history of banking research paper

The evolution of banking in the 21st century

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Evidence and regulatory implications, samuel g. hanson , samuel g. hanson marvin bower associate professor - harvard business school victoria ivashina , victoria ivashina professor of business administration - harvard business school laura nicolae , laura nicolae ph.d. candidate - harvard university @lauramnicolae jeremy c. stein , jeremy c. stein moise y. safra professor of economics - harvard university adi sunderam , and adi sunderam professor - harvard university daniel k. tarullo daniel k. tarullo nonresident senior fellow - economic studies , the hutchins center on fiscal and monetary policy.

March 27, 2024

The paper summarized here is part of the spring 2024 edition of the Brookings Papers on Economic Activity , the leading conference series and journal in economics for timely, cutting-edge research about real-world policy issues. Research findings are presented in a clear and accessible style to maximize their impact on economic understanding and policymaking. The editors are Brookings Nonresident Senior Fellows  Janice Eberly  and  Jón Steinsson .

See the spring 2024 BPEA event page to watch paper presentations and read summaries of all the papers from this edition.  Submit a proposal to present at a future BPEA conference  here .

Uninsured deposits should be subjected to tougher regulatory requirements to guard against the type of rapid runs that toppled three large regional banks last spring, suggests a paper discussed at the Brookings Papers on Economic Activity (BPEA) conference on March 29.

In the wake of the failures of Silicon Valley Bank, Signature Bank, and First Republic Bank (three of the four largest bank failures in U.S. history), the authors look at two trends over the past quarter century—the substantial growth of uninsured deposits and the migration of business lending to non-banks. The trends challenged the failed banks and banks like them, and in some cases left them vulnerable to runs. And, using a simple model they constructed, the authors assess regulatory options for reducing the risk of destabilizing runs.

“One of the most striking developments that we document … is a dramatic growth in the economy-wide ratio of bank deposits to GDP [gross domestic product], with much of this growth coming from large uninsured deposits,” write Samuel G. Hanson, Victoria Ivashina, Laura Nicolae, Jeremy C. Stein, Adi Sunderam, and Daniel K. Tarullo, all from Harvard University.

According to their paper—”The Evolution of Banking in the 21 st Century: Evidence and Regulatory Implications ” —total deposits in the fourth quarter of 1995 were 49% of GDP, with 20% of those deposits uninsured. By the third quarter of 2023, total deposits were 75% of GDP, 39% of them uninsured. Adding to that vulnerability, technology and social media have made it increasingly easier for large depositors to quickly withdraw their money.

Meanwhile, banks with the most rapid growth in deposits have seen the biggest declines in business lending, which has migrated toward non-bank entities such as securitization vehicles, mutual funds, insurance companies, and, in recent years, private-credit funds and business development companies. (Smaller community banks tend to specialize in lending to smaller firms and have been less affected by the growth of non-bank institutions.)

Instead of lending to large- and medium-size businesses, regional banks have shifted toward investing in longer-term Treasury securities and government-guaranteed mortgage backed securities. Those securities have little or no credit risk (the risk of default) but they are subject to interest-rate risk. When interest rates rise sharply, as they did in 2022 when the Federal Reserve raised rates to fight inflation, existing long-term securities lose value because investors can earn more from newly issued securities.

To reduce the risk of runs, the authors looked at expanding federal deposit insurance to cover all or most deposits. But that expansion of the government’s footprint would increase taxpayer exposure and could weaken banks’ incentives to guard against risk. Also, in the case of banks that have shifted away from lending, it would in effect subsidize bond holding rather than lending.

Instead, the authors favor strengthening liquidity regulations, which aim to ensure banks have funds available to meet deposit withdrawals. The authors would require banks with more than $100 billion in assets to back their uninsured deposits by pre-positioning collateral, largely in the form of short-term government securities, at the Federal Reserve. That requirement would enable them to withstand a run by borrowing from the Fed’s discount window and would encourage them to shift their asset-mix away from longer-term securities and toward short-term securities, which are much less subject to interest-rate risk.

The authors also recommend that regulators re-think rules that, except for the eight largest U.S. banks, shield regulatory capital from reflecting most market losses on the securities banks hold.

And, the authors recommend that regulators “look more positively on proposed mergers of mid-size regionals and on acquisitions of smaller banks by mid-sized regionals.” That could either help regionals to better compete with the largest banks or could aid in wringing out excess capacity to the extent that the business model of the regionals continues to be under pressure.

Hanson, Samuel, Victoria Ivashina, Laura Nicolae, Jeremy Stein, Adi Sunderam, and Daniel Tarullo. 2024. “The evolution of banking in the 21st century: Evidence and regulatory implications.” BPEA Conference Draft, Spring.

David Skidmore authored the summary language for this paper. Chris Miller assisted with data visualization.

Stein and Tarullo are former members of the Federal Reserve Board of Governors. Sunderam was a visiting scholar at the Federal Reserve Bank of Boston from January-June 2023, and Ivashina has been a visiting scholar there since 2015. The authors did not receive financial support from any firm or person for this article or, other than the aforementioned, from any firm or person with a financial or political interest in this article. The authors are not currently an officer, director, or board member of any organization with a financial or political interest in this article.

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Brookings Papers on Economic Activity Election ’24: Issues at Stake

Elaine Kamarck, Jordan Muchnick

May 24, 2024

Aaron Klein

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March 18, 2024

• Open access
• Published: 14 December 2021

Research evolution in banking performance: a bibliometric analysis

• S. M. Shamsul Alam 1 ,
• Mohammad Abdul Matin Chowdhury   ORCID: orcid.org/0000-0001-6860-2305 1 &
• Dzuljastri Bin Abdul Razak 1  

Future Business Journal volume  7 , Article number:  66 ( 2021 ) Cite this article

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Banking performance has been regarded as a crucial factor of economic growth. Banks collect deposits from surplus and provide loans to the investors that contribute to the total economic growth. Recent development in the banking industry is channelling the funds and participating in economic activities directly. Hence, academic researchers are gradually showing their concern on banking performance and its effect on economic growth. Therefore, this study aims to explore the academic researchers on this particular academic research article. By extracting data from the web of Science online database, this study employed the bibliometrix package (biblioshiny) in the ‘R’ and VOSviewer tool to conduct performance and science mapping analyses. A total of 1308 research documents were analysed, and 36 documents were critically reviewed. The findings exhibited a recent growth in academic publications. Three major themes are mainly identified, efficiency measurement, corporate governance effect and impact on economic growth. Besides, the content analysis represents the most common analysis techniques used in the past studies, namely DEA and GMM. The findings of this study will be beneficial to both bank managers and owners to gauge a better understanding of banking performance. Meanwhile, academic researchers and students may find the findings and suggestions to study in the banking area.

Introduction

The financial services formed a significant contributory trademark in the overall economic growth by stimulating employment, offering vast avenues for investment and services to the consumers and the society [ 1 ]. Thus, economic development is led by economic growth whereby required capital is provided by the financial services [ 2 ]. Suggestively, capital creation by the financial services industry through accumulation and mobilisation of resources is considered the most crucial economic growth strategy component [ 3 ]. The banking system associates with creating funds by accumulating funds from surplus and channelling them to the investors as credit; those exhibit excellent ideas to generate a surplus in the economy but lack the capital to implement such ideas [ 4 , 5 ]. Accordingly, the banking system plays a vital role to pledge the leading role of finance in economic development and promoting stable and healthy financial and economic development [ 6 ].

Banking performance has been regarded as a crucial factor of economic growth [ 7 ]. Efficiency and productivity change measures are rapidly used to evaluate banking performance. Academic researchers have been focusing on the efficiency and productivity of banking institutions for a long period, while economic growth is carried out in the discussions. Discovering research activities on banking efficiency and productivity in economic growth enables researchers to identify the local and international input to this particular discipline. More so, it will enable researchers to identify the ‘hot spots’ discussed by academic researchers and find the research gaps [ 8 ]. Indeed, banking performance in standings is a broad scientific topic, and estimating research activities might not be useful. For instance, research activities in this area extended to several constituents such as methodological approaches, banking approaches. In the current study, banking efficiency and productivity are considered as banking performance that contributes to the economic growth of an economy. Therefore, the main objective of this study is to explore the research activities of banking performance to economic growth. The investigation of banking performance research activities will enable the researchers to find the present directions of the research area and thus speculates the future research suggestions. Besides, it will also enable to expound the depth of past research activities and themes on banking performance relating to the economic growth measurements.

The use of the bibliometric method is appropriate to demonstrate the research shape and activity, volume and growth in a specific discipline [ 9 ]. A bibliometric method is a quantitative application of bibliometric data [ 10 ]. It analyses a wide-ranging quantity of published research articles employing the statistical tool to identify trends and citations or/and co-citations of a certain theme by year, author, country, journal, theory, method, and research constituent [ 11 ]. Significantly, this technique further distinguishes key research themes and active researchers, countries and institutions for future research planning and funding [ 12 ]. Scholars apply this method for several reasons: to reveal emerging trends in published research articles and journal performance, cooperation patterns, and research elements, and to reconnoitre the intellectual edifice of an exact domain in the existing literature [ 9 , 13 ].

Minimal studies have used bibliometric analysis related to banks. For instance, Violeta and Gordana have employed bibliometric analysis to spot the trends of DEA application in banking [ 14 ]. Another study conducted by Ikra et al. applied the bibliometric method to Islamic banking efficiency [ 15 ]. By an extensive search on the Scopus, Web of Science and Google Scholar, no such study was found related to bibliometric analysis on banking performance to the economic growth. Nevertheless, this study will be the first attempt to conduct bibliometric methods on the banking performance to the economic growth that could be the basis for future studies.

The findings of this study unfolded several contributions to both policymakers, bank managers and academic researchers. Firstly, the findings would benefit the policymakers regarding the contribution and trends of banking performance. It would allow them to take necessary initiatives to promote and improve banking performance, thus economic development. Meanwhile, bank managers may utilise the findings to strengthen their banking operations by acknowledging key factors that contributed to the performance. Finally, academic researchers are enabled to detect the current trend and topics related to the banking area that leads to further studies.

Bibliometric analysis has achieved enormous popularity in social sciences research in the current years [ 9 , 16 , 17 , 18 ]. The popularity of bibliometric analysis is observed from the development, accessibility and availability of software, for instance, Leximancer, Gephi, VOSviewer, Biblioshiny and publication databases (Web of Science and Scopus). Further, the rapid growth of bibliometric analysis in scientific production has emerged from business research to information science [ 9 ]. The popularity of bibliometric methodology in social science research is not a trend but moderately an image of its usefulness for constructing high research impact by handling excessive scientific data [ 9 ].

The bibliometric analysis is beneficial for briefing the trends in the research documents classifying ‘blind spots’ and ‘hot spots’, and finding a more inclusive understanding of the published research documents [ 19 ]. In detail, this analysis empowers the recognition of the most advanced (hot spots) and the less established topics (blind spots) within the documents that, shared with other bibliometric procedures, recommend future research avenues. The bibliometric analysis uncovers several ascriptions, such as unveiling emerging trends in documents and the performance of journals, research constituents and collaboration patterns and discovering the intellectual edifice of an exact domain in the existing literature [ 13 , 18 ]. The data that apply in this analysis incline to be immense (hundreds, thousands) and unbiased in nature (publications and citations number, keywords occurrences and topics). However, its explanations often depend on both subjective (thematic analysis) and objective (performance analysis) assessments formed through well-versed techniques and procedures [ 9 ]. Therefore, this study applied bibliometric analysis to examine the general perspective on banking performance and economic growth.

Two categories are mainly manifest in the bibliometric techniques, namely, performance and science mapping. Precisely, research elements’ contributions are accounted for in the performance analysis, while the connections between research elements are focused on science mapping [ 9 ]. This study follows performance analysis, science mapping and network analysis suggested by Donthu et al. [ 9 ].

Data extraction process

Two primary databases, the Web of Science and the Scopus, are commonly used in the bibliometric analysis [ 20 ]. Both databases are prominent for the peer-reviewed published research articles. The data for this analysis were a collection of bibliographic data from the Web of Science. The Web of Science (WoS) is a multidisciplinary online database providing access to several citation databases, namely Science Citation Index Expanded (SCIE), Social Sciences Citation Index (SSCI), Emerging Sources Citation Index (ESCI), Arts and Humanities Citation Index (AHCI), Conference Proceedings Citation Index, Index Chemicus and Current Chemical Reactions [ 18 , 21 ].

This study has applied a two-stage data extraction process, following Bretas and Alon, Alon et al. and Apriliyanti and Alon [ 16 , 22 , 23 ] as shown in Fig.  1 . The choice of the keywords is crucial to ensure that it covers the total body of published documents on banking performance and economic growth [ 21 ]. Accordingly, the selection of keywords was carried out by reviewing several abstracts and authors’ keywords in most related literature on the Web of Science. The selected keywords were executed in the WoS online database on 9 August 2021. A combination of keyword search terms was considered; (1) ‘banking performance*’ to nail all discrepancies of the term such as the role of the bank, bank efficiency, bank productivity, banking efficiency, banking productivity, banking performance, bank performance, upon refining the search by including only research articles from the categories; economics, business finance, business, management, operations research management, social sciences mathematical measures and documents written in English.

The second stage extracted raw data from the online database combined, checked for duplicate documents and merged using ‘R’. Further, the documents were filtered in the ‘biblioshiny’ tool to omit book chapters and conference proceedings. After the extraction process for the bibliometric analysis, several impactful documents were selected based on local and global citations to conduct content analysis. The content analysis allowed the researcher to identify the leading research scopes and trends. Further, it allows identifying the streams and recommendations for future studies [ 22 ]. A total of 36 documents were selected to conduct a comprehensive review and valuation of the documents.

Performance analysis

Performance analysis investigates the contributions of academic research elements to a particular discipline [ 24 ]. This analysis is naturally descriptive, which is the hallmark of bibliometric analysis [ 9 ]. It is a standard method in reviews to exhibit the performance of various research elements such as authors, countries, institutions and sources similar to the profile or background of respondents generally presented in empirical studies, albeit more statistically [ 9 , 18 ]. Many measures exist in the performance analysis; hence, the most protuberant measurements are publications number and citations per research constituent or year. The publication is considered productivity, whereby citation measures influence an impact [ 9 ]. Besides, citation per document and h -index associate both publications and citations with evaluating research performance [ 18 ].

Table 1 presents the publication’s performance of banking performance. The results show a total number of 1308 documents published from 1972 to the present. Among 2275 contributed authors, a total of 202 authors were solely, and 2106 authors collaborated to the publications. A total of 31,458 citations received by published documents lead to an average of 629.16 citations per year, while 775 in h -index and 1023 in g -index. Hence, the banking efficiency field acknowledged productivity of research published by an average of 26.16 documents per year whereby nearly two authors (CI = 1.9) published one article, and standardised collaboration is 0.43 (between 0 and 1).

The annual production of scientific publications on banking efficiency is presented in Fig.  2 . The first research article related to banking performance was published by Fraser and Rose [ 25 ], who studied the effect of new bank appearance in the market on bank performance. The annual growth of publications on banking performance or banking efficiency is recorded to 12.39%. The publications are significantly increasing in recent periods, especially from 2016 to the present. However, the mandated growth in publications is observed between 2004 and 2015, while earlier periods (1972–2003) were quite sluggish. In these consequences, academic researchers have started to focus on banking performance or banking efficiency in the recent period. As a result, it can be concluded that banking performance and its sphere are shaping upwards through the research contributions.

Annual Scientific production

Science mapping

Science mapping investigates the connections between research elements [ 26 ] that relates to the intellectual connections and structural networks within research constituents [ 9 ]. The science mapping includes citation analysis, bibliographic coupling, co-citation analysis, co-occurrence network, collaboration techniques. When combined with network analysis, these techniques are instrumental in exhibiting the research area’s bibliometric edifice and intellectual structure [ 27 ].

Citation analysis

The citation analysis is a fundamental approach for science mapping that runs on the assumption that citations reproduce intellectual contributions and impact the research horizons [ 28 ]. This analysis shows the impact of published documents by measuring the number of citations they received [ 9 ]. Accordingly, it enables the discovery of the most influential and informative documents in a research constituent. Thus, it allows gathering insights into that constituent’s intellectual dynamics [ 9 ]. Table 2 presents the top 20 impactful and influential documents in the field of banking performance or efficiency. The analysis has discovered that a total of 1112 documents (85%) out of 1308 documents received global citations. The global citations refer to the number of citations received in the overall Web of Science citations. However, 196 documents (about 15%) have not received any citation; meanwhile, 130 documents (about 10%) received only one citation. A document written by Berger An received the highest number (665) of citations which was published in 1997. The second most influential document was written by Seiford [51] received a total of 549 citations, followed by the document written by Back (2013) received 512 citations. In fact, a total of four documents written by Berger An rank in the top 20 impactful research articles in the field of banking performance or efficiency.

Factually, the majority of the documents without citations was published in a recent period. At the same time, the highly cited documents were published quite earlier. To detect the immediate influence of more recent documents is to apply the measurement of an average citation per year [ 29 ]. By evaluating the average citations per year, nine out of ten documents are also among the top 10 documents. Perpetually, Beck [45] holds the highest number of average citations per year (56.89), followed by Berger An (2013) ranked second position (51.44) and Beltratti A (2012) ranked the following position (48.40). Based on the citation analysis, it can be elucidated that Berger An is the most influential author in the banking efficiency research constituent.

Co-occurrence analysis

Co-occurrence analysis was projected by Callon et al. [ 30 ], considered as content analysis that is useful in plotting the strength of connotation within keywords in textual data. In other words, co-occurrence analysis is an approach that investigates the actual content of the document itself [ 9 ]. It maps the pertinent literature straight from the associations of keywords shared by research articles [ 24 , 27 , 31 , 32 ]. The co-occurrence analysis deduces words to appear recurrently in a cluster. It exhibits conceptual or semantic groups of various topics or sub-topics considered by research constituents [ 9 , 24 ]. Cobo and Herrera signified that spotted clusters could be applied with few objectives [ 24 ]. For instance, they can be applied to analyse their progression by gauging extension across successive subperiods and measuring the research area through performance analysis. Figure  3 displays the co-occurrence of keywords within the bank efficiency research constituent. As the focus of this research, bank performance represents the larger node associated with corporate governance, financial performance, financial crisis, nonperforming loans and others. In these scenarios, the red-coloured cluster depicts that these subtopics or variables are directly associated related to the bank performance theme due to repetitive co-occurrence of those words. Likewise, the green-coloured cluster represents a theme related to bank efficiency associated with performance and ownership. In the same cluster, the nonparametric data envelopment analysis is extensively used to measure commercial banks' technical and cost efficiency and productivity. Parametric stochastic frontier analysis is narrowly observed in efficiency measurements comparably. The green-coloured cluster depicts the determinants of bank profitability including other impactful variables such as risk, competition, corporate governance. This cluster applied panel data in order to examine performance, financial development as well as economic growth. Each of the cluster identifies the interacted themes used in the published documents using co-occurrence of keywords.

Co-occurrence of keywords, Tool: VOSviewer. Note the nodes represent the keywords, and the edges between words present their occurrence of interactions. Each colour of nodes represents a cluster/theme. The size of the node presents a greater frequency of occurrence

Collaboration networks

Collaboration analysis explores the associations within researchers in a particular constituent. It is a formal way of intellectual association among researchers [ 33 , 34 ]. Therefore, it is crucial to understand how researchers associate among themselves [ 9 ]. In the presence of growing theoretical and methodological complexity in research, intellectual networking (collaboration) has become commonplace [ 33 ]. Indeed, collaboration or interaction among researchers enables improvements in academic research; for instance, greater interactions among diverse researchers allow richer insights and greater clarity [ 35 ]. Researchers who collaborate form a network named ‘invisible collages’ whose research can help improve undertakings in the study field [ 36 ]. Figure  4 presents the collaboration network of authors those co-authored academic articles in banking efficiency. Based on the collaboration network, Wanke P (Universidade Federal do Rio de Janeiro) was the most collaborated author who co-authored with four authors from different institutions in different countries. At the same time, Matousek, R (University Kent), Hasan, I (Rensselaer Polytechnic Institute) and Mamatzakis, E (University of Sussex), have also exhibited as greater collaborative researchers. In these consequences, authors from different institutions and from different parts of the world are collaborating to the banking performance/efficiency field.

Source : VOSviewer. Note the nodes represent the authors, and the size represents the frequency of contribution, the colour presents a cluster or a particular group, and the link shows the link among authors that collaborated for research articles

Authors’ collaboration networks.

Bibliographic coupling

Co-authorship or collaborative networks within the authors and other crucial facets in the collaboration networks are the collaboration of author-affiliated countries and institutions [ 31 ]. Figure  5 exhibits the collaboration network within authors’ affiliated organisations. University Malaya and University Utara Malaysia, University Malaya and University Putra Malaysia, University Malaya and University Fed Rio de Janeiro all depict a strong collaboration network. In general, all the institutions display an embellishment among the institutions within the same region.

Source : VOSviewer

Bibliographic coupling of author-affiliated institutions.

Similar to co-authors’ affiliated institutions, the collaboration of authors’ country presents a steady association among authors’ connections that allow exploring comparative and concurrent research works. Figure  6 represents the network of collaborative authors’ affiliation countries. These countries include South Africa and the USA, England and the USA, Australia and the USA, Malaysia and the USA, Germany and the USA, representing a high proportion of authors’ affiliated institutions are in the USA with this country performing as a hub of co-authorship publications from 1972 to 2021.

Collaborative authors’ affiliated countries

This study discusses trending themes based on the bibliometric findings and reviews of highly cited and most recent documents (see Appendix 1 ). It also indicated the type of study, theories, methods and main findings to suggest comprehensive future studies.

Research directions

Between 1991 and 2010, studies related to banking performance have posited several antecedents to banking performance. Figure  7 displays the trend topics based on author keywords that appeared between 1972 and 2010. Studies in this period mainly focused on mergers and acquisitions, information technology and transition economies that emerged from universal banking deregulation and bank privatisation. The financial crisis during 2008–2009 drew the attention of scholars to evaluate the banking performance. Idiosyncratically, this phenomenon has been acknowledged by researchers from 2010 to 2015, focusing on the role of corporate governance in the performance of the banking industry, including compensation, risk management, determinants of stock returns, capital buffer, productivity. Idiosyncratically, a vast of studies were conducted on Chinese commercial banks and the effect on their economic growth.

Source : Biblioshiny analysis. Note the frequency of terms selected 3 times for 1972–2010, 5 times for 2011–2015, 10 times for 2016–2021

Trend topics in different periods.

In the recent period (2016–2021), diverse factors posited in the studies that dominantly present a significant interest from banking scholars. While studies earlier mainly focusing on efficiency and its contributing factors, recent periods extended research directions to multiple constituents. For example, how banks diversified their services and the role of human capital efficiency to the banking performance [ 37 ]. Bose et al. employed the effect of green banking on the performance that underpins the inclusion of the environmental sustainability approach by the banking industry [ 38 ]. Meanwhile, Bhattacharyya et al. showed the effect of CSR expenditures and financial inclusion on the performance that define the social sustainability indicator of the banks [ 39 ]. Repeatedly, the role and structure of the board, categorisation of deposits and loans, risk exposures (business cycle), macroeconomic factors were also acknowledged in recent banking performance studies [ 40 , 41 , 42 , 43 ]. Idiosyncratically, scholars recently focus the components of sustainability of the banking industry from economic, environmental and social aspects [ 44 ]. Furthermore, the effect of banking and its stability on economic growth has been broadly carried out in the recent period. Moreover, the development of studies was taken into account, which implies the contribution to the economic growth of particular regions. Based on the earlier and recent studies, it is precisely observed the diversification of research constituents in relation to bank performance studies. Earlier studies (up to 2015) mainly measured banking performance or efficiency based on accounting measurements, while recent studies started to include market measurements principally based on stock returns performance. On the other hand, the rise of Islamic banking and finance influenced academic researchers to compare the business models [ 45 ], banking efficiencies [ 46 ] between conventional and Islamic banks, and efficiency for Islamic banks [ 5 ].

Based on the review of impactful documents published from 1990 to 2010, two particular objectives were identified: the effect of the board of directors or ownership on the bank performance [ 47 , 48 , 49 ] and measurement of efficiency, including cost and profit efficiency [ 50 , 51 , 52 ]. These constituents extended during 2011–2020 by the inclusion of risk-taking management [ 53 ], CEO incentives [ 54 ], contributing factors including capital, banking crises on banking performance [ 42 , 55 , 56 , 57 ]. Meanwhile, the Islamic banking system got crucial attention from academic researchers. Accordingly, several studies evaluated and compared efficiency between Islamic and conventional banks [ 45 , 58 , 59 ]. Nevertheless, the role of the banking industry in economic growth was included in the research constituents in the recent decade. For example, Xu, Santana and a few more scholars investigated the correlation between financial intermediation and economic growth [ 57 , 60 , 61 ]. In recent years, scholars extended the banking-related research constituents to diverse areas. The effect of human capital efficiency [ 37 ], green banking [ 38 ], CSR expenditures [ 39 ] and bank stability was included to measure banking performance. These extensions of research themes within banking performance studies posited a significant interest by academic researchers.

Apparently, almost all documents adopted the quantitative method in measuring banking performance research constituents. However, studies that measured banking efficiency mainly applied nonparametric analysis DEA [ 5 , 51 ], while SFA was adopted by limited studies [ 37 , 42 , 43 ]. On the other hand, regression analysis was predominantly applied to investigate banking performance from 1990 to 2010 [ 49 , 50 ]. In recent studies, academic researchers have vastly adopted GMM (generalised method of moments) to examine the contributing factors on banking performance [ 39 , 42 , 57 , 60 ]. These methods are dominating the banking-related studies throughout the publication periods. Over the periods, scholars have developed DEA applications in several categories, such as bootstrap, networking. Meanwhile, GMM with different approach (dynamic and system) techniques exploited panel data primarily extracted from Bankscope, Datastream, annual reports etc.

Main findings

Earlier, banking inefficiencies were substantially observed low, negatively affecting profitability and marketability [ 50 , 51 ]. This trend was continuously depicted in studies [ 52 ]. However, Berger et al. evidenced better efficiency for larger banks than smaller banks [ 50 ]. On the contrary, Seiford and Zhu posited an adverse effect of bank size on marketability [ 51 ]. More so, Rehman et al. found larger banks are less efficient than smaller banks [ 40 ]. Hence, Moudud-Ul-Huq posited diverse impacts of bank size and competition on performance [ 62 ]. So, banking size is deemed to have a substantial effect on the overall performance of banks. However, Adesina embellished that diversification of services and choices of management decisions on loans (nonperforming, debt issuances) [ 63 , 64 ] and deposits [ 41 ] affect the banking performance [ 37 ]. Moreover, board structure affects banking performance [ 40 , 65 ], while higher human capital efficiency enhances banking performance [ 37 ].

Generally, foreign-owned banks provide better service, greater profitability and are better efficient than local banks. This phenomenon was evidenced in several studies; for example, Bonin et al. and other scholars demonstrated that foreign-owned banks are more cost-efficient than other banks [ 48 ]. However, this trend did not exist for Islamic banks as local banks showed better efficiency than foreign peers [ 58 ] and more efficient than conventional [ 59 ]. Meanwhile, state-owned or government-owned commercial banks were less efficient and provided poorer services [ 48 , 49 , 52 ]. But these banks’ efficiency was higher than urban/rural banks during credit risk shock [ 41 ]. Nevertheless, banking efficiency and performance substantially depend on diversification of services, managerial adequacy, ownership, types and size.

Studies have evidenced financial development and thus the banking industry’s role in economic growth [ 60 ]. In the nineteenth century, the establishment of the savings bank demonstrated city growth in Prussia [ 66 ]. Potentially, banks provide investment capital to increase per capita GDP [ 43 ]. However, Haini documented a contrasting effect of banking development on economic growth through a push out of private investment due to high levels of the banking sector [ 67 ]. However, Stewart and Chowdhury proved that a stable banking sector lessens the negative impact of a crisis on GDP growth and provides economic resilience in both developed and developing countries. Overall, findings elaborated a crucial link between banking sector development and economic growth.

Future study suggestions

This study has recommended several scopes for future studies in the hybrid review, mainly through bibliometric findings and the structured review of impactful articles [ 11 ]. In other words, the recommendations for future studies are made by observing and analysing discussions on highly cited and recent cited documents. Overall findings and analyses raised several questions that need to be addressed for future studies.

Firstly, does the banking sector improve economic growth in the least developed countries? Prior studies mainly focused on developed and developing economies, but less attention was given to least developed countries. Secondly, vast studies investigated contributing factors of banking performance, while political instability has been ignored. Future studies might include political instability on the banking performance. Apart from it, nonperforming loans can be another addition to future studies, and even few studies documented it. Thirdly, how do banks perform during the pandemic crisis, for instance, COVID-19? The current pandemic crisis can be a significant factor in banking performance related to future studies, including efficiency, mortgages, loan recovery, deposits and business services. The studies can include consumer behaviour (due to restricted movements, safety measurements), green banking (online transaction and services), financial technologies (inclusion of nonbanking services) and the contribution or continuance of economic activities in the country during and after the pandemic crisis.

Significantly, prior studies have ignored the current trend of FinTech inclusion in banking performance. Fourthly, will FinTech takeover the banking services and diminish banks in the near future? Future studies may investigate the effect of FinTech applications on banking. More so, future studies may explore the banking industry’s barriers, challenges and threats due to FinTech growth. Fifthly, almost all studies employed quantitative analysis related to banking performance. Therefore, future studies may use qualitative methods to explore the opportunities and practices of banks and their performance. Sixthly, the majority of the studies either applied parametric or econometric techniques to investigate the bank performance. Recent developments in technologies and methods may provide easy and robust results in such related studies as using machine learning for data analysis and predicting banking efficiency and productivity determinants. Seventhly, past studies mostly followed the intermediation approach, which scarcely included production and operating approach measurement. Future studies may extend the efficiency analysis using productivity growth analysis. Further, the majority of the studies observed efficiency only. Future studies can include a productivity change index along with an efficiency analysis. Finally, GMM and regression were broadly applied to investigate the effect of antecedents of banking performance and link to economic growth. Future studies may adopt other advanced data analysis techniques such as partial least squares, structural equations and other econometric techniques.

Conclusions

The main purpose of this study is to explore the trends and research activities in banking performance and the economic growth research domain. To achieve this objective, a bibliometric analysis was applied and performed several analyses, namely citation, co-occurrence of keywords, the collaboration between authors and coupling between institutions and countries, and discussion by reviewing most cited and most recent influential research articles. This study presents the most common themes, sub-themes associated with highly cited documents and authors; furthermore, the content analysis identified the research directions, research objectives, methodologies, topics and findings.

Based on the reviewing literature, the efficiency theory, banking theory mainly intermediation approach and nonparametric technique, namely data envelopment analysis along with econometric method, regression was used in the published documents. The findings of this study, along with future study suggestions, could be beneficial to bankers as well as academic researchers and students studying banking performance and its role in the economy.

Limitations

The most crucial limitation in any bibliometric analysis is the database selection. It means selecting the data and the limits of its interpretation [ 68 ]. This study has three key limitations; firstly, it has chosen ‘Web of Science’, one of the largest online databases to gather data on banking performance research articles from 1972 to 2021 and refined based on subject categories and language (English). The database could be improved if other databases were included and also if book chapters and conference proceedings were added. Secondly, the selection of keywords; although selected keywords are deemed to be most relevant to encompass the majority of articles related to banking performance, there is always an opportunity to search further articles by using additional keywords. Lastly, this study could not conduct co-citation analysis due to the unavailability of cited documents in Web of Science data format.

Availability of data and materials

The data collected from the Web of Science online database were saved on Microsoft excel and remained with authors. The data are available upon request.

Abbreviations

Data envelopment analysis

Generalized method of moments

• Web of Science

Collaboration index

Chief executive officer

Corporate social responsibility

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Alam, S.M.S., Chowdhury, M.A.M. & Razak, D.B.A. Research evolution in banking performance: a bibliometric analysis. Futur Bus J 7 , 66 (2021). https://doi.org/10.1186/s43093-021-00111-7

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• Banking performance
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Financial technology and the future of banking

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This paper presents an analytical framework that describes the business model of banks. It draws on the classical theory of banking and the literature on digital transformation. It provides an explanation for existing trends and, by extending the theory of the banking firm, it illustrates how financial intermediation will be impacted by innovative financial technology applications. It further reviews the options that established banks will have to consider in order to mitigate the threat to their profitability. Deposit taking and lending are considered in the context of the challenge made from shadow banking and the all-digital banks. The paper contributes to an understanding of the future of banking, providing a framework for scholarly empirical investigation. In the discussion, four possible strategies are proposed for market participants, (1) customer retention, (2) customer acquisition, (3) banking as a service and (4) social media payment platforms. It is concluded that, in an increasingly digital world, trust will remain at the core of banking. That said, liquidity transformation will still have an important role to play. The nature of banking and financial services, however, will change dramatically.

Introduction

The bank of the future will have several different manifestations. This paper extends theory to explain the impact of financial technology and the Internet on the nature of banking. It provides an analytical framework for academic investigation, highlighting the trends that are shaping scholarly research into these dynamics. To do this, it re-examines the nature of financial intermediation and transactions. It explains how digital banking will be structurally, as well as physically, different from the banks described in the literature to date. It does this by extending the contribution of Klein ( 1971 ), on the theory of the banking firm. It presents suggested strategies for incumbent, and challenger banks, and how banking as a service and social media payment will reshape the competitive landscape.

The banking industry has been evolving since Banca Monte dei Paschi di Siena opened its doors in 1472. Its leveraged business model has proved very scalable over time, but it is now facing new challenges. Firstly, its book to capital ratios, as documented by Berger et al ( 1995 ), have been consistently falling since 1840. This trend continues as competition has increased. In the past decade, the industry has experienced declines in profitability as measured by return on tangible equity. This is partly the result of falling leverage and fee income and partly due to the net interest margin (connected to traditional lending activity). These trends accelerated following the 2008 financial crisis. At the same time, technology has made banks more competitive. Advances in digital technology are changing the very nature of banking. Banks are now distributing services via mobile technology. A prolonged period of very low interest rates is also having an impact. To sustain their profitability, Brei et al. ( 2020 ) note that many banks have increased their emphasis on fee-generating services.

As Fama ( 1980 ) explains, a bank is an intermediary. The Internet is, however, changing the way financial service providers conduct their role. It is fundamentally changing the nature of the banking. This in turn is changing the nature of banking services, and the way those services are delivered. As a consequence, in order to compete in the changing digital landscape, banks have to adapt. The banks of the future, both incumbents and challengers, need to address liquidity transformation, data, trust, competition, and the digitalization of financial services. Against this backdrop, incumbent banks are focused on reinventing themselves. The challenger banks are, however, starting with a blank canvas. The research questions that these dynamics pose need to be investigated within the context of the theory of banking, hence the need to revise the existing analytical framework.

Banks perform payment and transfer functions for an economy. The Internet can now facilitate and even perform these functions. It is changing the way that transactions are recorded on ledgers and is facilitating both public and private digital currencies. In the past, banks operated in a world of information asymmetry between themselves and their borrowers (clients), but this is changing. This differential gave one bank an advantage over another due to its knowledge about its clients. The digital transformation that financial technology brings reduces this advantage, as this information can be digitally analyzed.

Even the nature of deposits is being transformed. Banks in the future will have to accept deposits and process transactions made in digital form, either Central Bank Digital Currencies (CBDC) or cryptocurrencies. This presents a number of issues: (1) it changes the way financial services will be delivered, (2) it requires a discussion on resilience, security and competition in payments, (3) it provides a building block for better cross border money transfers and (4) it raises the question of private and public issuance of money. Braggion et al ( 2018 ) consider whether these represent a threat to financial stability.

The academic study of banking began with Edgeworth ( 1888 ). He postulated that it is based on probability. In this respect, the nature of the business model depends on the probability that a bank will not be called upon to meet all its liabilities at the same time. This allows banks to lend more than they have in deposits. Because of the resultant mismatch between long term assets and short-term liabilities, a bank’s capital structure is very sensitive to liquidity trade-offs. This is explained by Diamond and Rajan ( 2000 ). They explain that this makes a bank a’relationship lender’. In effect, they suggest a bank is an intermediary that has borrowed from other investors.

Diamond and Rajan ( 2000 ) argue a lender can negotiate repayment obligations and that a bank benefits from its knowledge of the customer. As shall be shown, the new generation of digital challenger banks do not have the same tradeoffs or knowledge of the customer. They operate more like a broker providing a platform for banking services. This suggests that there will be more than one type of bank in the future and several different payment protocols. It also suggests that banks will have to data mine customer information to improve their understanding of a client’s financial needs.

The key focus of Diamond and Rajan ( 2000 ), however, was to position a traditional bank is an intermediary. Gurley and Shaw ( 1956 ) describe how the customer relationship means a bank can borrow funds by way of deposits (liabilities) and subsequently use them to lend or invest (assets). In facilitating this mediation, they provide a service whereby they store money and provide a mechanism to transmit money. With improvements in financial technology, however, money can be stored digitally, lenders and investors can source funds directly over the internet, and money transfer can be done digitally.

A review of financial technology and banking literature is provided by Thakor ( 2020 ). He highlights that financial service companies are now being provided by non-deposit taking contenders. This paper addresses one of the four research questions raised by his review, namely how theories of financial intermediation can be modified to accommodate banks, shadow banks, and non-intermediated solutions.

To be a bank, an entity must be authorized to accept retail deposits. A challenger bank is, therefore, still a bank in the traditional sense. It does not, however, have the costs of a branch network. A peer-to-peer lender, meanwhile, does not have a deposit base and therefore acts more like a broker. This leads to the issue that this paper addresses, namely how the banks of the future will conduct their intermediation.

In order to understand what the bank of the future will look like, it is necessary to understand the nature of the aforementioned intermediation, and the way it is changing. In this respect, there are two key types of intermediation. These are (1) quantitative asset transformation and, (2) brokerage. The latter is a common model adopted by challenger banks. Figure  1 depicts how these two types of financial intermediation match savers with borrowers. To avoid nuanced distinction between these two types of intermediation, it is common to classify banks by the services they perform. These can be grouped as either private, investment, or commercial banking. The service sub-groupings include payments, settlements, fund management, trading, treasury management, brokerage, and other agency services.

How banks act as intermediaries between lenders and borrowers. This function call also be conducted by intermediaries as brokers, for example by shadow banks. Disintermediation occurs over the internet where peer-to-peer lenders match savers to lenders

Financial technology has the ability to disintermediate the banking sector. The competitive pressures this results in will shape the banks of the future. The channels that will facilitate this are shown in Fig.  2 , namely the Internet and/or mobile devices. Challengers can participate in this by, (1) directly matching borrows with savers over the Internet and, (2) distributing white labels products. The later enables banking as a service and avoids the aforementioned liquidity mismatch.

The strategic options banks have to match lenders with borrowers. The traditional and challenger banks are in the same space, competing for business. The distributed banks use the traditional and challenger banks to white label banking services. These banks compete with payment platforms on social media. The Internet heralds an era of banking as a service

There are also physical changes that are being made in the delivery of services. Bricks and mortar branches are in decline. Mobile banking, or m-banking as Liu et al ( 2020 ) describe it, is an increasingly important distribution channel. Robotics are increasingly being used to automate customer interaction. As explained by Vishnu et al ( 2017 ), these improve efficiency and the quality of execution. They allow for increased oversight and can be built on legacy systems as well as from a blank canvas. Application programming interfaces (APIs) are bringing the same type of functionality to m-banking. They can be used to authorize third party use of banking data. How banks evolve over time is important because, according to the OECD, the activity in the financial sector represents between 20 and 30 percent of developed countries Gross Domestic Product.

In summary, financial technology has evolved to a level where online banks and banking as a service are challenging incumbents and the nature of banking mediation. Banking is rapidly transforming because of changes in such technology. At the same time, the solving of the double spending problem, whereby digital money can be cryptographically protected, has led to the possibility that paper money will become redundant at some point in the future. A theoretical framework is required to understand this evolving landscape. This is discussed next.

The theory of the banking firm: a revision

In financial theory, as eloquently explained by Fama ( 1980 ), banking provides an accounting system for transactions and a portfolio system for the storage of assets. That will not change for the banks of the future. Fama ( 1980 ) explains that their activities, in an unregulated state, fulfil the Modigliani–Miller ( 1959 ) theorem of the irrelevance of the financing decision. In practice, traditional banks compete for deposits through the interest rate they offer. This makes the transactional element dependent on the resulting debits and credits that they process, essentially making banks into bookkeeping entities fulfilling the intermediation function. Since this is done in response to competitive forces, the general equilibrium is a passive one. As such, the banking business model is vulnerable to disruption, particularly by innovation in financial technology.

A bank is an idiosyncratic corporate entity due to its ability to generate credit by leveraging its balance sheet. That balance sheet has assets on one side and liabilities on the other, like any corporate entity. The assets consist of cash, lending, financial and fixed assets. On the other side of the balance sheet are its liabilities, deposits, and debt. In this respect, a bank’s equity and its liabilities are its source of funds, and its assets are its use of funds. This is explained by Klein ( 1971 ), who notes that a bank’s equity W , borrowed funds and its deposits B is equal to its total funds F . This is the same for incumbents and challengers. This can be depicted algebraically if we let incumbents be represented by Φ and challengers represented by Γ:

Klein ( 1971 ) further explains that a bank’s equity is therefore made up of its share capital and unimpaired reserves. The latter are held by a bank to protect the bank’s deposit clients. This part is also mandated by regulation, so as to protect customers and indeed the entire banking system from systemic failure. These protective measures include other prudential requirements to hold cash reserves or other liquid assets. As shall be shown, banking services can be performed over the Internet without these protections. Banking as a service, as this phenomenon known, is expected to increase in the future. This will change the nature of the protection available to clients. It will change the way banks transform assets, explained next.

A bank’s deposits are said to be a function of the proportion of total funds obtained through the issuance of the ith deposit type and its total funds F , represented by α i . Where deposits, represented by Bs , are made in the form of Bs (i  =  1 *s n) , they generate a rate of interest. It follows that Si Bs  =  B . As such,

Therefor it can be said that,

The importance of Eq. 3 is that the balance sheet can be leveraged by the issuance of loans. It should be noted, however, that not all loans are returned to the bank in whole or part. Non-performing loans reduce the asset side of a bank’s balance sheet and act as a constraint on capital, and therefore new lending. Clearly, this is not the case with banking as a service. In that model, loans are brokered. That said, with the traditional model, an advantage of financial technology is that it facilitates the data mining of clients’ accounts. Lending can therefore be more targeted to borrowers that are more likely to repay, thereby reducing non-performing loans. Pari passu, the incumbent bank of the future will therefore have a higher risk-adjusted return on capital. In practice, however, banking as a service will bring greater competition from challengers and possible further erosion of margins. Alternatively, some banks will proactively engage in partnerships and acquisitions to maintain their customer base and address the competition.

A bank must have reserves to meet the demand of customers demanding their deposits back. The amount of these reserves is a key function of banking regulation. The Basel Committee on Banking Supervision mandates a requirement to hold various tiers of capital, so that banks have sufficient reserves to protect depositors. The Committee also imposes a framework for mitigating excessive liquidity risk and maturity transformation, through a set Liquidity Coverage Ratio and Net Stable Funding Ratio.

Recent revisions of theory, because of financial technology advances, have altered our understanding of banking intermediation. This will impact the competitive landscape and therefor shape the nature of the bank of the future. In this respect, the threat to incumbent banks comes from peer-to-peer Internet lending platforms. These perform the brokerage function of financial intermediation without the use of the aforementioned banking balance sheet. Unlike regulated deposit takers, such lending platforms do not create assets and do not perform risk and asset transformation. That said, they are reliant on investors who do not always behave in a counter cyclical way.

Financial technology in banking is not new. It has been used to facilitate electronic markets since the 1980’s. Thakor ( 2020 ) refers to three waves of application of financial innovation in banking. The advent of institutional futures markets and the changing nature of financial contracts fundamentally changed the role of banks. In response to this, academics extended the concept of a bank into an entity that either fulfills the aforementioned functions of a broker or a qualitative asset transformer. In this respect, they connect the providers and users of capital without changing the nature of the transformation of the various claims to that capital. This transformation can be in the form risk transfer or the application of leverage. The nature of trading of financial assets, however, is changing. Price discovery can now be done over the Internet and that is moving liquidity from central marketplaces (like the stock exchange) to decentralized ones.

Alongside these trends, in considering what the bank of the future will look like, it is necessary to understand the unregulated lending market that competes with traditional banks. In this part of the lending market, there has been a rise in shadow banks. The literature on these entities is covered by Adrian and Ashcraft ( 2016 ). Shadow banks have taken substantial market share from the traditional banks. They fulfil the brokerage function of banks, but regulators have only partial oversight of their risk transformation or leverage. The rise of shadow banks has been facilitated by financial technology and the originate to distribute model documented by Bord and Santos ( 2012 ). They use alternative trading systems that function as electronic communication networks. These facilitate dark pools of liquidity whereby buyers and sellers of bonds and securities trade off-exchange. Since the credit crisis of 2008, total broker dealer assets have diverged from banking assets. This illustrates the changed lending environment.

In the disintermediated market, banking as a service providers must rely on their equity and what access to funding they can attract from their online network. Without this they are unable to drive lending growth. To explain this, let I represent the online network. Extending Klein ( 1971 ), further let Ψ represent banking as a service and their total funds by F . This state is depicted as,

Theoretically, it can be shown that,

Shadow banks, and those disintermediators who bypass the banking system, have an advantage in a world where technology is ubiquitous. This becomes more apparent when costs are considered. Buchak et al. ( 2018 ) point out that shadow banks finance their originations almost entirely through securitization and what they term the originate to distribute business model. Diversifying risk in this way is good for individual banks, as banking risks can be transferred away from traditional banking balance sheets to institutional balance sheets. That said, the rise of securitization has introduced systemic risk into the banking sector.

Thus, we can see that the nature of banking capital is changing and at the same time technology is replacing labor. Let A denote the number of transactions per account at a period in time, and C denote the total cost per account per time period of providing the services of the payment mechanism. Klein ( 1971 ) points out that, if capital and labor are assumed to be part of the traditional banking model, it can be observed that,

It can therefore be observed that the total service charge per account at a period in time, represented by S, has a linear and proportional relationship to bank account activity. This is another variable that financial technology can impact. According to Klein ( 1971 ) this can be summed up in the following way,

where d is the basic bank decision variable, the service charge per transaction. Once again, in an automated and digital environment, financial technology greatly reduces d for the challenger banks. Swankie and Broby ( 2019 ) examine the impact of Artificial Intelligence on the evaluation of banking risk and conclude that it improves such variables.

Meanwhile, the traditional banking model can be expressed as a product of the number of accounts, M , and the average size of an account, N . This suggests a banks implicit yield is it rate of interest on deposits adjusted by its operating loss in each time period. This yield is generated by payment and loan services. Let R 1 depict this. These can be expressed as a fraction of total demand deposits. This is depicted by Klein ( 1971 ), if one assumes activity per account is constant, as,

As a result, whether a bank is structured with traditional labor overheads or built digitally, is extremely relevant to its profitability. The capital and labor of tradition banks, depicted as Φ i , is greater than online networks, depicted as I i . As such, the later have an advantage. This can be shown as,

What Klein (1972) failed to highlight is that the banking inherently involves leverage. Diamond and Dybving (1983) show that leverage makes bank susceptible to run on their liquidity. The literature divides these between adverse shock events, as explained by Bernanke et al ( 1996 ) or moral hazard events as explained by Demirgu¨¸c-Kunt and Detragiache ( 2002 ). This leverage builds on the balance sheet mismatch of short-term assets with long term liabilities. As such, capital and liquidity are intrinsically linked to viability and solvency.

The way capital and liquidity are managed is through credit and default management. This is done at a bank level and a supervisory level. The Basel Committee on Banking Supervision applies capital and leverage ratios, and central banks manage interest rates and other counter-cyclical measures. The various iterations of the prudential regulation of banks have moved the microeconomic theory of banking from the modeling of risk to the modeling of imperfect information. As mentioned, shadow and disintermediated services do not fall under this form or prudential regulation.

The relationship between leverage and insolvency risk crucially depends on the degree of banks total funds F and their liability structure L . In this respect, the liability structure of traditional banks is also greater than online networks which do not have the same level of available funds, depicted as,

Diamond and Dybvig ( 1983 ) observe that this liability structure is intimately tied to a traditional bank’s assets. In this respect, a bank’s ability to finance its lending at low cost and its ability to achieve repayment are key to its avoidance of insolvency. Online networks and/or brokers do not have to finance their lending, simply source it. Similarly, as brokers they do not face capital loss in the event of a default. This disintermediates the bank through the use of a peer-to-peer environment. These lenders and borrowers are introduced in digital way over the internet. Regulators have taken notice and the digital broker advantage might not last forever. As a result, the future may well see greater cooperation between these competing parties. This also because banks have valuable operational experience compared to new entrants.

It should also be observed that bank lending is either secured or unsecured. Interest on an unsecured loan is typically higher than the interest on a secured loan. In this respect, incumbent banks have an advantage as their closeness to the customer allows them to better understand the security of the assets. Berger et al ( 2005 ) further differentiate lending into transaction lending, relationship lending and credit scoring.

The evolution of the business model in a digital world

As has been demonstrated, the bank of the future in its various manifestations will be a consequence of the evolution of the current banking business model. There has been considerable scholarly investigation into the uniqueness of this business model, but less so on its changing nature. Song and Thakor ( 2010 ) are helpful in this respect and suggest that there are three aspects to this evolution, namely competition, complementary and co-evolution. Although liquidity transformation is evolving, it remains central to a bank’s role.

All the dynamics mentioned are relevant to the economy. There is considerable evidence, as outlined by Levine ( 2001 ), that market liberalization has a causal impact on economic growth. The impact of technology on productivity should prove positive and enhance the functioning of the domestic financial system. Indeed, market liberalization has already reshaped banking by increasing competition. New fee based ancillary financial services have become widespread, as has the proprietorial use of balance sheets. Risk has been securitized and even packaged into trade-able products.

Challenger banks are developing in a complementary way with the incumbents. The latter have an advantage over new entrants because they have information on their customers. The liquidity insurance model, proposed by Diamond and Dybvig ( 1983 ), explains how such banks have informational advantages over exchange markets. That said, financial technology changes these dynamics. It if facilitating the processing of financial data by third parties, explained in greater detail in the section on Open Banking.

At the same time, financial technology is facilitating banking as a service. This is where financial services are delivered by a broker over the Internet without resort to the balance sheet. This includes roboadvisory asset management, peer to peer lending, and crowd funding. Its growth will be facilitated by Open Banking as it becomes more geographically adopted. Figure  3 illustrates how these business models are disintermediating the traditional banking role and matching burrowers and savers.

The traditional view of banks ecosystem between savers and borrowers, atop the Internet which is matching savers and borrowers directly in a peer-to-peer way. The Klein ( 1971 ) theory of the banking firm does not incorporate the mirrored dynamics, and as such needs to be extended to reflect the digital innovation that impacts both borrowers and severs in a peer-to-peer environment

Meanwhile, the banking sector is co-evolving alongside a shadow banking phenomenon. Lenders and borrowers are interacting, but outside of the banking sector. This is a concern for central banks and banking regulators, as the lending is taking place in an unregulated environment. Shadow banking has grown because of financial technology, market liberalization and excess liquidity in the asset management ecosystem. Pozsar and Singh ( 2011 ) detail the non-bank/bank intersection of shadow banking. They point out that shadow banking results in reverse maturity transformation. Incumbent banks have blurred the distinction between their use of traditional (M2) liabilities and market-based shadow banking (non-M2) liabilities. This impacts the inter-generational transfers that enable a bank to achieve interest rate smoothing.

Securitization has transformed the risk in the banking sector, transferring it to asset management institutions. These include structured investment vehicles, securities lenders, asset backed commercial paper investors, credit focused hedge and money market funds. This in turn has led to greater systemic risk, the result of the nature of the non-traded liabilities of securitized pooling arrangements. This increased risk manifested itself in the 2008 credit crisis.

Commercial pressures are also shaping the banking industry. The drive for cost efficiency has made incumbent banks address their personally costs. Bank branches have been closed as technology has evolved. Branches make it easier to withdraw or transfer deposits and challenger banks are not as easily able to attract new deposits. The banking sector is therefore looking for new point of customer contact, such as supermarkets, post offices and social media platforms. These structural issues are occurring at the same time as the retail high street is also evolving. Banks have had an aggressive roll out of automated telling machines and a reduction in branches and headcount. Online digital transactions have now become the norm in most developed countries.

The financing of banks is also evolving. Traditional banks have tended to fund illiquid assets with short term and unstable liquid liabilities. This is one of the key contributors to the rise to the credit crisis of 2008. The provision of liquidity as a last resort is central to the asset transformation process. In this respect, the banking sector experienced a shock in 2008 in what is termed the credit crisis. The aforementioned liquidity mismatch resulted in the system not being able to absorb all the risks associated with subprime lending. Central banks had to resort to quantitative easing as a result of the failure of overnight funding mechanisms. The image of the entire banking sector was tarnished, and the banks of the future will have to address this.

The future must learn from the mistakes of the past. The structural weakness of the banking business model cannot be solved. That said, the latest Basel rules introduce further risk mitigation, improved leverage ratios and increased levels of capital reserve. Another lesson of the credit crisis was that there should be greater emphasis on risk culture, governance, and oversight. The independence and performance of the board, the experience and the skill set of senior management are now a greater focus of regulators. Internal controls and data analysis are increasingly more robust and efficient, with a greater focus on a banks stable funding ratio.

Meanwhile, the very nature of money is changing. A digital wallet for crypto-currencies fulfills much the same storage and transmission functions of a bank; and crypto-currencies are increasing being used for payment. Meanwhile, in Sweden, stores have the right to refuse cash and the majority of transactions are card based. This move to credit and debit cards, and the solving of the double spending problem, whereby digital money can be crypto-graphically protected, has led to the possibility that paper money could be replaced at some point in the future. Whether this might be by replacement by a CBDC, or decentralized digital offering, is of secondary importance to the requirement of banks to adapt. Whether accommodating crytpo-currencies or CBDC’s, Kou et al. ( 2021 ) recommend that banks keep focused on alternative payment and money transferring technologies.

Central banks also have to adapt. To limit disintermediation, they have to ensure that the economic design of their sponsored digital currencies focus on access for banks, interest payment relative to bank policy rate, banking holding limits and convertibility with bank deposits. All these developments have implications for banks, particularly in respect of funding, the secure storage of deposits and how digital currency interacts with traditional fiat money.

Open banking

Against the backdrop of all these trends and changes, a new dynamic is shaping the future of the banking sector. This is termed Open Banking, already briefly mentioned. This new way of handling banking data protocols introduces a secure way to give financial service companies consensual access to a bank’s customer financial information. Figure  4 illustrates how this works. Although a fairly simple concept, the implications are important for the banking industry. Essentially, a bank customer gives a regulated API permission to securely access his/her banking website. That is then used by a banking as a service entity to make direct payments and/or download financial data in order to provide a solution. It heralds an era of customer centric banking.

How Open Banking operates. The customer generates data by using his bank account. A third party provider is authorized to access that data through an API request. The bank confirms digitally that the customer has authorized the exchange of data and then fulfills the request

Open Banking was a response to the documented inertia around individual’s willingness to change bank accounts. Following the Retail Banking Review in the UK, this was addressed by lawmakers through the European Union’s Payment Services Directive II. The legislation was designed to make it easier to change banks by allowing customers to delegate authority to transfer their financial data to other parties. As a result of this, a whole host of data centric applications were conceived. Open banking adds further momentum to reshaping the future of banking.

Open Banking has a number of quite revolutionary implications. It was started so customers could change banks easily, but it resulted in some secondary considerations which are going to change the future of banking itself. It gives a clear view of bank financing. It allows aggregation of finances in one place. It also allows can give access to attractive offerings by allowing price comparisons. Open Banking API’s build a secure online financial marketplace based on data. They also allow access to a larger market in a faster way but the third-party providers for the new entrants. Open Banking allows developers to build single solutions on an API addressing very specific problems, like for example, a cash flow based credit rating.

Romānova et al. ( 2018 ) undertook a questionnaire on the Payment Services Directive II. The results suggest that Open Banking will promote competitiveness, innovation, and new product development. The initiative is associated with low costs and customer satisfaction, but that some concerns about security, privacy and risk are present. These can be mitigated, to some extent, by secure protocols and layered permission access.

Discussion: strategic options

Faced with these disruptive trends, there are four strategic options for market participants to con- sider. There are (1) a defensive customer retention strategy for incumbents, (2) an aggressive customer acquisition strategy for challenger banks (3) a banking as a service strategy for new entrants, and (4) a payments strategy for social media platforms.

Each of these strategies has to be conducted in a competitive marketplace for money demand by potential customers. Figure  5 illustrates where the first three strategies lie on the tradeoff between money demand and interest rates. The payment strategy can’t be modeled based on the supply of money. In the figure, the market settles at a rate L 2 . The incumbent banks have the capacity to meet the largest supply of these loans. The challenger banks have a constrained function but due to a lower cost base can gain excess rent through higher rates of interest. The peer-to-peer bank as a service brokers must settle for the market rate and a constrained supply offering.

The money demand M by lenders on the y axis. Interest rates on the y axis are labeled as r I and r II . The challenger banks are represented by the line labeled Γ. They have a price and technology advantage and so can lend at higher interest rates. The brokers are represented by the line labeled Ω. They are price takers, accepting the interest rate determined by the market. The same is true for the incumbents, represented by the line labeled Φ but they have a greater market share due to their customer relationships. Note that payments strategy for social media platforms is not shown on this figure as it is not affected by interest rates

Figure  5 illustrates that having a niche strategy is not counterproductive. Liu et al ( 2020 ) found that banks performing niche activities exhibit higher profitability and have lower risk. The syndication market now means that a bank making a loan does not have to be the entity that services it. This means banks in the future can better shape their risk profile and manage their lending books accordingly.

An interesting question for central banks is what the future Deposit Supply function will look like. If all three forms: open banking, traditional banking and challenger banks develop together, will the bank of the future have the same Deposit Supply function? The Klein ( 1971 ) general formulation assumes that deposits are increasing functions of implicit and explicit yields. As such, the very nature of central bank directed monetary policy may have to be revisited, as alluded to in the earlier discussion on digital money.

The client retention strategy (incumbents)

The competitive pressures suggest that incumbent banks need to focus on customer retention. Reichheld and Kenny ( 1990 ) found that the best way to do this was to focus on the retention of branch deposit customers. Obviously, another way is to provide a unique digital experience that matches the challengers.

Incumbent banks have a competitive advantage based on the information they have about their customers. Allen ( 1990 ) argues that where risk aversion is observable, information markets are viable. In other words, both bank and customer benefit from this. The strategic issue for them, therefore, becomes the retention of these customers when faced with greater competition.

Open Banking changes the dynamics of the banking information advantage. Borgogno and Colangelo ( 2020 ) suggest that the access to account (XS2A) rule that it introduced will increase competition and reduce information asymmetry. XS2A requires banks to grant access to bank account data to authorized third payment service providers.

The incumbent banks have a high-cost base and legacy IT systems. This makes it harder for them to migrate to a digital world. There are, however, also benefits from financial technology for the incumbents. These include reduced cost and greater efficiency. Financial technology can also now support platforms that allow incumbent banks to sell NPL’s. These platforms do not require the ownership of assets, they act as consolidators. The use of technology to monitor the transactions make the processing cost efficient. The unique selling point of such platforms is their centralized point of contact which results in a reduction in information asymmetry.

Incumbent banks must adapt a number of areas they got to adapt in terms of their liquidity transformation. They have to adapt the way they handle data. They must get customers to trust them in a digital world and the way that they trust them in a bricks and mortar world. It is no coincidence. When you go into a bank branch that is a great big solid building great big facade and so forth that is done deliberately so that you trust that bank with your deposit.

The risk of having rising non-performing loans needs to be managed, so customer retention should be selective. One of the puzzles in banking is why customers are regularly denied credit, rather than simply being charged a higher price for it. This credit rationing is often alleviated by collateral, but finance theory suggests value is based on the discounted sum of future cash flows. As such, it is conceivable that the bank of the future will use financial technology to provide innovative credit allocation solutions. That said, the dual risks of moral hazard and information asymmetries from the adoption of such solutions must be addressed.

Customer retention is especially important as bank competition is intensifying, as is the digitalization of financial services. Customer retention requires innovation, and that innovation has been moving at a very fast rate. Until now, banks have traditionally been hesitant about technology. More recently, mergers and acquisitions have increased quite substantially, initiated by a need to address actual or perceived weaknesses in financial technology.

The client acquisition strategy (challengers)

As intermediaries, the challenger banks are the same as incumbent banks, but designed from the outset to be digital. This gives them a cost and efficiency advantage. Anagnostopoulos ( 2018 ) suggests that the difference between challenger and traditional banks is that the former address its customers problems more directly. The challenge for such banks is customer acquisition.

Open Banking is a major advantage to challenger banks as it facilitates the changing of accounts. There is widespread dissatisfaction with many incumbent banks. Open Banking makes it easier to change accounts and also easier to get a transaction history on the client.

Customer acquisition can be improved by building trust in a brand. Historically, a bank was physically built in a very robust manner, hence the heavy architecture and grand banking halls. This was done deliberately to engender a sense of confidence in the deposit taking institution. Pure internet banks are not able to do this. As such, they must employ different strategies to convey stability. To do this, some communicate their sustainability credentials, whilst others use generational values-based advertising. Customer acquisition in a banking context is traditionally done by offering more attractive rates of interest. This is illustrated in Fig.  5 by the intersect of traditional banks with the market rate of interest, depicted where the line Γ crosses L 2 . As a result of the relationship with banking yield, teaser rates and introductory rates are common. A customer acquisition strategy has risks, as consumers with good credit can game different challenger banks by frequently changing accounts.

Most customer acquisition, however, is done based on superior service offering. The functionality of challenger banking accounts is often superior to incumbents, largely because the latter are built on legacy databases that have inter-operability issues. Having an open platform of services is a popular customer acquisition technique. The unrestricted provision of third-party products is viewed more favorably than a restricted range of products.

The banking as a service strategy (new entrants)

Banking from a customer’s perspective is the provision of a service. Customers don’t care about the maturity transformation of banking balance sheets. Banking as a service can be performed without recourse to these balance sheets. Banking products are brokered, mostly by new entrants, to individuals as services that can be subscribed to or paid on a fee basis.

There are a number banking as a service solutions including pre-paid and credit cards, lending and leasing. The banking as a service brokers are effectively those that are aggregating services from others using open banking to enable banking as a service.

The rise of banking as a service needs to be understood as these compete directly with traditional banks. As explained, some of these do this through peer-to-peer lending over the internet, others by matching borrows and sellers, conducting mediation as a loan broker. Such entities do not transform assets and do not have banking licenses. They do not have a branch network and often don not have access to deposits. This means that they have no insurance protection and can be subject to interest rate controls.

The new genre of financial technology, banking as a service provider, conduct financial services transformation without access to central bank liquidity. In a distributed digital asset world, the assets are stored on a distributed ledger rather than a traditional banking ledger. Financial technology has automated credit evaluation, savings, investments, insurance, trading, banking payments and risk management. These banking as a service offering are only as secure as the technology on which they are built.

The social media payment strategy (disintermediators and disruptors)

An intermediation bank is a conceptual idea, one created solely on a social networking site. Social media has developed a market for online goods and services. Williams ( 2018 ) estimates that there are 2.46 billion social media users. These all make and receive payments of some kind. They demand security and functionality. Importantly, they have often more clients than most banks. As such, a strategy to monetize the payments infrastructure makes sense.

All social media platforms are rich repositories of data. Such platforms are used to buy and sell things and that requires payments. Some platforms are considering evolving their own digital payment, cutting out the banks as middlemen. These include Facebook’s Diem (formerly Libra), a digital currency, and similar developments at some of the biggest technology companies. The risk with social media payment platform is that there is systemic counter-party protection. Regulators need to address this. One way to do this would be to extend payment service insurance to such platforms.

Social media as a platform moves the payment relationship from a transaction to a customer experience. The ability to use consumer desires in combination with financial data has the potential to deliver a number of new revenue opportunities. These will compete directly with the banks of the future. This will have implications for (1) the money supply, (2) the market share of traditional banks and, (3) the services that payment providers offer.

Further research

Several recommendations for research derive from both the impact of disintermediation and the four proposed strategies that will shape banking in the future. The recommendations and suggestions are based on the mentioned papers and the conclusions drawn from them.

As discussed, the nature of intermediation is changing, and this has implications for the pricing of risk. The role of interest rates in banking will have to be further reviewed. In a decentralized world based on crypto currencies the central banks do not have the same control over the money supply, This suggest the quantity theory of money and the liquidity preference theory need to be revisited. As explained, the Internet reduces much of the friction costs of intermediation. Researchers should ask how this will impact maturity transformation. It is also fair to ask whether at some point in the future there will just be one big bank. This question has already been addressed in the literature but the Internet facilities the possibility. Diamond ( 1984 ) and Ramakrishnan and Thakor ( 1984 ) suggested the answer was due to diversification and its impact on reducing monitoring costs.

Attention should be given by academics to the changing nature of banking risk. How should regulators, for example, address the moral hazard posed by challenger banks with weak balance sheets? What about deposit insurance? Should it be priced to include unregulated entities? Also, what criteria do borrowers use to choose non-banking intermediaries? The changing risk environment also poses two interesting practical questions. What will an online bank run look like, and how can it be averted? How can you establish trust in digital services?

There are also research questions related to the nature of competition. What, for example, will be the nature of cross border competition in a decentralized world? Is the credit rationing that generates competition a static or dynamic phenomena online? What is the value of combining consumer utility with banking services?

Financial intermediaries, like banks, thrive in a world of deficits and surpluses supported by information asymmetries and disconnectedness. The connectivity of the internet changes this dynamic. In this respect, the view of Schumpeter ( 1911 ) on the role of financial intermediaries needs revisiting. Lenders and borrows can be connected peer to peer via the internet.

All the dynamics mentioned change the nature of moral hazard. This needs further investigation. There has been much scholarly research on the intrinsic riskiness of the mismatch between banking assets and liabilities. This mismatch not only results in potential insolvency for a single bank but potentially for the whole system. There has, for example, been much debate on the whether a bank can be too big to fail. As a result of the riskiness of the banking model, the banks of the future will be just a liable to fail as the banks of the past.

This paper presented a revision of the theory of banking in a digital world. In this respect, it built on the work of Klein ( 1971 ). It provided an overview of the changing nature of banking intermediation, a result of the Internet and new digital business models. It presented the traditional academic view of banking and how it is evolving. It showed how this is adapted to explain digital driven disintermediation.

It was shown that the banking industry is facing several documented challenges. Risk is being taken of balance sheet, securitized, and brokered. Financial technology is digitalizing service delivery. At the same time, the very nature of intermediation is being changed due to digital currency. It is argued that the bank of the future not only has to face these competitive issues, but that technology will enhance the delivery of banking services and reduce the cost of their delivery.

The paper further presented the importance of the Open Banking revolution and how that facilitates banking as a service. Open Banking is increasing client churn and driving banking as a service. That in turn is changing the way products are delivered.

Four strategies were proposed to navigate the evolving competitive landscape. These are for incumbents to address customer retention; for challengers to peruse a low-cost digital experience; for niche players to provide banking as a service; and for social media platforms to develop payment platforms. In all these scenarios, the banks of the future will have to have digital strategies for both payments and service delivery.

It was shown that both incumbents and challengers are dependent on capital availability and borrowers credit concerns. Nothing has changed in that respect. The risks remain credit and default risk. What is clear, however, is the bank has become intrinsically linked with technology. The Internet is changing the nature of mediation. It is allowing peer to peer matching of borrowers and savers. It is facilitating new payment protocols and digital currencies. Banks need to evolve and adapt to accommodate these. Most of these questions are empirical in nature. The aim of this paper, however, was to demonstrate that an understanding of the banking model is a prerequisite to understanding how to address these and how to develop hypotheses connected with them.

In conclusion, financial technology is changing the future of banking and the way banks intermediate. It is facilitating digital money and the online transmission of financial assets. It is making banks more customer enteric and more competitive. Scholarly investigation into banking has to adapt. That said, whatever the future, trust will remain at the core of banking. Similarly, deposits and lending will continue to attract regulatory oversight.

Availability of data and materials

Diagrams are my own and the code to reproduce them is available in the supplied Latex files.

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6 Commercial Banking: Changing Interactions between Banks, Markets, Industry, and State

Gerarda Westerhuis is lecturer and postdoctoral fellow at the Department of History and Art History, Utrecht University, the Netherlands. Her main topics of interest are banking, financing, corporate governance, entrepreneurship, networks, and elites. In 2013, she started her new research project entitled ‘Unravelling the origins of a banking crisis: changing perceptions of risk and managerial beliefs in Dutch banking, 1957–2007’. Since 2015 she has also been part of a European Commission-funded international consortium of over thirty researchers from nine top research institutes called FIRES: Financial and Institutional Reforms for the Entrepreneurial Society. FIRES is commissioned to draft reform proposals that will channel more finance, talent, and knowledge into entrepreneurship.

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This chapter provides an overview of the development of commercial banking—defined as taking deposits payable on demand and originating loans to private and corporate customers—from the mid-nineteenth century to the present. Two characteristics are underlined: state regulation, primarily dictated by concerns about banks’ position as deposit takers; and banks’ role in the financing of industry and more generally in economic growth including their assigned responsibility. The changing nature of these two features has shaped the development of commercial banks since the onset of industrialization. In all countries, with the exception of England, commercial banks developed into some kind of universal bank in the course of the nineteenth century. This converging movement ended in the interwar years, when in many countries commercial banks were separated from investment banks. Universal banking became dominant again in the late twentieth century, but in the form of banking conglomerates.

Introduction

Commercial banks—institutions that accept deposits payable on demand and originate loans with personal and corporate customers—emerged in the nineteenth century in many countries. Their development is considered to be related to industrialization and economic growth. In the early years of industrialization, financial intermediation assisted economic development by mobilizing savings, mitigating risk and uncertainty, stimulating entrepreneurship, accumulating capital, and fostering development of a national legal and financial infrastructure. Consequently, the emergence of commercial banks, having deposits and loans under one roof, is often seen as the start of modern banking. Investment banks that specialize in underwriting activities, securities trading, fund management, and merger and acquisition advice are seen as another type of financial institution. Universal banks combine both commercial and investment banking activities (see e.g. Canals, 1997 ).

Following the distinction between specialized and universal banks, financial systems are often divided into market-based versus bank-based systems. In market-based systems, at arm’s length specialized investment banks prevail, whereas in bank-based systems universal banks are dominant. The rationale behind this division is that financial markets have difficulties developing without the support of investment banks. On the other hand, it is unlikely for markets and specialized banks to develop in a financial system where universal banks dominate. The argument goes that universal banks enjoy information economies of scope acquired by the credit and deposit activities which is of value for their investment activities (and back and forth), leading to a crowding out of other types of banks. Often Germany and Japan are seen as bank-based systems where universal banks prevail in the allocation of resources to the corporate sector, whereas in the US and England, both considered market-based systems, specialized investment banks and the financial market are dominant players. The extant literature, based on historical evidence in particular, has shown that these two dichotomies are rather stylized facts and mostly based on recent circumstances. Apart from the literature centred around the question how countries can be best classified, other literature has debated the effectiveness of both systems ( Allen and Gale, 2001 ). However, results indicate that ‘there is no support for either the bank-based or the market-based view’ in this respect ( Levine, 2002 : 398).

The goal of this chapter is to give an overview of the development of commercial banking in different parts of the world, in particular in Europe, the US, and Japan, and to show when and how financial systems changed over time. To fully understand the systems we go back to the nineteenth century, when in many countries industrialization unfolded. During this period most commercial banks developed into some kind of universal bank, with the exception of the English specialized banks. The period between the two world wars of the twentieth century, however, was a period of divergence. In many countries, such as Belgium, Italy, Japan, and the US, banks specialized away from universal banks. Divergence lasted until the late 1970s when universal banking became the dominant form again. However, it was another type of universal bank than the one that dominated in the nineteenth and early twentieth centuries. Not only did they combine commercial and investment banking activities, but they also started operating in real estate, mortgage markets, insurance, and asset management. As banks moved into different activities servicing different types of client, they started to become multi-business companies. This new type was a kind of financial conglomerate with large international presence and a broad range of activities. The revival of universal banking in many parts of the world was a reason to question whether the commercial bank ‘has outlived its usefulness and is in a state of terminal decline’ ( Rajan, 1998 : 524). However, due to the financial crisis of 2008 this question has been reversed as policy makers are now debating whether it would be better for financial stability to separate commercial and investment banking again.

In this respect two characteristics of commercial banking should be underlined. First, commercial banks are usually regulated. The first historical reason to regulate commercial banks’ activities was the capacity of commercial banks to create money as a result of being in a position to keep only a portion of their total deposits liquid. To assure the banks’ solvency two types of regulatory measure emerged: the reserve requirement and the solvency ratio ( Canals, 1993 ). Another measure was the securing of deposits arranged via the government often with the funds coming from the banks themselves. The system of deposit insurance is a kind of protective net to prevent serious damage when a financial institution goes bankrupt. A second reason which historically has justified regulation has been the need to ensure that credit is offered honestly and efficiently. A third reason has been the supposed need to prevent banking institutions from becoming too large, thus accumulating extreme power ( Canals, 1993 ).

A second important feature of commercial banks is their apparent relation with industrialization, or more broadly, with economic growth. The bank–industry relationship is the classical question in financial historiography. Two strands of literature should be mentioned here. First, in some countries, including the Netherlands, there have been debates on whether commercial banks could have contributed more to industrial development and economic growth. In this perspective it is argued that bank-based financial systems are better at allocating capital during early stages of economic development and in weak institutional environments ( Levine, 1997 ). To stress this claim, it is put into a comparative frame, contrasting it with Germany where banks had close relations with industry enabling them to provide firms with financing (see Gerschenkron, 1962 ; Cameron 1967 , 1972 for bringing the discussion on the role of banking in industrialization to the fore, and see e.g. Pollard and Ziegler, 1992 for comments on this relationship). An ongoing question remains, however, whether the development of commercial banks is a product or a cause of economic growth. In other words, the causal relation is still being questioned (see e.g. Levine, 1997 ). A second strand of literature, at least dating back to Brandeis (1914) and Hilferding (1910/1968) discusses the assumed power of banks. This literature, which has a more negative connotation, deals with interconnections between banks and industry created by financial links via the granting of loans or having shareholdings and/or by personal links via sitting on each other’s boards (see for a development of these corporate networks in 14 different countries in the twentieth and twenty-first centuries David and Westerhuis, 2014 ).

The remainder of the chapter is set up in chronological order. It starts with the emergence of commercial banks in the nineteenth century. First, the next main section compares developments in the US and England with Germany and Japan, being typical examples of market-based and bank-based systems respectively. The following section discusses the development of commercial banks in other continental European countries in the nineteenth century. Next we describe the divergence of the financial systems in the interwar period, and then the chronology ends with the revival of universal banks since the 1980s, before offering some final remarks. Two recurring topics in this overview are banking regulation and bank–industry relations, as both are specific features of commercial banking.

Market-based vs Bank-based Systems in the Nineteenth century: England and the US vs Germany and Japan

During the nineteenth century the demand for capital increased due to industrialization and the emergence of large firms. In particular during the Second Industrial Revolution (1860–1914) large-scale companies, such as railways and oil companies, required increasing amounts of capital. The many new products and new technologies posed information problems for external providers of finance. Joint-stock banks were created to fulfil the demand having the necessary resources in the form of deposits. We will elaborate on these general developments by comparing Germany and Japan, being defined as typical bank-based systems, with England and the US, seen as market-based systems.

In the nineteenth century the English financial sector consisted of two separate financial parts: London banking with a global outlook reflecting the country’s dominant position in the international economy, and country banking as a product of economic transformation in the regions ( Cottrell, 1992 : 39). In England, joint-stock banks were prohibited until 1826, after which it became possible to establish them but only outside a radius of 65 miles from London. In 1833 this latter condition was abolished and joint-stock banks could be set up in the City as well. They were required to give up note issuing though. One of the first was the London and Westminster Bank, established in 1834. Judged on criteria such as size, links to London, and organizational structure, commercial banking matured relatively late ( Cottrell, 1992 : 44). Thus, the joint-stock banks that emerged as of the 1830s remained small and possessed relatively few of their own branches. Moreover, commercial banks in the country had expensive correspondent relationships with London financial markets. Typically, banks in England were able to attract high amounts of deposits, due to a historically wealthy social class, which they transformed into short-term loans and discounting ( Cassis, 2006 : 44). Credits to corporate clients remained relatively low, as most firms had enough capital to re-invest. Consequently, the intermediating role of banks was hardly necessary and the relation between banks and industry remained weak.

The joint-stock banks started to displace the private banks in a concentration process by which a centralized banking system developed in England. The process lasted until the 1920s and was to a substantial degree characterized by provincial banks becoming ‘City institutions’ (the exception being Westminster which had its origins as the first London joint-stock bank). The resulting Big Five—Barclays, Lloyds, Midland, National Provincial, and Westminster—started to dominate the English banking sector and opened further branches in the 1920s. For example, Midland Bank and Lloyds Bank, two prominent banks from Birmingham, grew rapidly in the 1880s and 1890s by acquisitions and internal expansion. They acquired banks in London linking the city with the provinces, and became large national banks. By acquisitions in the provinces they expanded the number of branches, which were an important source for deposits ( Cottrell, 1992 : 48).

Although in the US a growing number of joint-stock banks emerged already in 1790s, and thus earlier than in Europe, they disappeared in the 1830s. During the period 1837–1862, also known as the ‘free-banking’ era, the US banking system consisted of state-chartered banks. They were not allowed to establish branches. Consequently, the US banking system was highly fragmented and, in contrast to England, there was no development of nationwide banks with wide-ranging branch networks. Lamoreaux (1995) shows that the fragmented banking system became more problematic as time went by. She argues that a change from insider to outsider orientation banking in New England was reflected by the increasing mismatch between the needs of large industrial firms and the resources of small, one unit banks. Thus, lending practices became more impersonal and professional, and the information problems banks faced when they began to conduct more of their business at arm’s length forced them to concentrate on providing short-term loans to firms. Another deficit of the fragmented banking system was that the US had not developed a central bank. In particular because of the Civil War, starting in 1861, this became a more serious problem. The National Bank Acts of 1863 and 1864 were meant to set up a national banking system and to increase the federal control over the banking system. It created nationally chartered banks, which had to comply with higher capital requirements and higher reserve requirements than their state bank counterparts. To improve safety they were not allowed to make real estate loans nor to lend an amount beyond 10% of the bank’s capital. Many state-chartered banks converted to nationally chartered banks because newly imposed taxes made state banking unprofitable. However, because of lower capital and reserve requirements, as well as the ease with which states issued banking charters, state banks again became the dominant banking structure by the late 1880s. The National Bank Acts created a dual banking structure, consisting of a federal and a state level, which was typical for the US banking sector.

In the US, investment banking business was centralized in a few investment banks, of which J.P. Morgan & Co. is the most well known. They played considerable roles on corporate boards of directors. As such, the Money Trust, as this network of firms and banks dominated by Morgan also came to be known, played an important monitoring role before the First World War ( Bradford De Long, 1991 ). During and after the First World War when many firms approached the capital markets, an increasing number of commercial banks, such as National City Bank, became active in underwriting operations. Because the National Bank Act of 1864 did not permit national banks to handle common stocks, they incorporated affiliates under state corporate charters. These state-chartered affiliates were allowed to perform many more activities ( Kroszner and Rajan, 1994 ). As a result increasingly more banks were extensively involved in both lending and securities underwriting activities. As we will see later in this chapter, their activities were thus similar to those of the large banks in Germany and Japan ( Vitols, 2001 ). They engineered major corporate reorganizations such as mergers in sectors including railroads and steel through extensive shareholdings and board representation ( Chernow, 1990 ).

In contrast to England, German banks developed close relations with industry, dating back to railroad building in the 1830s and 1840s. Universal banking was first developed by private bankers to organize and finance the construction of railroads. The bankers underwrote the issues of railroad securities, managed the firm’s current accounts, and occupied key board positions ( Tilly, 1989 : 191; Tilly, 1992 : 94). When railroad financing exceeded the resources of individual private bankers they often operated in syndicates. However, difficulties in forming and holding these syndicates together pressed them to look for alternatives ( Tilly, 1989 ). One of those was the creation of joint-stock banks, in which private bankers continued to play a significant role. In the 1850s, within a couple of years new banks were created with the explicit purpose of financing the nascent industry. One of the first was Bank für Handel und Industrie, also known as Darmstädter Bank, modelled after the Crédit Mobilier, and founded by the Pereire brothers together with three German private bankers. Its statutes stated that the bank was allowed to accept deposits and make loans on current account; it could hold shares in other companies, issuing securities, and organize mergers and acquisitions. In other words the bank was able to combine commercial and investment banking. Other banks followed suit: Deutsche Bank was founded in 1870 and Dresdner Bank in 1872 (see for a history of Deutsche Bank: Gall et al., 1995 ; Kobrak, 2008 ). Concentration since the 1880s led to the emergence of five large Berlin banks ( Tilly, 1989 ). In this concentration process private banks were often taken over by the joint-stock banks, and interlocking shareholdings among joint-stock banks became important. The close links between banks and firms led to what is known as the Hausbank system, where firms have long-term relations with one particular bank. An important lending instrument in sustaining relationships was the current account ( Kontokorrent ) which was already used by private bankers. The current account was an ‘overdraft vehicle where the borrower paid interest only on the balance outstanding at a particular time’ ( Guinanne, 2002 : 97). Thus, credit was extended on the current account with short repayment schedules. Every time the bank renewed credits it demanded the latest information of the firm. It lent to firms or individuals for many years, because this relationship could pass from father to son. The bank built up useful information on its clients. The links between industry and banks were intensified by proxy voting in the shareholder’s meeting, which enabled bankers to vote on behalf of their clients and thus to control strategic corporate decisions (see Tilly, 1992 : 94). The German banks remained active in the money as well as the capital markets. Compared with other countries, the dominance of large joint-stock credit banks in the German financial system is remarkable. However, despite their importance, the largest component of the German banking landscape was still formed by private banks, savings banks ( Sparkassen ), credit cooperatives, and mortgage banks ( Guinnane, 2002 ). It is important to note that the German case shows that financial markets and universal banks can co-exist, which is in contrast to the literature ( Fohlin, 2007a , 2007b ). Fohlin argues that ‘the importance of universality—the combination of investment and commercial banking—appears mostly in the active use of securities markets, not in the domination of industry nor in the dramatic alteration of firm behavior or performance’ ( Fohlin, 2007a : 13).

The pre-war zaibatsu , or financial cliques, in Japan played a similar influence over industry as the Hausbanken in Germany and the investment banks, such as J.P. Morgan in the US. Much of the financing of Japanese firms came from commercial banks; Mitsui Bank, established in 1876, being the first one. In 1907 the five largest banks held 21% of all bank deposits; four of them were part of a leading zaibatsu : Mitsui, Mitsubishi, Sumitomo, and Yasuda. Important for the emergence of zaibatsu has been the role of the government. When it started to privatize its firms during the Meiji period (1868–1912), most of the assets were bought by family-owned firms. Accordingly, they became major zaibatsu by acquiring many industrial firms during the late nineteenth century, and by 1900 these zaibatsu , which financed their own subsidiaries by retained earnings, had become the most important source of finance. As the zaibatsu banks were allowed to borrow from the Bank of Japan at special rates, they were able to grant loans to industrial firms ‘at levels well above those permitted by their own liabilities’ ( Lazonick and O’Sullivan, 1997 : 120). By the interwar period the zaibatsu were the driving force behind industrial development in Japan. Also new ones emerged, such as Nissan and Nichitsu and Mori, which financed their expansion mainly via public stock issues ( Lazonick and O’Sullivan, 1997 ).

From this short overview two conclusions can be made. First, only in England did specialized banks develop, whereas in the other three countries universal banks emerged. Even in the US, often classified as a market-based financial system, universal banks emerged. Close relations between banks and industry were established, because these universal banks granted loans and participated in security related activities, and their bankers sat on the corporate boards of directors. Second, in contrast to the other three countries, nationwide banks with extensive branch networks did not develop in the US.

Industrialization and Joint-stock Banks in other Continental Countries

Modern banking, as defined in the introduction appeared in France around 1850. The haute banque , banking houses that belonged to very rich banking families, such as the Rothschilds, had remained in control for a long time. Only from 1850s onwards with the emergence of deposit banks, did this financial system start to change. The private banks were often involved in the creation of the newly joint-stock banks, sometimes as shareholders or as a member of the managing board. Crédit Mobilier, an investment bank, was established in 1852 by the brothers Emile and Isaac Pereire. Its goal was to allocate resources to firms in industry, transport, and public utility. To achieve this goal the bank had to issue bank bonds and obtain direct participation in manufacturing and railway companies. However, the government as well as the haute banque resisted its development. In 1854 it was not allowed anymore to issue bonds; at the same time the bank had difficulties placing the securities of the companies it had created, and often it had to take them back. The bank went bankrupt in 1867 and was liquidated four years later. More successful were, for example, the Comptoir d’Escompte de Paris, the first discount bank created in 1848, Société Générale in 1864, and Crédit Lyonnais created in 1863. These large banks increased banks’ deposits in the 1890s by extending their branch network. They were followed by regional banks. However, by 1913, their total number of branches remained far behind that of English banks ( Lescure, 1995 : 315). At the same time, between 1880 and 1914, the large banks gave up their role as universal banks and became specialized deposit banks, as an answer to the financial crisis of 1882. Short-term self-liquidating credit became their most important activity ( Lescure, 1995 : 317). The growing importance of commercial banks went in parallel with a growth of the corporate sector and a decline in private banks. In the French and other literature the role of banks in the financing of investments has been questioned. Gueslin (1992) argues that due to the consolidation of the credit institutions, banking credit remained limited and the financing of firms was done by self-financing (reinvesting cash flows) and by transfer of savings via the financial market. He also stresses financial orthodoxy in this period as an important reason, reflected for example by owners of firms distrusting credit ( Gueslin, 1992 : 80). Apart from the deposit banks, investment banks were created to provide long-term loans and to take participations and shareholdings in firms, such as the Banque de Paris et des Pays-Bas (Paribas). Some younger deposit banks did become universal banks, probably because of Swiss and German involvement in their establishments. Also most regional banks were shaped on the universal banking model, and here rolling-over of short-term credit often turned industrial loans into long-term credit. Gueslin (1992 : 86) concluded: ‘Where the local economy was buoyant, the regional banks answered to its needs, and indeed were a key element in regional growth.’

Despite Crédit Mobilier’s ultimate failure it is believed that the ideas of the Pereire brothers spread over Europe, influencing the development of banking in Germany, Switzerland, and the Netherlands among others. However, according to Kurgan-van Hentenryk (1992) the Belgian banking system had already developed well before the Crédit Mobilier, that is, at the beginning of the nineteenth century with the rise of Belgian industrialization, into one that channelled funds to important parts of industry. During the second half of the nineteenth century the system was dominated by two competing banks: Société Générale (established in 1822) and Banque de Belgique (established in 1835). During the financial crises of 1876 and 1885 several financial institutions disappeared including the Banque de Belgique, leaving Société Générale, which had developed into a universal bank, with a dominant position within the Belgian banking system, as the only banking institution to supply a huge amount of capital to joint-stock companies. Société Générale developed into a major multinational bank during the late nineteenth century ( Cassis, 1990 ; Kurgan-van Hentenryk, 1992 ). During the same period other important banks changed from specialized investment banks or holding companies to universal banks by combining their existing activities with those of deposit banks. As a result around the 1910s Société Générale was no longer the sole frontrunner in industrial finance, but shared this position with several other universal banks.

The development of Dutch banking is placed between the German and English system. Here too, the concentration of wealthy classes and relatively small scale firms reduced the need for commercial banks in the modern sense of the word. Initiatives in the 1850s to set up Crédit Mobilier-style banks failed due to government resistance. In the 1860s joint stock banks were created but they focused much more on trade financing and short-term loans than on financing industrialization (in particular railways), which had been the initial idea. The absence of a modern banking sector was in the past considered the main reason for the relatively late industrialization of the Netherlands. However this view has been undermined by arguments that there were many alternatives, such as self-financing as well as financing via informal (family) networks. The prolongatiemarkt also played an important role. Here one could get short-term credit for a period of three months with securities as collateral. Often credit was prolonged automatically. Due to this system well-off citizens and entrepreneurs could invest their working capital. This system, in which intermediation by banks was unnecessary, functioned well until the 1910s (Jonker, 1997). The picture changed between 1910 and 1920, when banks and manufacturing industry became more closely connected. This development was first explained by an increase in the credits granted by banks to finance the process of industrialization ( Jonker, 1991 ). To develop a stronger capital base, a concentration process in the Dutch banking sector headed in. It resulted in the dominance of the market by five large commercial banks: Amsterdamsche Bank, Rotterdamsche Bank, Twentsche Bank, Nederlandsche Handel-Maatschappij, and Incasso Bank. In a later article Jonker concluded that concentration had not led to a qualitative change. Rather it meant an expansion of the existing type of banking, consisting of passive intermediation typical of trade financing ( Jonker, 1995 : 188). Recent research, focused on the demand side by investigating Dutch exchange-listed firms, shows that these firms hardly used long-term loans to finance their activities, at least until the Second World War. After an initial public offering (IPO) these firms favoured financing by retained earnings, preferred shares, and/or bonds. For investors, fixed-income bonds and preferred shares, were popular financing instruments. This preference had to do with the low degree of transparency of corporate accounts, which were not always very clear or informative, with the result that outside investors could not verify the level of profits to be paid out. Also firms themselves preferred those two financing instruments because they kept voting rights and power with the original owners ( Westerhuis and De Jong, 2015 ). As in England and the US, a strong capital market emerged in the Netherlands, and in particular in the 1910s the stock exchange blossomed with many initial public offerings as well as issues of shares and bonds. Dutch banks often played an important role in issuing and underwriting the securities needed for the financing of industry. They sometimes granted loans in anticipation of the issue and/or kept securities in their portfolio after a failed issue but they hardly ever participated in the firms’ stock. Interestingly, the Dutch case also shows that universal banks could exist alongside an active capital market ( Westerhuis and De Jong, 2015 ). However, Dutch banks were neither as specialized as the English deposit banks, because they were allowed to be active in securities, nor entirely similar to the German universal banks, because they did not grant long-term loans or take participations in firms.

In Sweden, joint-stock banks emerged in the 1820s and 1830s, following the example of the English deposit banks. Commercial banking was dominated by short-term lending. With industrialization proceeding accompanied by an increasing demand for long-term loans, these loans were more often prolonged. Also commercial banks gradually transformed by adopting universal banking activities, such as the trade in shares and bonds. In contrast to the German universal banks, however, Swedish banks were not allowed to trade in shares on their own account until 1912. This restriction was relaxed by the Banking Law of 1911; it granted commercial banks a certain degree of freedom to purchase shares, depending on the size of a bank’s equity. However, their greater freedom went hand in hand with an extension of public control. In practice this meant that commercial banks had to be chartered by the government ( Larsson, 1995 ; see also Larsson and Lindgren, 1992 ). As in the Netherlands, the 1910s witnessed a transformation of the banking sector in Sweden. Economic upheaval during the First World War up to 1920 resulted in credit expansion and an increase in the volume of share issues on the stock market. Whereas new commercial banks were established, even more banks merged to form larger organizations. Overall the number of banks was reduced, while the number of branches was extended considerably. The government did not intervene in the concentration process because it considered large banks more stable than smaller banks ( Larsson and Lindgren, 1992 : 347–8). Denmark, Norway, and Finland followed in the footsteps of Sweden (see Andersen, 2011 for the development of organized capital and credit markets in the Nordic countries).

In Switzerland banks were created on the model of Crédit Mobilier. Around the mid-nineteenth century the Swiss banking system was unable to meet the increased capital demand for financing railway construction and manufacturing industry. As a result joint-stock banks, capable of providing capital for large investment projects, emerged ( Cassis and Tanner, 1992 : 295). Today’s big universal banks, Crédit Suisse of Zurich (CS), Swiss Bank Corporation of Basel (SBC), and the Union Bank of Switzerland (UBS)—the latter two merged in 1998—developed in this period. They emerged in a rather unconcentrated banking system consisting of cantonal banks, local banks, savings banks, and finance companies ( Cassis, 1990 : 163). The big banks not only became important for domestic capital accumulation but from the end of the nineteenth century onwards increasingly participated in international financial activities. However, the international financial position of the Swiss banks should not be exaggerated. Until the 1950s the Swiss banks hardly possessed overseas banks, in contrast to, for example, some Dutch and Belgian, as well as English, French, and German banks ( Cassis, 1990 ).

To conclude, banks in many continental European countries were less specialized than the English ones, but also less ‘universal’ than the German ones. This overview shows that the first joint-stock banks appeared in Europe in the beginning of the nineteenth century, and although at that time they met with quite some resistance, in many countries their number increased considerably. Joint-stock banks differed from the already existing private bankers and credit houses in the higher amount of external resources and in operating under limited liability, whereas in qualitative terms fewer differences could be detected. Indeed, on the European Continent the joint-stock banks were often established by private bankers; so they performed the same activities as before but on a larger scale ( Lescure, 2008 : 330). In most countries, the increase in the number of banks was followed by a concentration process leading to the domination of national banking systems by a small number of large banks with extensive branch networks. As we have seen, an exception to this rule was the US where in most states branching was forbidden. But also in Portugal, Denmark, and Norway, branch banking failed to develop. Many commercial banks were used for short-term lending, attracting mainly short-term deposits. Around the 1870s and 1880s, in some countries earlier than others, these banks diversified into securities related activities due to the increasing importance of stock markets and joint-stock firms. They provided loans in anticipation of a share issue or held securities in their portfolio. With respect to possible governmental interference banks enjoyed a high degree of freedom in their financial activities. Thus around 1900 in many countries some type of universal bank dominated in a laissez-faire regulatory regime ( Vitols, 2001 : 4). However, these universal banks were less universal than those in Belgium and Germany, which also participated in company stocks and focused more on long-term credits. The only real exception was England where a clear distinction between specialized banks (deposit banks, merchant banks, stockbrokers) was apparent.

In this period the stylized distinction between market-based versus bank-based systems does not seem so clear-cut. On the contrary, in most countries a hybrid form emerged. Evidence from Germany ( Fohlin, 2007b ; Fear and Kobrak, 2010 ), the US ( Kroszner and Rajan, 1994 ) and the Netherlands ( Westerhuis and De Jong, 2015 ), shows that universal banks and active capital markets could co-exist. This finding is in contrast to what is stated in the existing literature that argues that markets cannot prevail in a financial system where universal banks dominate. Thus, in this hybrid form banks played an important role as ‘special intermediaries’ in both the corporate governance of firms and stock exchanges ( Fear and Kobrak, 2010 : 733). We will now analyse how in the interwar period divergence between the financial systems took off, and what factors played a role in the divergence.

Divergence of Banking Systems in the Interwar Period

The differences between financial systems were not yet very clear in the nineteenth century. In fact it might be better to trace the roots of the distinction between market-based versus bank-based financial systems back to the first decades of the twentieth century. In this respect the divergence seems to be related to two different banking crises—in some countries in the 1920s and in others in the 1930s ( Jonker and van Zanden, 1995 )—and subsequent banking legislation.

The country best known for its separation between commercial and investment banking has been the US. Due to the Great Depression the US federal government took several measures to prevent banking institutions from becoming too big and too powerful. A series of severe banking crises and bank closures between 1930 and 1933 led to the Glass–Steagall Act of 1933 which separated commercial banking from investment banking and prevented state banks from acting as advisors in mergers and acquisitions and issuing of corporate debt ( Canals, 1997 : 10). Combined with an increasing support for restrictions on interstate banking, the Act ensured that banks were restricted even more than markets ( Allen and Gale, 2001 : 34). Thus the distrust of power in the hands of some large financial institutions resulted in antitrust legislation preserving competition in the banking sector. Consequently many relatively small banks persisted in the US.

In Belgium and Italy, two countries where universal banks had been dominant, the depression of the 1930s also led to a separation between investment and commercial banking. In Belgium this type of legislation was passed in 1934. Before that year banks had enjoyed almost complete freedom and there was no real banking legislation. However, a Royal Decree enacted on 22 August 1934 forced the universal banks to split up into deposit banks and holding companies before 1 January 1936. It was a reaction to the Great Depression, when, especially after 1932, some Belgian banks came into distress. By the Decree, banks were not allowed to hold bonds and shares, and they had to restrict their activities either to investment banking or to deposits and loan activities. The newly created holding companies became the most important shareholders of the deposit banks ( Kurgan-van Hentenryk, 1995 ). Consequently, within a few years the banking system had changed profoundly. As banks were not allowed to hold stock in industrial companies and demand for short-term loans by firms was low, the banks were more or less forced to use their funds to grant loans to the public authorities ( Kurgan-van Hentenryk, 1992 : 328; 1995: 47). And whereas Belgium’s banks could not hold stocks in firms, the opposite, that is, financial or industrial firms holding interests in banks, was not forbidden. As a result, the biggest banks became part of industrial or financial groups.

In Italy, where universal banking also was the dominant form of banking in the 1890s, the system changed during the 1930s. However, after the First World War universal banking first became even more dominant. After the war many firms were not able to repay their debts and banks decided to transform debt into shareholdings. Consequently these banks became important shareholders of firms. The system collapsed with the Great Depression and the state decided to intervene. The universal banks and their corporate shareholdings were taken over by the Istituto per la Ricostruzione Industriale (IRI), which was created by the fascist government in 1933. In 1936 a new banking law was enacted by which banks and industry were separated. Banks were allowed to grant short-term credit only, and their shareholdings in non-financial firms were severely restricted. At the same time, specialized institutes were created to grant industrial credit ( Rinaldi and Vasta, 2014 ).

In contrast to the US, Belgium, and Italy, in most other European countries universal banking continued to be allowed. The major structural change in the German banking sector in this period was the creation of a national banking system by which commercial banks, special banks, savings banks and co-operatives were amalgamated ( Hardach, 1995 : 229). In Switzerland changes to the banking system started from the First World War onwards. In particular due to increasing international business the Swiss big universal banks increased in asset size ( Cassis, 1995 : 68), with some of them (Swiss Bank Corporation and Crédit Suisse) becoming almost as large as French and German banks. On the national market they became bigger than the cantonal banks. This growth came to an abrupt end during the Great Depression when, as in other countries, tighter state regulations were implemented. The Banking Act of 1934, however, did not forbid universal banking as had been the case in the US and Belgium. The main objective of the Act was to protect creditors by trying to avoid bank insolvencies. To this end a general framework for banking practices was established ( Cassis, 1995 : 70). Also the banks agreed on voluntarily limiting capital exports in return for a law on bank secrecy. In France, large deposit banks, such as Société Général, Credit Lyonnais, Comptoir d’Escompte, and Banque Nationale de Paris, were nationalized just after the First World War. Moreover, the Banking Law of 1944 made a distinction between the activities of investment banks and those of commercial banks. These changes in the banking sector could be seen as a belated response to the problems of the depression of the 1930s (see Lescure, 1995 : 334). Direct state ownership of major banks, which lasted until 1982, makes France somewhat unique and different from most other countries (another exception being Italy).

Interestingly Sweden, Denmark, and the Netherlands, all three neutrals in the First World War, experienced a banking crisis in the early 1920s (see for more details Jonker and van Zanden, 1995 : 79–81) and they avoided a severe crisis in the 1930s. The reasons for the latter are less known. It is important to stress here that whereas in the Netherlands no legislation separating investment from commercial banking was enacted, banks themselves returned to trade financing and short-term credits again because they were concerned about liquidity ( Jonker, 1991 ; Westerhuis and de Jong, 2015 ). The reorganization of the Dutch banking system between 1921 and 1924 might be the reason why the Dutch banks were less affected by the Great Depression. In Sweden, the banking sector was also severely hit by the depression of the early 1920s, and returned to commercial banking in the 1930s, characterized by a revival of deposit banking. In contrast to the Dutch case, in Sweden new legislation prohibited shareholding and share purchasing by commercial banks in 1934. This had to do with a new political situation after the First World War, which called liberalism into question. However, in practice many large commercial banks did not dispose of their shareholdings, but transferred them to affiliated investment companies that were indirectly controlled by the banks ( Larsson and Lindgren, 1992 : 351).

The English banking sector had changed from a rather competitive to a very concentrated one between 1880 and 1920 ( Capie and Rodrik-Bali, 1982 ; Capie and Billings, 2004 ). In 1920 the Big Five, based in London, held around 80% of deposits and had about 10,000 branches ( Billings and Capie, 2011 : 197). This development has spurred much debate about the possible relationship between banking concentration, even called it a cartel (see e.g. Capie and Billings, 2004 ), and England’s slow economic growth since the First World War (e.g. Ross, 1996 ). The unwillingness of English banks to take a more active role in financing troubled industries has been attributed to the banks’ continuing concern about remaining liquid, resulting in banks focusing on short-term lending. However, this line of reasoning has been questioned more recently, by arguments that the British banking system offered ample support to its customers ( Ross, 1996 : 314; see also e.g. Ross, 1995 ; Collins, 1998 ; Baker and Collins, 2010 ). Moreover, the commercial banks represented only one source of external finance and operated in a much larger financial system. In other words, industrial investments were financed by institutions outside the banking system, such as stockbrokers and dealers. Due to specialization within the financial system ‘the transfer of ownership or the provision of large amounts of capital was not a function of banks, but of specialist markets and institutions which existed precisely for those purposes’ ( Ross, 1996 : 314). This specialization in credits and investments contrasts to the wide range of services offered by the German universal banks. Research on the interwar period (see James, Lindgren, and Teichova, 1991 ; Cottrell, Lindgren, and Teichova, 1992 ) shows that indeed the British capital markets were different from the ones in continental Europe in the late nineteenth and early twentieth centuries. Thus the British banks were not like the German ones, which however did not necessarily mean that they performed worse (see for this conclusion also Ross, 1995 : 274). Interestingly, the reverse has been argued: the fact that the Big Five were not universal banks, and their presumed conservatism ‘helped them to avoid the fate of banks elsewhere’ during the Great Depression of the 1930s ( Billings and Capie, 2011 : 211). Indeed England and Finland were the only two countries that did not experience a banking crisis in the interwar period.

In Japan the large number of banks was reduced by law in 1928 when the principle of one bank in one prefecture was adopted, giving the banks a monopoly in a limited area ( Allen and Gale, 2001 : 39). The essential decline in the number of banks was realized via mergers, which was facilitated by loans from the Bank of Japan. The state became directly involved in the financial system and increased that involvement even more in 1937 by a law that controlled loans to firms that were categorized as ‘favoured’. This had to do with the development of the economy, which became ‘increasingly dominated by investment requirements of militarism and imperial expansion’ ( Lazonick and O’Sullivan, 1997 : 123). With the 1937 law the state’s power became concentrated in a few zaibatsu . After the Second World War, when the Allied powers insisted on the dissolution or breaking-up of the zaibatsu , they met with little resistance from the Japanese people. However, because old- zaibatsu relations served as a basis for cross-shareholdings in the 1950s, a similar kind of institution emerged, but under a different name: keiretsu . The business groups or ‘keiretsu’ were centred around a former zaibatsu bank, known as main bank. The concept of main bank includes ‘the relationships and practices between a company and its principal bank which range from the provision of financial services to share swapping and includes the presence of the bank’s representatives on the company’s board of directors’ ( Canals, 1997 : 186). The main bank system in Japan is often compared to the Hausbank system in Germany, the main difference being that the Hausbank system developed in the private sector whereas for the main bank system the government was instrumental. The development of the main bank system went hand in hand with the cross-shareholding movement. As a result the Japanese system after the Second World War can be defined as a hybrid form: both the size of its financial markets and the development of its banking system has been substantial ( Lescure, 2008 : 323). At the same time, these banks could lend substantial funds to industrial firms, because the Bank of Japan lent at low rates to these city banks. Thus, once again the state played an important role in ensuring financial commitment to industry ( Lazonick and O’Sullivan, 1997 : 126).

To conclude, the interwar period clearly shows a break with the nineteenth and early twentieth centuries. Allen and Gale state that ‘different reactions to instability associated with financial markets led to two broad types of financial system: market vs bank based systems’ ( Allen and Gale, 2000 : 8). Divergence in financial systems took off after a series of banking crises, which exposed the instability of the existing system. In many countries, the divergence was marked by increasing intervention of the state. This was part of a broader development: the liberalism and laissez-faire attitude, dominant in most countries during the nineteenth and early twentieth centuries, came under fire. The period of high international expansion and trade ended and was followed by a refocus on national economies. Banking activities were brought back to national economies. Countries such as Japan and Italy, although being exceptional cases, show how the banking sector was even transformed to support militarism (Japan) or fascism (Italy).

The Resurgence of Universal Banks

The popularity of state intervention in the 1950s and 1960s, caused by the market failures of the Wall Street crash in 1929 and the following Great Depression in the 1930s, started to diminish in the 1970s when it became increasingly criticized. The banking sector was strongly impacted by structural changes in the world, most importantly the globalization of finance, financial deregulation, the creation of the European Union, and the developments in information and communication technologies (ICT). These led to increased competition on both sides of the bank’s balance sheet. On the assets side, commercial paper and bonds markets gave large firms an alternative for borrowing from banks. And on the liabilities side, new technologies, such as the internet, and deregulation gave households and firms more choices ( Rajan, 1998 ). The traditional intermediation function of commercial banks lost ground to (foreign) financial and non-financial companies, a process also known as financial disintermediation. These structural developments pressured banks to rethink their strategies. Before discussing these new strategies, the most important structural changes will be explained first.

Financial globalization was made possible by financial deregulation and new information technologies. The process started in 1971 with the collapse of the Bretton Woods system, the system of fixed exchange rates based on the US dollar. In response, many countries implemented a liberalization of capital movements. In continental Europe, a key driver for deregulation was the creation of the Single Market due to be completed by the end of 1992. For financial services this brought freedom of capital movements and the freedom for financial institutions to provide financial services and establish operations in all EU member states ( Benink, 1992 ). In the US the deregulation process is commonly dated to the Supreme Court decision in Marquette vs First of Omaha in 1978, which set in motion the relaxation and partial removal of interest rate ceilings through a process of competitive deregulation among different states. It reached its culmination with the Riegle–Neal Interstate Banking and Branching Efficiency Act replacing the McFadden Act of 1927, allowing banks to expand in different states, and the Gramm–Leach–Bliley Act of 1999, which fully repealed the Glass–Steagall Act of 1933 and the limitations it had put on bank activities, notably the separation of commercial and investment banking (see, for a summary, Sherman, 2009 ). In 1998 Japan followed by introducing the so-called Big Bang legislation.

One result of innovation was the emergence of high interest bearing instruments for investors. The market rates of these instruments were much higher than the rates commercial banks could offer. Consequently, commercial banks lost an important type of customer: the large depositors which formerly had been their main source of income. For firms it also became more attractive to borrow directly on the capital markets than from banks, due to the growth and internationalization of capital markets and the process of securitization. As a result, commercial banks’ lending activities started declining as well ( Canals, 1997 : 277). In sum, the traditional function of commercial banks—accept deposits and originate loans—came under pressure.

The institutional changes challenged commercial and universal banks, because they lost part of their traditional activities, namely financial intermediation, to the market and to foreign and non-financial competitors. Accordingly banks had to rethink their strategies and they started focusing on consolidation by mergers and acquisitions, internationalization, and product diversification. We will now elaborate on these new banking strategies.

As mentioned earlier, in the US the restrictions of the Glass–Steagall Act were gradually relaxed. In 1987 Banker’s Trust and Citicorp were among the first commercial banks to set up Section 20 subsidiaries to undertake underwriting activities. Many other banks followed as approval was given on a case-by-case basis. Also restrictions on bank’s crossing state borders were gradually lessened. Thus the Riegle–Neal of 1994 set up a timetable for relaxing rules and between 1994 and 1997 states had the option to permit interstate banking. It allowed for mergers between the largest US banks, creating some enormous financial conglomerates. Thus J.P. Morgan, which had become a worldwide investment bank, merged with Chase, which had developed into a retail bank. Citibank, active in the international market and focused on worldwide consumer banking, added international investment banking activities by merging with Travelers ( Slager, 2004 ).

In Japan three types of commercial banks had developed: city banks, regional banks, and foreign banks. The regional banks operated within a particular region and were specialized in providing services to local small and medium-sized companies and local governments. Most important, however, were the city banks, which had their headquarters in a large city and network of branches covering the country. Most of their lending was directed to large companies. In 1992 Japan had 13 city banks; four of them belonged to larger financial conglomerates offering a wide range of products and services: Mitsubishi, Mitsui, Sumitomo, and Fuyo. These city banks formed the centre of the Japanese main bank system, in which firms relied on direct bank finance and formed close relationships with a specific bank (Hodder and Tschoegl, 1984; Berglöf and Perotti, 1994 ). In the 1970s and 1980s Japanese banks showed a remarkable growth and became important players in the world’s rankings. This growth was severely hampered when the Japanese financial crisis in 1991 ended this positive development. Many banks ran into problems when borrowers went bankrupt and many could not pay back their loans. Problems deepened by an important regulation proposed by the BIS in 1988, which increased minimum capital requirements. After 1993 all Japanese banks had to comply. However, meeting these requirements brought many Japanese banks into even more problems ( Honda, 2002 ). Consequently, in the late 1990s, reforms known as the Japanese Big Bang were introduced to modernize the Japanese banking system, such as a gradual relaxation of restrictions on universal banking. Mergers and acquisitions between banks were allowed, resulting in the emergence of some large Japanese financial institutions.

In continental Europe many commercial banks diversified into investment banking in order to assist their large corporate clients to enter the money and capital markets. In so doing they increased their fee income compensating for the decreasing interest-income. European regulation further facilitated the diversification of commercial banks and consolidated the European model of universal banking. Thus the Second Banking Directive of 1989 permitted the development of bancassurance. Banks were allowed to provide insurance services, by either merging with or acquiring an insurance company or by creating their own subsidiaries in insurance. In the Netherlands, for example, structural supervision was relaxed by the end of the 1980s. It allowed for mergers between large banks and between banks and insurance companies. Four financial conglomerates emerged as a result: ABN AMRO, ING, Fortis, and Rabobank. They had a large international presence and provided a wide range of financial products and services to a wide range of clients ( Westerhuis, 2008 ). Even in England the four commercial banks that dominated the English banking sector—Barclays, National Westminster, Midland, and Lloyds—had in essence developed into universal banks. They provided a wide range of banking services to consumers and firms, and they also offered underwriting and other services through wholly owned subsidiaries. In France involvement of the state after the end of the Second World War had been important; the government dominated the allocation of credit via an encadrement system. By restricting the expansion of credit, it put limits on the lending autonomy of banks. The state also created public agencies to allocate credits to specific sectors of the economy ( O’Sullivan, 2007 ). By the end of the twentieth century the role of the state had become more modest though, whereas financial markets had expanded enormously. One of the exogenous reasons for this development was a systematic process of financial liberalization from 1984 onwards. In contrast, the German banking sector remained rather fragmented during the 1990s. Deutsche Bank, Dresdner Bank, and Commerzbank, the three largest commercial banks with branch networks over the whole country, were accompanied by cooperatives, savings banks, and Landesbanken.

A change in the Belgian law in 1967 abolished all restrictions on bond holdings by which the conditions for banks considering shareholdings were made more flexible. Another important step was taken in 1990 when, due to stock exchange reforms, banks were authorized to participate in listed firms ( Kurgan-van Hentenryk, 1995 : 55). It is important to note that it was not only politicians who decided to deregulate the banking sector. The Association Belge des Banques, founded in 1936, also convinced public authorities to make the rules more flexible, in order to be able to grasp new opportunities and counter the increasing pressures felt by the banks. From the late 1980s, as a result of deregulations the three big commercial banks created departments whose activities resembled those of investment banks and thus increased the share of non-interest income. Despite an increasing international presence, Belgian banks did not become as large as many other internationally operating banks; in other words they did not become global players. Kurgan-van Hentenryk (1995) sees in the absence of multinationals in Belgium and the increasing rise of foreign control of industry since the late 1980s the main reason for this development. Taxation on transferable incomes also led to a transfer of a large amount of savings to Luxembourg, The Netherlands, and Switzerland, so that for Belgian banks is was hard to attract sources locally ( Kurgan-van Hentenryk, 1995 : 61).

Thus a new type of universal bank with a large international presence and a broad range of activities developed (see Chapter 8 by Christopher Kobrak in this volume). The process by which these banks emerged often dates back to the late 1970s and is considered a reaction to the structural changes signalled here. However, in many countries (though not in Germany) the fragmentation in banking activities along segregation lines disappeared earlier than the 1970s. Already directly after the Second World War commercial or universal banks started to compete rather aggressively with savings and cooperatives banks on the home market for household savings. Households turned to banks for administering their rising wages, savings, and pensions, whereas the commercial banks were anxiously trying to strengthen their capital base for financing the reconstruction effort. Commercial banks, which before the Second World War often focused on firms and wealthy individuals, now also targeted private households, broadening their range of customers and increasing their types of financial services and products (diversification). On the other hand, cooperatives, traditionally focused on agri-businesses, also started broadening their scope to private households and small and medium-sized firms. For example, in the Netherlands the amount of debt increased enormously during the 1960 and 1970s, as a result of both mortgages and consumer credits, consisting of personal loans, revolving credits, and buying on hire purchase.

The financial conglomerates, as they may be called, are extremely large and in many countries they have become an important part of the economy, as is shown by their large share of gross domestic product (GDP). They are different from the universal banks of the late nineteenth century. They differ in types of activities and clients, as well as in organizational structure. The financial conglomerates combine hierarchy with autonomy and accountability at all levels, while the centre exercises control through explicit management tools, including budgeting and planning. By taking into account banks in the US and Western Europe, Kipping and Westerhuis (2014) argue that many banks had already become more managerial in the late 1960s and 1970s. The banks adopted a multidivisional organizational structure and in so doing the authors show that they started to move away from being traditional banking institutions to become more dynamic and aggressive. It might be that the roots of more risky behaviour in the banking sector, as exposed during the 2008 financial crisis, are related to these organizational changes. However, Kipping and Westerhuis also stress that more research is needed to fully understand this process of change, by which for example also bankers themselves had to become ‘managers’ ( Kipping and Westerhuis, 2014 ).

Concluding Remarks

The chapter has shown that the dichotomy between market-based versus bank-based systems as the two main forms of financial systems is oversimplified. In particular, historical research has played an important role in nuancing the picture. Thus in many countries commercial banks developed into universal banks in the nineteenth and early twentieth century. Only in the interwar period did countries diverge into specialized versus universal banks, and since the 1980s a revival of the universal banks has taken place. This chapter has mostly focused on exogenous factors, such as formal rules and regulation, as an explanation for changes in financial systems. It should be stressed, however, that this is only part of the story. Individual banks and their bankers are important actors that decide on goals and strategies influencing the context they operate in ( Kipping and Westerhuis, 2014 ).

An important characteristic of commercial banking is its close links with industry. The many studies of commercial banking in the nineteenth and early twentieth centuries made clear that in assessing their role in the industrialization process, one should bear in mind that for financing companies had options other than banks. Thus in the debate on the relation between banks and industrialization one often assumes that long-term credit was essential for industrialization and that this was seldom granted by commercial banks. However, it turns out that in many countries alternatives were present, such as retained earnings, family capital, wealthy entrepreneurs, and short-term loans that were rolled over or prolonged. These findings imply that in order to assess the financing of industry one should not just focus on markets or banks but on the financial system as a whole. This is an important consideration, because with the 2008 financial crisis the issue has become relevant once again. Policy makers are increasingly concerned with the financing relation between banks and medium-sized enterprises (SMEs). The current financial institutions focus mostly on more profitable investment and asset management activities, and are reluctant to finance SMEs, because of relatively high monitoring costs, it is argued. Large firms are no longer restricted to domestic financial institutions. Instead, due to financial globalization, they increasingly use foreign markets. However, for many modes of market finance SMEs are too small to utilize them economically. For them bank debt is still the most important source of external finance ( Deeg 2009 ; Westerhuis and De Jong, 2015 ).

An important factor for explaining differences and nuances in the development of financial systems is the institutional context. Lescure concludes that financial systems ‘are a result of a lot of different forces and the way these forces interact vary according to the context in which they operate’ ( Lescure, 2008 : 338). Tilly argues that differences in the political histories and structures of Germany, Great Britain, and the US in the nineteenth and early twentieth century seem to have been important determinants of the institutional differences in banking and how it developed over this period ( Tilly, 1989 : 206). Particularly interesting in this respect is the fact that commercial banks have been regulated separately from other financial institutions in most countries. This typical feature of commercial banking is not self-evident, however, and it has been the breeding ground for many questions. To what extent should commercial banking be regulated? Is competition or consolidation more efficient for commercial banks? Should commercial banking and investment banking be separated or combined? What about nationwide branching versus one unit banking? Behind these questions lies a more general debate on whether or not state regulation or market forces stabilize institutional structures (Cassis, 1996: 2). The 2008 financial crisis and its worldwide impact makes this debate all the more relevant again.

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Banking Crises in Historical Perspective

This article surveys the recent empirical literature on historical banking crises, defined as events taking place before 1980. Advances in data collection and identification have provided new insights into the causes and consequences of crises both immediately and over the long run. We highlight three overarching threads that emerge from the literature: first, leverage in the financial system is a systematic precursor to crises; second, crises have sizable negative effects on the real economy; and third, government interventions can ameliorate these effects. Contrasting historical episodes reveals that the process of crisis formation and evolution varies significantly across time and space. Thus, we also highlight specific institutions, regulations and historical contexts that give rise to these divergent experiences. We conclude by identifying important gaps in the literature and discussing avenues for future research.

We thank Effi Benmelech, Michael Bordo, Mark Carlson, Eric Hilt, Eric Monnet, Dimitris Papanikolaou, Kenneth Rogoff, Alan Taylor and an anonymous reviewer for very helpful comments. Olena Bogdan, Isabella Grace Duncan, William Halverson, and Qirui Wang provided excellent research assistance. The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research.

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Carola Frydman & Chenzi Xu, 2023. " Banking Crises in Historical Perspective, " Annual Review of Financial Economics, vol 15(1).

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• Understanding Banking History

Banking in the Roman Empire

European monarchs discover easy money, adam smith gives rise to free-market banking, merchant banks come into power, j.p. morgan rescues the banking industry, the end of an era, the birth of the fed, world war ii and the rise of modern banking, banking goes digital.

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The Evolution of Banking Over Time

From the ancient world to the digital age

Banking has been in existence since the first currencies were minted and wealthy people realized they needed a safe place to store their money. Ancient empires also needed a functioning financial system to facilitate trade, distribute wealth, and collect taxes. Banks were to play a major role in that, just as they do today.

Key Takeaways

• Religious temples became the earliest banks because they were seen as safe places to store money.
• Before long, temples got into the business of lending money at interest, much as modern banks do.
• By the 18th century, many governments gave banks a free hand to operate, based on the theories of economist Adam Smith.
• Numerous financial crises and bank panics over the decades eventually led to increased regulation.

Banking Is Born

The barter system of exchanging goods for goods worked reasonably well for the earliest communities. It prove problematic as soon as people started traveling from town to town in search of new markets for their goods and new products to take home.

Over time, coins of various sizes and metals began to be minted to provide a store of value for trade.

Coins, however, need to be kept in a safe place, and ancient homes did not have steel safes. Wealthy people in Rome stored their coins and jewels in the basements of temples. They were seen to be secure, given the presence of priests and temple workers, not to mention armed guards.

Historical records from Greece, Rome, Egypt, and Babylon suggest that temples loaned money in addition to keeping it safe. The fact that temples often functioned as the financial centers of their cities is one reason why they were inevitably ransacked during wars.

Coins could be exchanged and hoarded more easily than other commodities, such as 300-pound pigs, so a class of wealthy merchants took to lending coins, with interest , to people in need of them. Temples typically handled large loans, including those to various sovereigns, while wealthy merchant money lenders handled the rest.

The Romans, who were expert builders and administrators, extricated banking from the temples and formalized it within distinct buildings. During this time, moneylenders still profited, as loan sharks do today, but most legitimate commerce—and almost all government spending—involved the use of an institutional bank.

According to the World History Encyclopedia, Julius Caesar initiated the practice of allowing bankers to confiscate land in lieu of loan payments. This was a monumental shift of power in the relationship of creditor and debtor , as landed noblemen had previously been untouchable, passing debts on to their descendants until either the creditor’s or debtor’s lineage died out.

The Roman Empire eventually crumbled, but some of its banking institutions lived on in the Middle Ages through the services of papal bankers and the Knights Templar. Small-time moneylenders who competed with the church were often denounced for usury .

Eventually, the monarchs who reigned over Europe noted the value of banking institutions. As banks existed by the grace—and occasionally, the explicit charters and contracts—of the ruling sovereignty, the royal powers began to take loans, often on the king’s terms, to make up for hard times at the royal treasury.

This easy access to financing led kings into gross extravagances, costly wars, and arms races with neighboring kingdoms, not to mention crushing debt.

In 1557, Philip II of Spain managed to burden his kingdom with so much debt due to several pointless wars that he caused the world’s first national bankruptcy —as well as the world’s second, third, and fourth, in rapid succession. These events occurred because 40% of the country’s gross national product (GNP) went toward servicing the nation's debt.

The practice of turning a blind eye to the creditworthiness of powerful customers continues to haunt banks today.

Banking was already well-established in the British Empire when economist Adam Smith introduced his invisible hand theory in 1776. Empowered by his views of a self-regulating economy, moneylenders and bankers managed to limit the state’s involvement in the banking sector and the economy as a whole. This free-market capitalism and competitive banking found fertile ground in the New World, where the United States of America was about to emerge.

In its earliest days, the United States did not have a single currency. Banks could create a currency and distribute it to anyone who would accept it. If a bank failed, the banknotes that it had issued became worthless. A single bank robbery could crush a bank and its customers. Compounding these risks was a cyclical cash crunch that could disrupt the system at any time.

Alexander Hamilton , the first secretary of the U.S. Treasury, established a national bank that would accept member banknotes at par , thus keeping banks afloat through difficult times. After a few stops, starts, cancellations, and resurrections, this national bank created a uniform national currency and set up a system by which national banks backed their notes by purchasing Treasury securities , thus creating a liquid market . The national banks then pushed out the competition through the imposition of taxes on the relatively lawless state banks .

The damage had been done, however, as average Americans had grown to distrust banks and bankers in general. This feeling would lead the state of Texas to outlaw corporate banks with a law that stood until 1904.

Most of the economic duties that would have been handled by the national banking system, in addition to regular banking business like loans and corporate finance , soon fell into the hands of large merchant banks . During this period, which lasted into the 1920s, the merchant banks parlayed their international connections into enormous political and financial power.

These banks included Goldman Sachs ; Kuhn, Loeb & Co.; and J.P. Morgan & Co. Originally, they relied heavily on commissions from foreign bond sales from Europe, with a small backflow of American bonds trading in Europe. This allowed them to build capital.

As large industries emerged and created the need for major corporate financing, the amounts of capital required could not be provided by any single bank. Initial public offerings (IPOs) and bond offerings to the public became the only way to raise the amount of money needed.

Successful offerings boosted a bank’s reputation and put it in a position to ask for more to underwrite an offer. By the late 1800s, many banks demanded a position on the boards of the companies seeking capital, and if the management proved lacking, they ran the companies themselves.

J.P. Morgan & Co. emerged at the head of the merchant banks during the late 1800s. It was connected directly to London, then the world’s financial center, and had considerable political clout in the United States.

Morgan & Co. created U.S. Steel, AT&T, and International Harvester, as well as duopolies and near- monopolies in the railroad and shipping industries, through the revolutionary use of trusts and a disdain for the Sherman Antitrust Act .

It remained difficult, however, for average Americans to obtain loans or other banking services. Merchant banks didn’t advertise and rarely extended credit to the “common” people. Racism was widespread. Merchant banks left consumer lending to the lesser banks, which were still failing at an alarming rate.

The collapse in shares of a copper trust set off the Bank Panic of 1907 , with a run on banks and stock sell-offs. Without a Federal Reserve Bank to take action to stop the panic, the task fell to J.P. Morgan personally. Morgan used his considerable clout to gather all the major players on Wall Street and persuade them to deploy the credit and capital that they controlled, just as the Fed would do today.

Ironically, Morgan’s move ensured that no private banker would ever again wield that much power. In 1913, the U.S. government formed the Federal Reserve Bank (the Fed). Although the merchant banks influenced the structure of the Fed, they were also pushed into the background by its creation.

Even with the establishment of the Fed, enormous financial and political power remained concentrated on Wall Street. When World War I broke out, the United States became a global lender, and by the end of the war, it had replaced London as the center of the financial world.

At that point, the government decided to put some handcuffs on the banking sector. It insisted that all debtor nations pay back their war loans—which traditionally were forgiven, especially in the case of allies—before any American institution would extend them further credit.

This slowed world trade and caused many countries to become hostile toward American goods. When the stock market crashed on Black Tuesday in 1929, the already-sluggish world economy was knocked out. The Fed couldn’t contain the damage, which led to some 9,000 bank failures from 1929 to 1933.

New laws emerged to salvage the banking sector and restore consumer confidence. With the passage of the Glass-Steagall Act in 1933, for example, commercial banks were no longer allowed to speculate with consumers’ deposits, and the Federal Deposit Insurance Corp. (FDIC) was created to insure accounts up to certain limits. The insured limit as of 2023 is $250,000 per account.

World War II may have saved the banking industry from complete destruction. For the banks and the Fed, the war required financial maneuvers involving billions of dollars. This massive financing operation created companies with huge credit needs that, in turn, spurred banks into mergers to meet the demand. These huge banks spanned global markets.

More importantly, domestic banking in the United States finally settled to the point where, with the advent of deposit insurance and widespread mortgage lending , the average citizen could have confidence in the banking system and reasonable access to credit. The modern era had arrived.

The most significant development in the world of banking in the late 20th and early 21st centuries has been the advent of online banking , which in its earliest forms dates back to the 1980s but really began to take off with the rise of the internet in the mid-1990s.

The growing adoption of smartphones and mobile banking apps further accelerated the trend. While many customers continue to conduct at least some of their business at brick-and-mortar banks, a 2021 J.D. Power survey found that 41% of them have gone digital-only.

What Does a Central Bank Do?

A central bank is a financial institution that is authorized by a government to oversee and regulate the nation’s monetary system and its commercial banks. It produces and manages the nation's currency. Most of the world’s countries have central banks for that purpose. In the United States, the central bank is the Federal Reserve System.

Who Regulates Banks in the U.S. Today?

Depending on how they are chartered, commercial banks in the United States are regulated by a number of government agencies, including the Federal Reserve, the Office of the Comptroller of the Currency (OCC) , and the Federal Deposit Insurance Corp. (FDIC).

State-chartered banks are also regulated by the state in which they do business.

Investment banks are largely regulated by the U.S. Securities and Exchange Commission (SEC) .

What Is the Difference Between a Commercial Bank and an Investment Bank?

Commercial banks provide services to the general public and to businesses. They take deposits, issue loans, and operate ATMS.

Investment banks provide services only to large companies, institutional investors , and some high-net-worth individuals . Those services include helping companies raise money by issuing stocks or bonds or obtaining loans. They may also be deal-makers, facilitating corporate mergers and acquisitions.

Investopedia / Yurle Villegas

Banks have come a long way from the temples of the ancient world, but their basic business practices have not changed much. Although history has altered the finer points of the business model, a bank’s purposes are still to make loans and to protect depositors’ money.

Even today, where digital banking and financing are replacing traditional brick-and-mortar locations, banks still perform these fundamental functions.

World History Encyclopedia. “ Banking in the Roman World .”

World History Encyclopedia. “ Caesar as Dictator: His Impact on the City of Rome .”

World History Encyclopedia. " Knights Templar ."

New World Encyclopedia. “ Philip II of Spain .”

Adam Smith Institute. “ The Theory of Moral Sentiments .”

JSTOR. " Banks' Own Private Currencies in 19th-Century America ."

Office of the Historian, United States House of Representatives. " The First Bank of the United States ."

Federal Reserve History. " National Banking Acts of 1863 and 1864 ."

Texas Department of Banking. " History of the Banking Industry in Texas and the Department ."

National Bureau of Economic Research. " Banks, Insider Connections, and Industrialization in New England: Evidence from the Panic of 1873 ."

JPMorgan Chase & Co. " History of Our Firm ."

National Bureau of Economic Research. " Did J. P. Morgan's Men Add Value? An Economist's Perspective on Financial Capitalism ," Table 6.2.

Federal Reserve History. “ The Panic of 1907 .”

Federal Reserve History. " Overview: The History of the Federal Reserve ."

East Tennessee State University. " Neither a Borrower Nor a Lender Be: America Attempts to Collect its War Debts 1922-1934 ," Pages 5-6.

Federal Deposit Insurance Corp. “ The First 50 Years: A History of the FDIC .”

Federal Reserve History. " Banking Act of 1933 (Glass-Steagall) .

Federal Deposit Insurance Corporation. " Deposit Insurance at a Glance ."

J.D. Power. “ U.S. Retail Banks Nail Transition to Digital During Pandemic, J.D. Power Finds .”

Board of Governors of the Federal Reserve System. " About the Fed ."

Federal Reserve Bank of San Francisco. “ Are All Commercial Banks Regulated and Supervised by the Federal Reserve System, or Just Major Commercial Banks? ”

U.S. Securities and Exchange Commission. " The Role of the SEC ."

• A Primer on Important U.S. Banking Laws 1 of 29
• Dodd-Frank Act: What It Does, Major Components, and Criticisms 2 of 29
• Major Regulations Following the 2008 Financial Crisis 3 of 29
• Too Big to Fail: Definition, History, and Reforms 4 of 29
• Volcker Rule: Definition, Purpose, How It Works, and Criticism 5 of 29
• Understanding the Basel III International Regulations 6 of 29
• What Is Basel I? Definition, History, Benefits, and Criticism 7 of 29
• Basel II: Definition, Purpose, Regulatory Reforms 8 of 29
• Basel III: What It Is, Capital Requirements, and Implementation 9 of 29
• What Basel IV Means for U.S. Banks 10 of 29
• A Brief History of U.S. Banking Regulation 11 of 29
• The Evolution of Banking Over Time 12 of 29
• How the Banking Sector Impacts Our Economy 13 of 29
• What Agencies Oversee U.S. Financial Institutions? 14 of 29
• Dual Banking System: Meaning, History, Pros and Cons 15 of 29
• Glass-Steagall Act of 1933: Definition, Effects, and Repeal 16 of 29
• Bancassurance: Definition, How It Works, Pros & Cons 17 of 29
• Electronic Fund Transfer Act (EFTA): Definition and Requirements 18 of 29
• Bank Secrecy Act (BSA): Definition, Purpose, and Effects 19 of 29
• How Banking Works, Types of Banks, and How To Choose the Best Bank for You 20 of 29
• Chartered Bank: Explanation, History and FAQs 21 of 29
• Nonbank Financial Institutions: What They Are and How They Work 22 of 29
• Shadow Banking System: Definition, Examples, and How It Works 23 of 29
• Islamic Banking and Finance Definition: History and Example 24 of 29
• What Is Regulation E in Electronic Fund Transfers (EFTs)? 25 of 29
• What Is Regulation CC? Definition, Purpose and How It Works 26 of 29
• Regulation DD: What it is, How it Works, FAQ 27 of 29
• Regulation W: Definition in Banking and When It Applies 28 of 29
• Deregulation: Definition, History, Effects, and Purpose 29 of 29

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Foreign Currency Liquidity Risk Management at Japanese Major Banks: Efforts and Enhancement

May 22, 2024 Financial System and Bank Examination Department, Bank of Japan Strategy Development and Management Bureau, Financial Services Agency

• Full Text [PDF 779KB]

Securing stable foreign currency liquidity is one of the most important issues for Japanese major banks, as it is the basis of the expansion of their overseas businesses. The March 2023 banking turmoil in the United States and Switzerland shed new light on the importance of managing liquidity risk. Against this background, major banks have been enhancing their risk management through foreign currency liquidity stress testing based on more conservative and appropriate stress scenarios, early warning frameworks, and prompt and accurate liquidity data management. The Financial Services Agency and the Bank of Japan have supported these efforts through initiatives including joint surveys. As a result, major banks' resilience to foreign currency liquidity risk has steadily improved. However, there remains room for further enhancement. Going forward, banks are expected to continue their efforts to further enhance their risk management in line with changes in the risk profiles of their overseas businesses and the external environment.

The Bank of Japan Review Series is published by the Bank to explain recent economic and financial topics for a wide range of readers. This report, 2024-E-3, is a translation of the Japanese original, 2024-J-7, published in May 2024.

If you have any comments or questions, please contact Financial System and Bank Examination Department (E-mail : [email protected]).

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Historic christian leader annual scholarship offers student research opportunity and university scholarship.

The Mary Helen and Bill George Annual Scholarship for the Study of Historic Christian Leaders

Established through a generous donation, Waynesburg University will offer The Mary Helen and Bill George Annual Scholarship for the Study of Historic Christian Leaders to eligible applicants.

This is a great opportunity for our students to apply themselves to the rigor of research, writing and presenting at the graduate level." Josh Sumpter

The fund will provide an annual scholarship that encourages and inspires a student at Waynesburg University to study and write about a Christian leader in historical context along with his or her application of leadership skills. The scholarship will cover tuition, room and board over a 12-month period for a student in return for their research.

Over time, the goal of this scholarship is to develop a library of scholarly research related to understanding the leadership characteristics of significant Christian leaders and their impact on the world, available on campus.

 “This is a great opportunity for our students to apply themselves to the rigor of research, writing and presenting at the graduate level,” said Josh Sumpter, assistant professor of Biblical and Ministry Studies and University Chaplain. “This scholarship is consistent with our mission at Waynesburg University, where students make connections between faith, serving and learning so that they may faithfully impact their communities and the world. I am looking forward to working with our applicants as they grow in faith, in knowledge and in the ways that they grow as Christian leaders themselves through this project.”

Current Waynesburg University undergraduate juniors and seniors as well as graduate students, including graduate assistants, may apply for The Mary Helen and Bill George Annual Scholarship for the Study of Historic Christian Leaders.

Candidates must submit a research proposal for review and consideration along with completing a brief application. The scholarship recipient will be mentored by a member of the selection committee, who will also help in the development and review of the research paper. After completing the research and paper, the recipient will share their work in a public forum on campus.

Applications for the inaugural scholarship are currently being accepted for the 2024-2025 academic year and are due by Monday, June 17. For more information, please contact Sumpter at [email protected] .

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I.C.C. Prosecutor Requests Warrants for Israeli and Hamas Leaders

The move sets up a possible showdown between the international court and israel with its biggest ally, the united states..

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This week, Karim Khan, the top prosecutor of the International Criminal Court, requested arrest warrants for Israel’s prime minister, Benjamin Netanyahu, and the country’s defense minister, Yoav Gallant.

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On today’s episode

Patrick Kingsley , the Jerusalem bureau chief for The New York Times.

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Why did a prosecutor go public with the arrest warrant requests ?

The warrant request appeared to shore up domestic support for Mr. Netanyahu.

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