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
2
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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