was not there, the banks of today would have looked differently. What if the computer was not invented? What if printing was not accepted? What if the British empire was not allowed to grow? What if the industrial revolution had not happened?

These forces were not just causal forces, but these forces were also further shaped by the banking industry. We may call these forces and the banking industry cyclical friends – A shapes B and B further shape A in return.

None of these forces were planned but were the result of how humanity progressed. Perhaps the single biggest shapers of the banking industry have been the evolution of humans and their tenacity to succeed.

In the last part, we looked at the rise of trade and the emergence of empires as the contributing factors towards the growth of banking. In this part, we will look at two other major factors that drove banking in the early parts of human history – wars and paper money.

The horror of wars

Empires were not built on dialogues and discussions. Along with tactical nous, they also needed strong-arm tactics and military might. Loyalty would not have been the only drug that propelled millions of soldiers to fight for their kings. Machines, weapons, cavalry, horses, chariots – all needed money to be built or to be maintained.

In the pre-historic age, when kings ruled with an iron fist, the king and a few religious leaders controlled the money of each state. In times of war, the king could always levy extra taxes. As nations grew, the distribution of wealth amongst its citizens became more widespread. The concept of ownership shifted from the concept of kingship to individualism. Kings and religious leaders were part of a large social ecosystem that contained people and corporations.

Around the 5th century AD, the Roman Empire collapsed and with it, the growth of the banking industry came to a standstill. Around the 12th century AD, the kings needed more money to facilitate their expansions, but they could not force people to pay more taxes for the kings feared revolutions.

The leaders needed one overpowering feeling that united people to contribute money. This overpowering feeling was faith. By the 12th century, after lying dormant for nearly 700 years, religious fervor stimulated the re-emergence of banking. Crusades were the stimulant. The Church needed hordes of money to facilitate their wars and banks came forward to finance these wars. Probably, the banks were forced to come forward. In some cases, bankers of Italy and other European nations were forced to lend money. Money was moved across nations to feed far-flung armies.

After several years, the Crusades stopped. But, the insatiable urge for kings to expand never came to an end. A great push to the modern-day banking came in 1797, when England, threatened by war, suspended cash payments through its central bank – The Bank of England. This move created panic and forced the Bank of England to create notes of the lower denomination which helped banking spread beyond nobles.

Wars also acted as the cause for the creation of central banks across many nations. In fact, most of the central banks were set up to facilitate the flow of money from the people and merchants to the government in times of war. For example, the War of the Second Coalition led to the formation of Banque de France, the French central bank, in 1800 AD. The aim of Banque de France was to improve the public financing for the war.

Probably Napoléon Bonaparte didn’t know, but he also played a critical role in the development of new-age banking knowingly or unknowingly. The Rothschild banking family had funded Napoleon’s major wars and colonial expansion, but their involvement with the war helped Rothschilds to get the information of Napoleon’s defeat much before the English forces thereby aiding them in investing their money in a proper manner.

The last great war of the modern era, the Great World War II, resulted in the creation of the International Monetary Fund and World Bank. Encouraged by these institutions, commercial banks started to lend to sovereign states in the third world. The US became the new global center of banking.

While wars brought with them great despair, the role of banks in rebuilding nations after the war has also been praiseworthy.

A war requires enormous financial resources but in the end, humanity suffers because of wars. From an independent point of view, the wars created the demand for large sums of money which could be satisfied through banks only. Was then wars unavoidable for banks to grow? For the scores who lost their lives through wars, it never looked necessary.

The growth of paper money

On November 8, 2018, the Government of India demonetized the notes of Rs. 500 and Rs.1000 of the Indian Rupee. In one night, what was once enough to buy a meal for a family of four for a week was just paper.

Yet, as the online magazine, Quartz pointed out, it was but a small moment in the history of money and banking, of which a significant moment was the invention of paper money.

Modern notes are not just pieces of paper, but promissory notes that promise to pay the bearer the denoted sum, but in a matter of minutes, these notes can become paper.

Earlier money came in all forms – grains, beads, weapons, cattle, etc. But it was difficult to carry around, tough to transact and even tougher to store. Counting in decimals was not even an option.

Gradually, coins came, and they solved most of the problems that the earlier forms of monies had. But they were still heavy. In fact, in China, copper coins were designed with square holes in the middle so that they could be carried around in a string. It worked, but it was tough. Imagine if you got your next salary with a sack of coins.

During the 7th and 8th centuries, trade was flourishing along the Silk Route. The Tang Dynasty was ruling China. Traders from China needed an easier way of storing their money as carrying around hundreds of coins was not an option. They deposited their money (or coins) with a trustworthy agent, who in return gave them a note which denoted how much money they had deposited with the agent. The traders could use the note for trade. While this was not technically a printed note, this did set a strong precedent.

In the early part of the 10th century in China, under the leadership of the Song Dynasty, the government licensed certain agents to issue these promissory notes and gradually the government took control of the system, printing the promissory notes themselves.  They called it jiaozi. The Song dynasty established factories to print this paper money. They were even issued in multiple colors.

As ThoughtCo points out in their website, ‘In 1265, the Song government introduced a truly national currency, printed to a single standard, usable across the empire, and backed by silver or gold.’

But this amazing achievement was short-lived as the visionary Song Dynasty fell to the Mongols. While the succeeding dynasties tried to print currencies and even impressed the renowned traveler Marco Polo with the idea, the paper currency collapsed and was not to see the light of the day till 1890 when yuan was printed as paper currency.

But good ideas spread fast. Across the other end of the Silk Route, in Europe, the trade was growing, and the traders needed a convenient way of transferring large sums of money over large distances. The traders fell in love with the idea of promissory notes and started using it.

Here also, the promissory notes were the precursor to bank notes. In fact, the term bank note is also derived from the Italian word nota di banco which meant bench note.

While the first bank notes were issued by private lenders in Europe from the 14th century itself, it was not until 1661 that the first bank note was issued by a bank – by Stockholm’s Banco, the predecessor of Bank of Sweden. Sadly, the bank ran out of coins to redeem these notes and had to shut down in 1664. Call it an irony, but that is what happened.

In the United States also, while bank notes were issued by each of the thirteen colonies in the early 18th century, it was just one of the different currencies in circulation. It was not until 1933 that the bank notes were formally accepted as the preferred form of currency over other precious metals.

Paper money made handling money easier and banking more convenient. Paper money also introduced the concept of counterparty risk. Since paper is not always durable, we are now shifting to plastic money. Paper may be easy to counterfeit and not issuing the right amount of paper money can destabilize a nation, but paper money has saved precious metals, is easy to count and can be mass-produced with uniform quality. Would gold be considered so valuable if everyone had gold coins with them?

It is sure banks have greatly benefited from the invention of paper money and the modern banks must be thankful to the Tang Dynasty for this unique invention.

Paper money also helped drive an increase in trade which was one of the contributors for the industrial revolution, which further helped the banking industry grow.

In the final part, we will look at the factors that made banking the behemoth it is today – industrial revolution, globalization, and the rise of technology.

When it is the question of money, everybody is of the same religion. – Voltaire

In the last part, we looked at the rise of civilization and the emergence of writing as the contributing factors towards the growth of banking. In this part, we will look at two other major factors that drove banking in the early parts of human history – trade and empires.

The expansion of trade

As the Roman empire collapsed during the 5th century AD, the evolution in banking also came to a standstill. While people were still saving money in banks and taking money on credit, there was no significant progress. For nearly 500 years, the status quo continued.

Banking, in its current sense of form, is traceable to medieval and early Renaissance Italy, to rich cities in the north such as Florence, Venice, and Genoa and the reason banks flourished in these regions was because of the growth in trade.

The original banks were “merchant banks” that Italian grain merchants invented in the Middle Ages. In the 11th century, as the Lombardy plains in Italy grew more fertile, the merchants of Lombardy also grew rich and expanded their trade.

Meanwhile, by a twist of fate, Jews, one of the richest classes, were being shunted out from many parts of the world. We may call it selective discrimination or the result of the depraved human mindset, but few Jews benefited from this tragic act.

The Jews moved around and were attracted to the richness of the Lombardy plains. The Jews, well versed with the trade practices of the Middle East and the Far East through silk trade, adapted these trade practices and financed grain production and trading in the fertile plains of Italy. They had one great advantage over the local Christians – the local Christians could not lend out money for interest whereas the Jews could.

Initially, the Jews, with lots of money in hand, lent out money to finance grain production and insured their loans against the grain produce. Gradually, the Jews moved forward the value chain and began to advance the payment against the delivery of the grains to traders. In both cases, luck and profits favored the Jews. Probably, these were the first futures contracts. In due course of time, these bankers learned to trade debt and performed financing along with underwriting. Soon this practice flourished, money grew, and more people entered the banking industry. As I had mentioned earlier, it was during these times that the word bank and bankrupt originated.

The growth in trade also necessitated a way to measure the time value of money and the practice of discounting was started to cater to this need. This also helped intelligent bankers to override the usury rule.

But the happiness of Jews did not last for long. Wars disrupted the success that Jews were enjoying, and they were again displaced. These Jewish families moved to Poland and Germany and became the people who defined the banking industry.

During the later stages, even goldsmiths began to lend out money on behalf of the depositor.

But the Church caught up. The rise of Protestantism freed many Christians from the boundaries of usury. The increase in trade from the late 16th century pulled many more merchant families into the gold mine of banking. Some survived, some flourished and some lost. In trading countries like the United Kingdom, Germany, and the Netherlands, the number of banks virtually doubled in the second half of the 18th century. Even in the 19th century, as a new superpower was rising in the form of the US, the increased requirement for investment created a new set of banks – the investment banks.

The demands of trade made banks become structured corporations. As nations began to trade further, the national banks crossed boundaries and became multinational banks. The demands of modern-day trade also led to the creation of several practices and technologies that are being used by banks these days. Mainstream technologies such as SWIFT happened because corporations wanted to send money across continents in the fastest way possible. Practices such as overdraft happened when the famous merchant William Hog, who was a customer of Royal Bank of Scotland, was having problems in balancing his books and was able to come to an agreement with the newly established bank that allowed him to withdraw money from his empty account to pay his debts before he received his payments.

The growth of trade created a huge demand for capital. Nor the kings nor the government had this kind of money. Only the banks which were the original platforms could cater to this demand. Thus, the growth of trade helped in the growth of banks and this formed a virtuous circle. To this day, this remains the gospel truth.

The world of empires

The political history of the world is intricately linked with the rise and fall of several great empires. At its core, an empire is the domination of one state by another. To achieve this domination, empires needed money – to wage wars, to feed the soldiers and to build weapons. Additionally, empires needed access to credit to pay for foreign goods and services.

Just as banks financed the traders, banks also financed emperors. Loyalty does not buy mercenaries.

The world’s first empire, the Akkadian Empire, which existed around 2,000 BC, understood the power banking provided. This empire created systems that provided them with the capital in times of need.

The next great empire was the Roman Empire. From around 27 BC to 476 AD., the Roman Empire established the roots of the modern banking industry. Even Rome had temples which acted as quasi banks. Priests were the quasi bankers.

As the Roman Empire grew the Mediterranean, the need for more credit came up. The money stored in the temples could not cater to these needs. This led to the establishment of modern-day banking as money changers, who sensed an opportunity in these times, set up benches outside government buildings and started to handle banking activities. This also led to the establishment of three kinds of bankers in Rome – the argentarii, who were private individuals who lent money and handled foreign transactions; the mensarii who were the de-facto representatives of the government and ensured social equality through their banking; and the nummularii, who tested the quality and genuineness of minted coins – new and old.

Banking was also growing in empires that were far from Rome. In India, the Mauryan dynasty (321 BC – 185 BC) played a critical role in the development of banking in India. In China, the Qin dynasty (221 BC – 206 BC), helped introduce standardized coins to facilitate easier trade across China.

The fall of the Roman empire led to a decay in the growth of the banking, but the practices established by the Roman empire lived on because the mindset of humans never changed – the need for more was always there. Kings, like any normal human being, wanted to expand their kingdoms.

In fact, in 1157 AD, the real reason the first state-guaranteed bank was established was to cover the costs for the expansion of the empire under Doge Vitale II Michiel, who was a key military leader in Italy at that time.

After the first bank, Medici Bank was established in 1397, the 15th century saw the rise of new empires. This period saw the establishment of many banks in Spain, Germany, Holland, etc. The common thread amongst all these banks was that they funded the expansion of empires as well as the voyages undertaken by the ambitious seafarers of this time.

But it is interesting to note that in England, at the home of the empire where the sun never set, there were not any banking houses operating in a manner recognized as so today until the 17th century.

The last great period of the empires was from the 17th century to the mid-20th century. During this time, the rise of empires helped spread the banking practices followed in these nations across the world. While the conquered nations had their own banking practices, the current banking practices that are followed across most nations reflect the empires of the era from the 17th to 20th centuries. The empires also helped in setting up the infrastructure and processes for the modern-day banks in these conquered nations. And this was the greatest impact empires had in the world of banking.

While banks provided money for countries to expand, the countries, through their conquest of new nations (or shall we call them organized loot) and forced trade agreements, provided banks with the largesse of gold and other precious artifacts for storage.

While these precious items were the wealth of the nations from which they were taken, there was a need for a safe place to store them and banks acted as the default safe-houses. An abundance of wealth helped the banks further expand their services, but it is debatable whether they benefited the citizens of the conquered nations who led lives filled with poverty, hunger, and diseases.

In the next part, we will look at the factors which made the growth of banking from a national industry to an international industry – the wars and the emergence of printing paper money.