An essay whereupon the author expands on a short and merrie historie of banks.
By Master Gordon Kelly, recently of this parish.
Have you ever worked in a bank and suffered through their induction program? Or perhaps you studied business studies in school, economics, or a similar subject. If so, you will have come across a nonsense chapter about banking and principles. In this you are told to learn the following five credit factors obediently. Apparently, all banks make credit decisions based on Character, Capacity, Capital, Collateral and Conditions.
This is of course ‘bulldust’ (a technical term in banking referring to an assertion that is rarely accurate). Well, here is the truth. There are not 5 key factors. There are only 2. These two pillars of lending that have applied to all loans, at all times, in all places, everywhere in human history.
The most important thing about loans are the following paired principles.
- Security (also known as collateral)
- i.e. if you don’t; pay your loan, can the bank take back your house, car, business, and get their money back.
- Serviceability – are you earning enough cash to pay the loan back.
To get a loan you need to be able to satisfy both of the above. So the next time a wealthy dowager shrieks aloud about how “the bank said NO to me, and my house is worth easily $4m”, it is likely that she has no verifiable income from ACME slave holdings, or that her $4m mansion is actually Takeshi’s Castle.
Here is what is known in modern cinema as the “origin story” of banking.
The modern idea of banking originates in Venice, Italy, around the 14th Century. Venice being a centre point of trade between two empires, it was perfectly located to exploit burgeoning opportunity between two worlds that needed to trade. On the west was a pretty conservative and fundamentalist Christian Europe (sorry, but bacon, bikinis and beer would have to wait a little while yet to be the norm). On the east side was a thriving, liberal theocracy in the late Byzantine and subsequent Ottoman empire. Trading between the two superpowers of the time required the constant availability of money, enforceable laws, nuanced cultural understanding and a degree of flexibility that you would never find in a modern bank.
Originally to finance trading voyages, merchants would approach the money-men of the Venice in one of the many squares. The merchants would be seeking a loan to fund a trade venture across the Adriatic Sea. Not unlike today, those in the know (the money men) would sit at one end of the town square (piazza) and each occupy one of the stone benches – known as a “banca”. From this came the expression ‘andare in banco’ or going to the banker. (‘banco’ originally referring to the man who sat upon the ‘banca’ or bench).
The loans were typically over 6-12 months. The banco wanted to know what you were trading in (purpose of the loan), the apparent risks (length of the voyage, far flung lands, pirates, weather, perishable goods). The lender would also be keen on ascertaining the merchant’s personal history (his credit worthiness and character – was he trustworthy or just another exotic swindler (‘artista de bulashite’). And ultimately, the lender would want collateral in the form of something that could be resold e.g. the merchant’s house (not common back then, as most people rented from nobles and the church), other ships, and even the merchant’s wife or children that could be sold into slavery if the borrower defaulted on his loan.
If all looked good to the money lender (prestatoro) they would either lend the funds themselves or share the lending risk among other lenders (they were clever people indeed) to the merchant on the basis of faith. The Italian verb “dare credito” from “Credere” (to grant belief) from which we get the term “Credito” (I believe) or as is now called a loan. Even in English we still use the term “Credit” for a loan or “Line of credit” more commonly. This was the summation that the lending risk looked good and the “banco” would grant the loan.
As the centuries passed, and Western Europeans figured that the ban on Christians lending money that use to be in place was by now outdated, they collectively muscled in on the banking business and expanded. However, the nature of loans themselves have changed very little since their origin.
As home and land ownership started to devolve into the hands of the many over the last few centuries, the nature of the length of loan terms have changed to accommodate the useful life of assets. So for example, houses were not a common purchase in the 14th Century. By the 20th century they became the most common financed purchase. However a house needs to be paid off over a reasonable life span and so loans for originally 25 years became the norm. This is now 30 years as the norm, with some lenders even allowing up to 40 years in Australia.
The idea of the “mortgage” is simply a legal term that allows a lender put a legal claim over your collateral “(your house most commonly) in the event you default on your loan. Alas there still exists the misperception that the bank actually owns your home until you pay it off. This is categorically wrong. You own it, but the bank can repossess it if, and only if, you default continuously on your repayments. In Australia, the NCCP laws offer protection to consumers against predatory bank behaviour when it comes to possession.
The term mortgage itself originated from the Old French terms “mort” (meaning ‘death’) and “gage” (meaning ‘pledge’). Essentially a “mort-gage” was a pledge to make repayments on a loan until death. The pledge in question would be considered “dead,” or nullified, once the loan was repaid; or if the borrower could not fulfill the terms of the deal (death has often proven a good excuse not to continue with loan repayments).
You may have come across a type of car or asset loan referred to as a chattel mortgage (works very similar to a lease, for moving goods like vehicles). The origin of this was to differentiate between a mortgage over something fixed and immovable like a property (the French term for real estate is “immobilers”) and a movable asset, which in the day, was most commonly cows or livestock (hence the Old French word “chattel” from where we get the English word ‘cattle’)
Originally money lending and depositing money for safe keeping were totally separate businesses and the idea of putting cash and jewels into someplace safe like with the “banca” was unthinkable. Although this might have had something to do with religious intolerance.
The English, with their relatively advanced technology in locksmiths and “strongboxes” led the way. They attempted to attract people to deposit their cash and jewels in a safe place that could be guarded and withdrawn with a written record exchangeable for the goods. There was no interest given on the goods deposited. The “safe keepers” would charge a percentage of the coinage deposited.
It took nearly another two centuries before the idea of the bank accepting deposits and paying a nominal interest on them, while similarly lending the same deposits out to other customers would yield even more profits for banks. This was then the birth of the modern banking system. The English dominated this in the late 16th and 17th Centuries. The idea of a bank acting as a middle mad taking deposits from those who didn’t need it and lending it to those who did, formed the backbone of the English Imperial expansion and period of world dominance. There evolved an old maximum of success in banking that existed up to the 1980s in London. The secret to success in banking was buy following the “3:6:3 rule”:
- pay 3% on deposits.
- charge 6% on loans.
- be on the golf course by 3pm.
For an industry that spends so much money on advertising and convincing us that they are the cutting edge of everything new, banking and its practise, has in fact evolved little over its long history. The original two tenants of 1. Security and 2. Serviceability have not changed to any large degree.
There are laws responsible regarding lending and consumer protection that have only been recently introduced over the last 15-20 years. While these are all welcome, there is still much work to be done. Most rules and regulations come in ‘after the fact’ and There is nothing funnier than talking to a bank executive after a serious financial crisis. The same poacher, now turned gamekeeper, will sing at the top of his voice about how “compliant” and “customer focused” he is. With an agility that belongs in Cirque du Soleil, he will bend over backwards to convince you how “customer centric” he and his colleagues are. (weren’t they always supposed to be so?).
The fact remains that most bankers are targeted by sales volumes and so their interests are rarely aligned to your own. The end of the 20th Century saw banks move into the Insurance and Superannuation (Pension) sector. The results of this led to some unconscionable conduct whereby customers were ripped off and their faith destroyed in both banks and insurance. Most recently, as a consequence of this, many banks have begun to divest themselves of their “Wealth Management” or insurance and investment functions.
The good news is that this divestment and return to ‘staying in their own lane’, will most likely increase competition in the marketplace. With a greater diversity of sales channels, the need for customers to feel looked after by someone independent will create its own opportunity. For example, 7 years ago the broker share of the home loan market was only about 38%. This is now close to 70%. This means that in just over 7 years, the average consumer is now about twice as likely as they were before to trust an independent broker over direct channel with the bank.
Similarly with insurance, the return to independent (non-aligned) financial planners has already begun. There is significant growth in Financial planning and there exist great opportunities for good planners and brokers who can work together, but more importantly work to look after their clients.
If you would like to discuss anything further in this article, please don’t hesitate to contact us.