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Interesting times

From grain stores and notched sticks to PINs and switch cards - banking has been a constant for three millennia. Wanda Opalinska brings the account up to date

If only King Hammurabi of Babylon could be around today to mediate between banks and customers. Back in about 1780bc, when Hammurabi recorded humanity's first written code of laws on a seven-foot tall slab of stone, he included many laws about money and money lending. Take, for example, law number 106 which states:"If the agent accept money from the merchant, but have a quarrel with the merchant (denying the receipt), then shall the merchant swear before God and witnesses that he has given this money to the agent, and the agent shall pay him three times the sum."

Swearing before God to the likes of the high street banks in an effort to prove one's case no longer cuts the mustard but banks such as Lloyds, Barclays, NatWest and HSBC can trace their industry back to the days of Hammurabi and beyond.

Prototype bankers can be found throughout the ancient world, from pharoah Rameses II (1290-1224bc), who established a national network of grain warehouses (grain being the currency of the period) to the money changers who were driven from the temple in Jerusalem by Jesus.

The royal houses of Mesopotamia (modern-day Iraq) in the second millennium bc stored their valuables in strong rooms for safekeeping. Later, some of the more enterprising families, such as Babylon's Egibi family started lending money to entrepreneurs with interest during the reign of king Kandalanu (c648-625bc), and Mesopotamia also gave us the first banking code, in the Code of Hammurabi.

Roman citizens used money shops to pay taxes and settle bills. In Athens, metic (foreign residents who had no political rights) bankers accepted coins for safe-keeping, and paid interest on deposits.

The first modern bankers were to Italian merchants of the 12th century - the word "bank" being derived from the Italian banco, or bench, that the merchants used to trade from in the marketplace. These benches were broken if the merchant was ruined, hence "bankrupt".

Perhaps the most remarkable thing about early banking is that it survived at all. Medieval Europe was dominated by Church and State, and trade was mostly conducted by barter. The Church in particular did much to put a brake on banking's development and was vociferous in its condemnation of usury as a sin. Lending someone money wasn't a sin but charging them interest for doing so certainly was - as it still is in Islamic banking.

The Crusades gave a fresh impetus to international trade in the 11th to mid-13th centuries. In return for providing financial and military support, Italian city states at the centre of trade routes from the Far and Middle East, such as Venice and Genoa, were given valuable trading privileges throughout the Mediterranean. Moreover, the crowned heads of Christian Europe needed money to finance their crusades and few could do it without borrowing. Intermediaries, such as the Knights Templar and Italian merchants, stepped in and transferred money to the Holy Land.

International banking really took off, however, with the medieval trade fairs of Champagne. Six trade fairs were held each year in different towns, providing an almost continual trading calendar. At first, these fairs were attended by merchants trading goods, but others were soon travelling there to offer financial services, allowing traders to defer payment for goods until the next fair. Bills of exchange were drawn up so that merchants didn't have to carry large amounts of coin around with them.

Such a way of representing payment owed wasn't new: the tally, a notched wooden stick, was in common use. However, these bills also provided a loophole in the usury laws. Anyone making a bill deferring payment had to include a forward rate of exchange, to allow for any fluctuations in price between the day of purchase and that of settlement - in practice this usually concealed an interest charge, transforming the bill into a loan.

Fairs set up clearing houses to process these bills and debts, and the Church itself used the same system. Italian merchants were soon recognised as financial specialists; the Lombards set up in London as bankers - the name commemorated in the City's Lombard Street.

By the 13th century, travel to the fairs in large numbers had stopped.

Banking firms and families emerged from this fertile commercial environment, with associates or families working together, contributing capital to the business. The head of the family would remain at home while younger sons were sent to open branches of the family business. Houses such as the Bardi family had more than 330 branches, including offices in London, North Africa and present-day Syria. Some banking families soon rose to positions of immense wealth and power.

Such families were not only able to lend money to other merchants, but also to the royal houses of Europe and even the papacy. Although such patronage could bring benefits and prestige, it could also prove to be something of a poisoned chalice. Chief among the bad debtors of medieval Europe were kings and queens, with repayment histories that would make a modern banker blanch. Wealthy banking families such as the Fuggers of Austria (who bankrolled the Habsburgs) were ruined when royalty defaulted. The Bardi family collapsed after King Edward III defaulted on loans made to finance the Hundred Years War in the 1330s and 1340s, and Lorenzo de Medici had to close his family's London office when King Edward IV refused to honour his debts. And it wasn't just the larger firms: by 1585, 96 of 103 private banks had closed or failed in Venice. It became clear that there was a need for a more institutionalised way of raising money, one that could survive defaulting monarchs and acts of God.

By the 16th century, commerce was growing rapidly, fuelled partly by the discovery of New World gold. The need for an expanded credit system was clear and the financial centre of Europe shifted away from the Italian city states to Amsterdam and London. The first bank as we know it, the Wisselbank, was founded in Amsterdam in 1609 and was modelled on earlier Italian state banks, or montes, which were guaranteed by the state, therefore boosting public confidence in them. The Wisselbank's status was also the official repository for coin and exchange, and any bill over 600 florins had to be paid via the bank, ensuring that all major financial houses had to open an account there. As the bank was backed by the state, it was seen as secure, convenient and, above all, stable.

The idea of a state bank took a little longer to take hold in England - and even then it was seen only as a temporary arrangement. Continual defaults by sovereigns had badly tarnished the reputation of official repositories such as the Royal Mint at the Tower of London, which was seized by Charles I during the Civil War (1642-46). Matters weren't helped when Charles II failed to pay his debts in the 1670s, ruining many of the larger goldsmiths who had lent him money. By now, with the government in almost permanent debt and fresh wars to fight with France, money was a major stumbling block. This deficit was partially managed by selling confiscated land and defaulting on debts already undertaken, but this did little to boost public confidence. Eventually, with Parliament's approval, the monarch had to approach the City of London - with its rich merchants and businessmen - for help.

The result was a central bank in England, in 1694. In return for lending the government pound;1.2m at 8 per cent (the entire loan was raised in 12 days), subscribers were allowed to form a corporation, the Governor and Company of the Bank of England. This had joint-stock status - that is, it was owned by its shareholders. But the Bank of England wasn't just established to service outstanding government loans (or the National Debt, as it became known): it also traded foreign exchange and bullion, issued payment to the government's creditors, opened accounts for private customers and issued banker's notes.

Scotland acquired its own national bank in 1695, with the formation of the Bank of Scotland in Edinburgh. Its shareholders were all naturalised Scots, but it differed from other banks in that government loans were forbidden and its primary focus was on the private customer.

Banking revolution England's growth in private banking came from two distinct traditions.

Goldsmiths had allowed people to leave precious items and money in their strong rooms for safekeeping and were paid interest to do so. These deposits formed the capital that was then lent, with interest, to borrowers. After the seizure of the Mint by Charles I in 1640, goldsmiths became an even more popular repository for surplus cash and developed the "running cash account" (depositors could ask for partial sums of their savings when they needed it). Goldsmiths then issued written notes, promising to pay back the amount left in the individual's account. These notes became a substitute for money and the forerunner of the present day banknote.

There was an alternative tradition, that of the scrivener, who from the 16th century supplied a range of legal services, such as mortgage broking and conveyancing. Like the goldsmiths, they also issued "promise to pay" notes.

As few people could read or write, goldsmiths, in common with other businesses of the time, used shop signs to identify themselves. Many of these signs were later adopted by the private banks when they moved premises and can still be seen in Lombard Street today: among them the black horse, later adopted by Lloyds Bank, and the spreadeagle, taken up by Barclays Bank.

For many goldsmiths and scriveners, banking became their primary activity.

The oldest London banks are their descendents: Hoare's Bank (founded in Cheapside, 1673) and Coutts (1692) started life as goldsmiths' concerns.

People living in the provinces were now dependent on London banks for most of their financial needs but by the mid 18th century, the growth of "country banks" heralded the arrival of local banking. Family banks such as the Quaker-run Gurneys of Norwich (founded in 1775, now part of Barclays Bank) were developed by brewers and tradesmen who knew a growth industry when they saw one. In 1765, Sampson Lloyd II, an ironmaster, and John Taylor, a button manufacturer, opened a banking firm in Birmingham that became Lloyds Bank. However, these country banks were still dependent on their London counterparts: many just received deposits and sent their bills to the London banks, who acted as their agents.

By the time of the Industrial Revolution in the late 18th and 19th centuries, other factors were starting to play a part in the banking revolution. The Napoleonic Wars saw a shift in currency use: the Bank of England's suspension of gold payments saw the rise of paper money. Bank notes had until then, promised to pay the holder the note's value in gold.

The introduction of paper money in quantities, supported by the loans made to government (or credit) rather than the Bank's Gold Reserve was seen as a threat to economic stability and was hotly contested at the time.

While many of these country banks were privately owned, at the same time there was an expansion in joint-stock banking (where a bank's shareholders bought shares, or stock in the company). As with the Bank of England, shareholders formed a company with set rules of operation. By the 19th century, these joint-stock banks dominated the market as existing restraints were removed (banks such as Midland - 1836 - arrived at this time). Many banks failed in the banking crises of 1815-16 and 1825. As a result, the Banking Companies Partnership Act of 1826 ended the Bank of England's exclusive status, clearing the way for joint-stock banks with any number of shareholders, and the right to print their own bank notes (as long as they were 65 miles outside London). Even this restriction was removed in 1833, although London-based joint-stock banks still weren't allowed to issue their own notes. The competition increased when the Bank of England was allowed to open its own provincial branches. Joint-stock banking even spread to the colonies, where companies such as Hong Kong Shanghai Banking Corporation (HSBC) acted as agents to imperial China.

Competition was stiff between the banks, and intensified with the inception of savings banks - in addition to the Post Office Savings banks, authorised by the government in 1861. The rise of the building society, in particular those founded by the temperance movement on the Victorian values of thrift and self-help, encouraged the working class to leave off drinking and save their money. They clearly did save: by 1904, there were 400 savings banks in England and Wales. However, attempts by the working classes to form their own banking co-operative were resisted. It wasn't until 1947 that the Government authorised the Cooperative Bank which had to trade from its foundation in 1872 as a loan and deposit department to circumvent legislation.

Such a crowded financial market was sure to have its casualties and sure enough some soon folded, often at a terrible cost to those banking with them. Provincial banks started to merge with their London counterparts, forming some familiar names - Lloyds (1885) and Barclays (formed by the merger of 20 private banks in 1896).

At the same time, the great privately-owned, international merchant houses such as Rothschilds and Barings, which traded in national debt and financed the expansion of railways, established themselves often with familiar results - Barings almost went under in 1890, creating a national scandal.

It finally collapsed in 1995 with losses of more than pound;800m caused by "rogue trader" Nick Leeson.

Banks began to assume international power and influence. During the First World War, they financed the war effort and kept currency payments going.

Most Allied countries were forced to give up the Gold Standard - the use of gold as the standard value for the money of a country - during this period, one which also saw a shift in international power, as the US became the world's banker. The Wall Street Crash of 1929 caused uproar in the financial markets, and Britain was finally forced off the Gold Standard in 1931 (it had returned to it after the war in 1925).

Remarkably, the Bank of England remained a private company until its nationalisation in 1946. Along with the Treasury, it has continued to play its part in the stabilising of the national economy.

However, the Bank of England's position as financial regulator has not been unquestioned. The Bank currently faces a lawsuit brought by creditors of the Bank of Credit and Commerce International, which crashed in 1991 owing pound;7 billion, alleging that the central bank was negligent in its handling of the crisis and challenging the Bank's immunity (guaranteed in law) against being sued.

So what lies ahead for banking? Many predict a further reduction in bank branches as innovations such as telephone and internet banking - already apparent in the existence of branchless banks such as First Direct and Cahoot - gather pace. Whether the expected boom in online finance leaves the present high street banking landscape unscathed remains to be seen.

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