For many hundreds of years, nations have depended on the services of their everyday banking institutions. The role which banks have played in the development of government, trade and the day to day fabric of our societies places them squarely at the forefront of modern life. Today, with the advent of digital payments and contactless technology, our daily transactions look vastly different to how they would have for many years, but the core products which banks offer has changed very little. In order to understand how the commercial banks of today have evolved we need to look at what makes a bank tick, and how the services they’ve developed influence almost every part of our lives.
The Roots of Banking
The term “bank” actually comes from the Italian term banco, meaning “desk” or “table”. This is a literal description of how the original Italian bankers would operate; they would spread a green tablecloth on a desk, and conduct their business from there. Of course, the idea of lending money was not invented by the Italians, and since the dawn of civilisation there have been merchant financers who created a system to back travelling traders. What we know of today as a bank, though, came to prominence in Renaissance Italy.
In the 14th and 15th centuries, Italian culture underwent a dramatic change – the country became the world’s centre of art and philosophy, and many individuals became exceedingly wealthy. Families such as the Medici dynasty were well-known for their vast wealth, and spent huge amounts of money on artistic and philanthropic sponsorship. With such enormous amounts of money around, a systemised method for managing it was necessary, which led to the birth of the famous Italian banking houses (the Medicis were in fact a banking family, and rose to prominence thanks to their financial talents). The Banca Monte dei Paschi di Siena in Siena, Italy, was founded during this period, and is still operating today; it is the world’s longest continuously trading bank, having remained in business since 1472.
These family banks offered services which would look familiar to us today, and the basic operation of a commercial bank has changed little in the past five centuries; a bank accepts deposits from clients with a promise to keep their valuables safe. They also pay interest on the deposit, incentivising customers to deposit with them rather than investing elsewhere or simply holding on to their money. The bank then uses their customers’ deposits to finance loans to other clients, on which they charge a higher rate of interest than they pay out on their deposits. In essence, banks operate like any other merchant; they provide a product (a loan) in exchange for a price (the interest), and make a profit in doing so because they pay less to their depositors than they receive from their borrowers.
This basic system has remained the staple operation of commercial banks throughout history, with several key innovations which have driven change. Banking has evolved to cater to the needs of many different individuals, and over the course of the past few centuries several distinct variants on commercial banking have appeared.
The Evolution of Banking
The system of banking which was developed during the Renaissance was suited to the needs of extremely wealthy individuals and families. Banks made their money by receiving large deposits and financings large loans, which meant that their clientele was generally restricted to those customers who were sufficiently wealthy to need their services.
In the late 1700s, though, two distinctly different forms of bank sprang up as alternatives to commercial banking; the Trustee Savings Bank and building societies. These two forms of banking provided a genuine competitor to commercial banks for the first time in hundreds of years, and changed the face of modern banking.
Trustee Savings Banks
The goals of a trustee savings bank could not be further from those of a commercial bank; instead of aiming to make a profit by financing loans, these banks prioritised safety and dependability above all else. The first trustee savings bank was set up by a parish priest in a small English village specifically so that his poorest parishioners would have a savings option. The concept proved so popular that within a hundred years there were trustee saving banks all over the country, with millions of pounds in assets collectively. Over time, the “TSBs” gradually drew closer and closer together until in the 20th century they were essentially one organisation, which they eventually incorporated under in the 1980s. The “TSB” was bought out by Lloyd’s in 1995, but was sold again in 2013 and now operates under its own name.
Trustee Savings Banks were quasi-governmental in operation, because they worked very closely with the government to provide rock-solid investments for their depositors. A large portion of the TSB’s assets would be placed in Government bonds, since these were more reliable than loans or shares, and provided a better guarantee for their clients.
Nowadays, many building societies are nearly identical to commercial banks on the surface. However, when they were first formed, building societies were a revolutionary new concept which swept across the nation; within only a few decades of the first building societies being formed, there was one in almost every town. The widespread success of these organisations gave them a large share of the market, and though there are only a few dozen still trading today (Nationwide being the largest of these), their popularity forced commercial banks to compete and offer similar products.
The basic concept of a building society is that instead of funding loans with depositor’s money, their deposits are used to finance the construction of property. This property will then belong to the investors; typically, this will be organised so that each investor contributes regularly to the “pool” of funds, and eventually the money will be used to build them a house. A “closed” building society has a set number of members and will be disbanded once every member has a home, whereas an “open” society allows new members to join continually.
Another key difference between a building society and a commercial bank is that anyone who deposits with a building society becomes a voting member of that organisation, much like a shareholder in a bank would. They have a right to vote on important matters, and towards the end of the 20th century many of these building societies held votes to decide whether they should “demutualise” and convert into regular commercial banks. The members of many societies chose to do so, causing the building society sector to shrink from hundreds to dozens of organisations in a few short years – many banks today were originally building societies, such as Halifax and Alliance & Leicester (now Santander).
Impact on Commercial Banking
The diversification of the banking industry had a profound effect on commercial banks. No longer were they the only option for savers; there were thousands of competitors, all offering different services to cater to different people, and though these banks were usually tiny in comparison to the established banks, collectively they began to eat up a fair share of the market.
Realising that there was an opportunity to reach a whole new market, commercial banks began to diversify and offer services that were previously unheard of. New saving products and loans became available, and now almost anyone could open a savings or current account with a major bank, taking advantage of their experience and professionalism built up over hundreds of years. Of course, not every bank followed this trend, and many specialised in high net worth individuals or private banking. Others still catered to both markets, offering highly specialised services for the very wealthiest individuals, whilst also providing mass-market financial services for those with smaller budgets. A good example of this is HSBC, who operate an extensive system of high-value “family offices” across the world, whilst also leading the market in day to day financial products and investment banking.
So what does a commercial bank do, and what products do they offer? We’ve seen that they provide general financial services, but what does this mean for consumers? There are several key aspects to the services of a commercial bank, which are outlined below.
This is the most common product which customers take advantage of, and something which very few people can do without. There are several benefits to depositing earnings with a bank, rather than investing it or holding on to it:
- Earning Interest
Depending on the type of account and the terms of the agreement, the interest you earn could be just enough to keep up with inflation or enough to grow your money slowly over time. Either way, the slow creep of inflation means that money which isn’t earning interest is essentially depreciating in value, albeit slowly.
Originally, banks had to be incredibly secure buildings, with impregnable vaults to protect their customers’ deposits. Nowadays, with the majority of transactions taking place online, banks can afford to hold smaller reserves of cash in-branch and in their central reserves, but the security of their customers is their top priority. In addition to this, the Financial Services Compensation Scheme backs depositors’ savings up to £70,000 in the event that the bank is unable to repay. This means that “runs” on the bank are unlikely, and savers have a guarantee that no matter what happens, they’ll be able to get their money back.
Money that’s invested in stocks and shares must be liquidated before it can be spent, a process which can take several weeks to complete. Money that’s held in a bank can be accessed from any high street cash machine or bank branch, can be spent directly with a debit card or spent online without ever leaving your seat. A bank account provides consumers with unprecedented access to their own money, and allows them to spend it in a dazzling variety of ways.
Commercial banks will always offer a variety of different services to consumers in order to attract a different set of customers; one bank may offer a rewarding interest rate, whilst another may trade on their innovative savings scheme. What they all have in common, though, is that they reward savers with a safe and secure way to save.
This is the flip side of the savings options that commercial banks offer; the money which is deposited into their accounts is used to finance loans to those in need of funding. This can be provided in a variety of formats, and the most common ways in which banks loan money are outlined here.
- Home Loans and Mortgages
When you’re looking to buy a house, most people will turn to a commercial bank for help with the finances. The large size of these loans and the long terms over which they’re repaid mean they’re the most important financial decision most people are ever likely to make, and so the reliability of a lender is of the utmost importance. Mortgages are typically offered with a variety of options to suit different borrowers, and the types of interest rate on offer usually allow buyers to find a mortgage which suits their particular circumstances. Mortgages are “secured” loans, which mean that the buyer’s home is collateral against the loan. Should the homeowner fall behind on their payments, the bank is permitted to repossess and sell the property in order to recoup their initial investment.
- Unsecured & Personal Loans
Many people take out loans for non-specific purposes, or simply to cover costs over a short period. A homeowner looking to remodel their kitchen, for example, could take out a loan of several thousand pounds to help cover the costs in the short term, and could then spread their repayments out over several months. This helps people to work to a schedule which suits them; they don’t have to save up for months to buy something they need today. Instead, they can buy it upfront and pay it off as they earn over time.
Lending is an important part of any commercial bank’s operations, and it’s also vital for the UK economy. Borrowing money allows people to spend without being constrained by the total of their bank balance (though of course banks carry out checks to ensure that borrowers can meet repayments), and this helps to keep the economy active.
Impact of Digital Revolution on the Commercial Banking Sector
The face of banking has changed more in the past ten years than it did in the preceding five hundred. A visitor from Renaissance Italy would still recognise the branch banks of the 1930s as essentially performing the same function as he did at his banco, but the digitised transactions of today would leave him scratching his head. Many of the functions which a bank teller would traditionally perform are now carried out remotely by a computerised system, which means there are fewer and fewer high street branches. Those that remain are focused on providing advice for mortgages, or for the more specialised products which banks offer.
Most goods can be bought online, and most high street retailers accept card payments as well, so there’s little need to carry cash except as a back-up. Few customers ever have to visit their branch in person, since most banking services can be carried out online; it’s possible to open an account, fund it and use it every day without once stepping foot in an actual branch. With mobile banking apps becoming ever more popular it’s increasingly common for banking to be done on the move, as part of everyday life.
One of the first banks to embrace digital technology was Sainsbury’s Bank, which has remained forward-thinking throughout their long history. Sainsbury’s were the first “supermarket bank”, and are one of the few banks to suffer little to no negative side effects of the digital revolution. Many high street banks are being forced to close their branches, as it’s simply not cost-effective to keep them open when most banking is done online. This reduces their presence on the high street, and makes it hard for them to establish an identity: Sainsbury’s, however, is able to maintain its corporate identity and presence even without physical branches, meaning that the digital revolution has in fact given them (and other supermarket banks) a slight edge over many mainstream commercial banks.
Commercial Banking in the Future
Commercial banks are part of our daily lives. Whether we access banking services through our smartphones or buy our houses with loans from them, the services they provide are a huge part of our day-to-day existence. As time goes on, it’s likely that digitalisation will create more and more opportunities for banks to reduce the cost of offering services, which suggests that more bespoke products will become available; fewer staff are needed to provide the daily services we all use, so banks will be able to dedicate employees to providing specialist advice and services.
Commercial banking is a competitive industry, and one which requires constant innovation in order to thrive. For many of today’s banks, their current position is one which has been achieved from hundreds of years of hard work – maintaining this position requires that they move with the times, and take advantage of the opportunities digital technology provides.
Official resources about UK regulatory bodies:
- The Financial Conduct Authority (FCA)
- Bank of England Website
- Prudential Regulation Authority
- Financial Conduct Authority
- The Financial Policy Committee
- Financial Services Compensation Scheme
Other Unofficial Guides
Covering areas of UK financial regulation and aspects of Commercial Banking.
Research provided by Bridging.com