1. Prof. Dr. John JA Burke
Securities and Banking Law for Foreign Direct Investment in Emerging
Markets
HISTORY OF BANKING
2. Sources of Funds
Type Debt Capital Equity Capital
Informal Sources Loans from owners Retained earnings
Informal external Loans from family, Investments by
sources and friends, trade informed
credit, brokers participants
Financial Lending by Some Joint Stock
intermediaries financial Companies
institutions [banks]
Public Markets Bond issues Stock Issues
Source: P. Temin, Financial Intermediation in the Early Roman Empire, MIT
3. Banks
Credit intermediaries
Banks are financial institutions that accept
deposits and make loans
Banks obtain funds by borrowing [taking deposits]
and acquire assets through lending or purchase of
securities
Deposits are bank liabilities
Loans are bank assets
4. Interest Rate Spread
Pay no or low percentage interest on
liabilities [the deposits]
Demand deposits: 0
Savings: low interest rate
Time: Higher rate [Money is committed]
Charge higher rate of interest on assets
loans]
Spread is earnings
5. Financial Systems
Facilitate pooling of funds
Aggregation of household wealth
Fund indivisible or efficient-scale enterprises
Without “pooling” firm size would be
constrained by wealth of single or few
households
Banks solve problem of information
asymmetry
Assume risk of non-payment
6. Agricultural Societies: Roman
Empire
Banks are unnecessary
Large landholders have excess income
[savers]
Large landholders also are investors
Intermediation therefore is unnecessary
No asymmetric information
7. Institutions: Solve Asymmetry
Merchants
Engaged in repetitive transactions with other
merchants
Merchant that pays bills on time is quite likely to
pay a loan on time
Brokers
Bring lenders and borrowers together
Find people who want to lend
Find people who want to borrow
8. Progression of Financial Sytem
Internal sources of capital
No financial system at all
Informal external sources
Limited financial system
Financial intermediation
Very good financial system
Public capital markets
Advanced industrial financial system
9. History
Most advanced capital markets were located
in Amsterdam and London
Merchant banking
E.g., 1500’s Medici Family in Italy, Fuggers in Germany
Wealthy merchants would extend credit to their
customers and to governments
Private loans, involving only the capital of the
merchant (no depositors)
Activity was in certain cases so profitable that it
overshadowed their trading activity and became their
main business.
10. Contemporary Merchant Banks
Merchant banks today classically defined as investment
banks.
Fortis is a current example of the classical European merchant
bank (rare)
Merchant/Investment banks were organized as partnerships
In U.S., investment banks started in this same vein, such
as Morgan Stanley, Goldman Sachs
Use their own capital to finance corporate underwriting
Today, many investment banks are public firms, so they
now risk outside investor money (although not
depositors)
11. Merchant Banks
Value of Reputation
Merchant banks are successful only as far as their
reputation
Credit works only if counterparties are credible
Credit markets prefer reputations with longer life
than an individual, hence the family unit
Longer lived reputations include corporations
and government entities
12. The Bill of Exchange
The bill of exchange is a specialized type of negotiable
instrument commonly used to expedite foreign money
payments in any type of international transaction
Purpose:
1. Act as a substitute for money;
2. Act as a financing or credit device
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13. Bills of Exchange are Governed Today
US = Uniform Commercial Act
England = Bills of Exchange Act
More than 20 countries = 1930 Convention on
Bills of Exchange and Promissory Notes
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14. Brief Requirements of a Bill of
Exchange
1. An unconditional order in writing;
2. Addressed by one person to another;
3. Signed by the person giving it;
4. With the requirement that the person to whom it is
addressed pay on demand or at a fixed or determinable
future time;
5. A sum certain in money;
6. To or to be in order of a specified person, or to bearer
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15. Negotiation is defined
Negotiation is the transfer of an instrument
from one party to another so that the
transferee (called a holder) takes the legal
rights in the instrument
Purchase and sale of bills of exchange
facilitated credit intermediation
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16. BE: How it Works
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1 Exporter Bill of Exchange Bank
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3
$97,000
Bill of Exchange Signed Bill
Goods
$100,000
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Importer
Assumptions: Bill of Exchange
3 months to pay the bill
Bank buys at discount
17. Slight Variation: Interpose a Bank
Exporter Discount Sale Bank
Return
Exporter asks banks to accept the bill
Presents for $100,000
Bank accepts because it will be repaid 100 000 in 3 months
Accepts
Importer Accepting Bank
Accepting Bank recovers
from Importer or better its
bank
18. Back to Original Merchant Banks
Merchant would issue a promissory note
Bill obligatory
Merchants borrowed on their good names
Bill could be sold in England
Would not travel far because holder had to go to
borrower for re-payment
19. Historical Route
• Rome
1 • Internal and Informal Sources of Capital
• Italy and France
2 • Precursors of Merchant Banking
• Amsterdam and London
3 • Financial Intermediation
• US
4 • Global
• Complex capital markets
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