Elements of Banking. Made Simple

442 Pages·1987·24.429 MB·English

by  Julia Hoyle and Geoffrey Whitehead (Auth.)

Elements of Banking
Made Simple
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Elements of Banking
Made Simple
Julia Hoyle, ACIB
and
Geoffrey Whitehead, BSc (Econ)
HEINEMANN : London
Made Simple Books
An imprint of Heinemnann Professional Publishing Ltd
22 Bedford Square, London WC1B 3HH
LONDON MELBOURNE JOHANNESBURG AUCKLAND
First published 1987
© Julia Hoyle and Geoffrey Whitehead 1987
This book is sold subject to the
condition that it shall not, by
way of trade, or otherwise, be lent,
re-sold, hired out, or otherwise
circulated without the publisher's
prior consent in any form of binding
or cover other than that in which it is
published and without a similar condition
including this condition being imposed
on the subsequent purchaser.
British Library Cataloguing in Publication Data
Hoyle, Julia
Elements of banking made simple. -
(Made Simple Books)
1. Banks and banking
I. Title II. Whitehead, Geoffrey
III Series
332.1 HG1601
ISBN 0-434-98611-9
Made and printed in Great Britain
by Richard Clay Ltd, Bungay, Suffolk
Foreword
This book provides a sound background in all the elementary principles of
banking. The whole range of banking services is covered - savings, lending,
investment and more sophisticated functions - and there is a historical
section recounting the development of banking from its earliest days to the
present.
While the book is specifically designed to meet the requirements of the
Institute of Bankers' Banking Certificate and Foundation Courses, and
the BTEC National Certificate in Business and Finance, the authors hope
it will meet the introductory needs of students in the wider fields of
accountancy, business administration, management, and so on.
At the end of the main text there is a large section of rapid revision
exercises, in question and answer form. The student covers the page with a
sheet of blank paper and lowers it sufficiently to reveal the first question.
After attempting to answer it the paper is lowered to reveal the author's
idea of a good answer, and the second question. We hope students will
find this format helpful for revision purposes.
In writing this book we have inevitably come up against the problem of
sexism; the English language not having been modified to overcome the
use of words like 'him' and 4her\ There is no discrimination in banking,
and we follow the legal rule that where a male word is used it also means
the female word and vice versa (Interpretation Act 1978). We hope readers
who are sensitive on this point will accept our apologies, but the endless
use of 'him' or 'her' becomes tiresome in a book of this sort.
In writing this book we have received much help from various individuals
and institutions who have supplied data, and permitted the use of illustra-
tions. These are acknowledged elsewhere in the book, but we must em-
phasize to the reader that the courtesy of these institutions in no way
suggests that the text is sponsored by them. We must take full responsibility
for all the statements made, and trust that we have done so without giving
any offence.
Julia Hoyle
Geoffrey Whitehead
Acknowledgements
We gratefully acknowledge the help of the following:
George Vyner Ltd, Huddersfield: for permission to reproduce extracts from
Simplex accounts books.
Lloyds Bank PLC: for permission to reproduce a specimen cheque, a bank
giro credit form, extracts from Access agreements and a personal loan
application form.
The Bank of England: for permission to reproduce a bank return.
The Office of Fair Trading: for permission to reproduce wording to be
used on credit documents.
Formecon Services Ltd: for permission to reproduce a documentary col-
lection form.
Barclays Bank Countertrade Unit: for permission to reproduce two dia-
grams.
The Institute of Bankers: for permission to reproduce their educational
structure diagram.
Bank of Scotland: for permission to describe their Home and Office
Banking Service.
Baring Brothers: for material used in Chapter 9.
1
The origin and
development of banking
1.1 The origin of banking
Banking is a specialist activity developed over the course of the last 500
years or so to handle the financial aspects of production, distribution and
exchange inseparable from any developed economy. When Adam delved
and Eve span there was no need for a banker. Primitive production shows
the dawning of specialization, for even in the most primitive economy the
best hunter hunts, the best angler fishes and the best potter makes the
pots; there is no money system, no need of money capital, and no banker.
Specialization, which Adam Smith recognized as being the chief source
of the 'wealth of nations', gradually extended over the millenia, and part
of it was the development of a money system as a means of facilitating
exchanges between producers. Many things have been used as money to
facilitate trade in the course of human history, usually items of intrinsic
value such as wheat (the Greek drachma means handful - of wheat) and
hides. The Myceanaean talent was shaped like an oxhide, and an early
Greek coin shows ears of wheat to link the new coinage with the traditional
value. It was not only trade that was facilitated in this way. 'Bride-price'
and 'blood-price' (revenge for a killing) were early concepts which were
eventually settled by a financial transaction, and are still so settled in many
societies today.
Financial expertise developed as the money system developed, par-
ticularly at the level concerned with public expenditure and the admini-
stration of national and imperial affairs. The Latin word fiscus, which was
the Roman Emperor's privy purse, gives us the term 'fiscal policy' meaning
'taxation policy' - the provision of funds for public affairs. The earliest
financial managers were the great imperial paymasters of ancient Persia,
Greece and Rome. With the decline of the Roman Empire financial ex-
pertise suffered a set-back. Trade and wealth slowly recovered and the
term 'merchant prince', used to refer to the powerful and wealthy mer-
chants of the Middle Ages, clearly shows the link between trade, the wealth
that followed from it and earthly power. The three chief centres were
Venice, Lombardy and the Hansa towns of North Germany and the Low
Countries, and it was in these areas that banking first reached significant
stature. The centre of banking in London is still in Lombard Street, though
the Lombards themselves were long ago bankrupted by lending money to
English kings who failed to honour their debts. For some time the Hansa
2 Elements of Banking Made Simple
merchants had the English crown jewels in Germany as security for royal
debts, while the word 'sterling' is a corruption of 'easterling', the medieval
name for the Germans from the Hansa towns of the Baltic Sea, whose
currency was the most reliable during the latter half of the medieval period.
The pound easterling and the thaler (a silver coin made from silver mined
at Joachim's Thai, a valley in Bohemia) gave their names to the two most
important currencies of this century, the pound sterling and the dollar.
The Hansa merchants were finally driven from England in the year 1602,
by which time native wealth and native wit were ready to assume a financial
role and develop the financial expertise which eventually became the City
of London and the English banking system.
1.2 Safe deposits and royal power
After the departure of the Hansa merchants the City of London began to
develop its own financial system. Cash deposits took the form of coins and
bullion, both vulnerable methods of holding wealth, and for safe-keeping
the London merchants deposited their surplus funds at the Royal Mint. As
troubles developed between the Crown and Parliament in the years leading
up to the Civil War, Parliament refused to use its power to vote royal
funds for state purposes; whereupon in 1640 Charles I seized £200 000 of
the merchants' money. Unable to use the Mint for safe-keeping after that,
the merchants turned to the goldsmiths, whose premises were securely
guarded, for safe custody of their funds. The goldsmiths issued receipts for
the sums deposited, and began to develop what were essentially banking
services as a sideline to their ordinary activities as gold and silver smiths.
The funds deposited were called 'running cashes'. The current account had
been discovered.
1.3 Goldsmiths and the banking system
The seizure of funds by Charles I took place in 1640. The industrial rev-
olution is usually said to have begun about 1760, by which time a fully
developed industrial system could be recognized in the United Kingdom.
Such a system - a capitalist system - could not spring into existence
overnight. It was a more gradual process, where workshops grew into
factories, where international trade provided increasing wealth to finance
the new industrial projects and where an agricultural revolution (usually
dated as 1700-60) set labour free from the land. This revolution consisted
partly of better working methods, agricultural machinery, etc., but also
included the enclosure of ancient common lands which removed from the
peasantry their chance of supplementing agricultural wages by home pro-
duce from animals, geese, etc. reared on the common land. One Dorset
commentator surmised 'the cuckoo will soon be arrested for a trespass in
some fellow's tree.'
The financial side of this gradual process of developing a fully fledged
capitalist system was played by the goldsmiths. Noticing that their receipts
were beginning to pass from one person to another, they began to issue
The origin and development of banking 3
them in denominations of a convenient size payable to bearer. Thus a
deposit of £50 might be acknowledged by the issue of five £10 receipts, and
delivery of any one of these to a third party constituted a payment of £10
to that person. This was more convenient and much safer than drawing
coin and paying in coin, which then had to be redeposited by the new
owner. The bank note had been discovered!
Noticing also that the working balances in any deposit were small
compared with the total deposit, the goldsmiths began to lend out surplus
funds at interest. This was a lucrative business, but brought possible
dangers. By making loans to customers the goldsmiths enabled them to
spend money for all sorts of business purposes. This money returned as
deposits from those who had supplied goods and services. The goldsmiths
had 'created credit' (a subject dealt with later in this book) and had opened
up the chances of a 'run on the bank'. To reduce the risks of a run on the
bank it became necessary to pay depositors interest on their deposits to
encourage them to leave funds with the bank. Thus the deposit account
was invented.
The Royal Mint could not keep pace with the increasing circulation of
money and the general rise in business activity. Coinage, particularly the
smaller denominations, became scarce. Gentlemen wasted much time
'riding round the country in search of shillings'. These problems were
solved to some extent by the use of tokens (coins issued by a particular
firm for local use in the area) and also by the development of 'company
stores' and payment in 'truck'. If workmen were paid in coinage they had
to spend it at once in the company stores so that the money could then be
used to pay another group of workers. If employees were paid in truck
(trade goods) they had to barter these as best they could for food etc. Pity
the poor seamstress - paid in fancy waistcoats.
One way to provide finance for short-term projects was the use of inland
bills of exchange. Bills of exchange are described later in this text; they are
orders in writing drawn by one person (the drawer) on another (the drawee)
requiring him to pay a sum of money - say £100 - at a definite future date.
The drawee accepts the obligation to pay the bill by writing 'accepted' on
the face of the bill and signing it. Even a bare signature will do. The
drawer can now discount the bill with a banker (in those days with a
goldsmith), who paid the drawer the value of the bill, that is £100 less the
discount (interest at the prevailing rate for the number of days before the
bill fell due and was honoured by the acceptor). Bills of exchange were
widely used in the early days of the capitalist system and trade bills are still
an important and popular method of raising short-term capital.
An offshoot of this popular use of bills of exchange by the landed
aristocracy, merchants and industrialists was the development of the
cheque. As a sight bill, drawn on a banker, payable on demand it became
a logical and safe way to pay a creditor any amount, as distinct from
counting out 'notes' to the value required. By the end of the seventeenth
century the cheque was established as the simple way to settle debts.
The goldsmiths thus played an important part in the development of
banking, particularly in the half century from 1640 to 1694, but a wider base
was needed for banking, and a nation-wide growth was needed if the indus-
trial areas remote from London were not to be starved of capital. Two
4 Elements of Banking Made Simple
developments were to provide this wider basis - the foundation of the
Bank of England in 1694, and the growth of the 'country banking' system
at an accelerating pace throughout the eighteenth century.
1.4 The Bank of England
The Bank of England was granted a Royal Charter as a 'joint stock' bank
as a result of an Act of Parliament passed to 'confer certain privileges on
such persons as would contribute funds to a total of £1 500 000 ... to
finance the war against France'. In fact the sum raised was £1 200 000, and
the whole capital was used to back a note issue of that amount which was
made available to the government, and used to pay contractors for military
supplies. One of the privileges accorded the Bank was a monopoly of joint
stock banking in England, which in its case meant that the subscribers had
limited liability. It also had a monopoly of note issue in London.
The early years of the Bank's history were not easy. There was opposition
by the goldsmiths who resented the competition it presented; there was
political opposition to the Bank as a 'Dutch' idea brought over by William
of Orange; and the demands of the government seemed insatiable. Despite
these problems the Bank survived to become the source of a reliable note
issue widely used by other bankers to settle their mutual indebtedness, and
as it become the bankers' bank and collected deposits from them all it
finally became the only real depository of gold bullion in the whole country.
By the end of the eighteenth century it could be described by Sheridan as
'an elderly lady in the City, of great credit and long standing'. The Old
Lady of Threadneedle Street was the soundest, most reliable institution in
the City of London.
1.5 Country banking in the eighteenth century
The development of banking could not proceed fast enough and meet the
needs of the industrial areas without a country-wide network of banks.
The industrial revolution was based upon the agricultural revolution which
preceded it, and which provided the wealth to finance the new develop-
ments. The landed aristocracy banked in the fashionable West End; the
West End banks provided funds to the City of London, and the City
banks loaned them to the mine owners, ironmasters, mill owners and mer-
chants of the industrial areas. The situation is illustrated in Figure 1.1.
Banking became a sideline activity for many leading merchants and
manufacturers, particularly those who had large labour forces to pay.
Where such a person had an account in London with a reputable bank he
became the natural channel to which others could turn to transact business.
They began to act as correspondents for the London banks, to send re-
mittances and bills for collection. The original Lloyd was a Birmingham
ironmaster, Smith was a draper from Nottingham, and Jonathan Back-
house was a Quaker merchant of Darlington.
The country bankers opened accounts for neighbours and businesses in
the locality; made loans to local businessmen; issued notes which became a