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Introduction to Banking
A01 Introduction to Banking 40336.indd 1 17/09/2021 12:36

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Third Edition
Introduction to Banking
Barbara Casu
Bayes Business School, City, University of London
Claudia Girardone
Essex Business School, University of Essex
Philip Molyneux
Bangor Business School, Bangor University
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ISBN: 978-1-292-24033-6 (print)

978-1-292-24035-0 (PDF)
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British Library Cataloguing-in-Publication Data
A catalogue record for the print edition is available from the British Library
Library of Congress Cataloging-in-Publication Data
Names: Casu, Barbara, author. | Girardone, Claudia, author. | Molyneux,
Philip, author.
Title: Introduction to banking / Barbara Casu, Claudia Girardone, Philip
Molyneux.
Description: Third edition. | Harlow, England ; New York : Pearson, 2022. |
Includes bibliographical references and index. | Summary: “The aim of
this textbook is to provide a comprehensive introduction to theoretical
and applied issues relating to the global banking industry. Despite the
fears of Henry Ford, we do not think reading this book will cause a
revolution but we do hope it will at least provide you with an enjoyable
and interesting insight into the business of banking”-- Provided by
publisher.
Identifiers: LCCN 2021034509 (print) | LCCN 2021034510 (ebook) | ISBN
9781292240336 (paperback) | ISBN 9781292240374 (epub)
Subjects: LCSH: Banks and banking--Europe. | Banks and banking. | Bank
management--Europe. | Bank management.
Classification: LCC HG2974 .C375 2022 (print) | LCC HG2974 (ebook) | DDC
332.1--dc23
LC record available at https://lccn.loc.gov/2021034509
LC ebook record available at https://lccn.loc.gov/2021034510
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Cover designed by Two Associates
Print edition typeset in 9.5/12.5pt Charter ITC Std by Straive
Printed and bound in Slovakia by Neografia
NOTE THAT ANY PAGE CROSS REFERENCES REFER TO THE PRINT EDITION

To my late father, Antonio. To Martin, Lila, Milan, Monika and to Beth.
And to my mum and sister (BC)
To Marc, Matteo and Leonardo. To my parents Nieves and Sandro (CG)
To Delyth, Alun, Catrin, Gareth, Gethin, Lois and Rhiannnon (PM)

Contents
List of figures xiv

List of tables xviii
List of boxes xxi
Preface xxiv
Acknowledgements xxx
List of acronyms and abbreviations xxxii
Part 1 Introduction to banking
1 What is special about banks? 3

1.1 Introduction 3
1.2 The nature of financial intermediation 3
1.3 The role of banks 7
1.4 Information economies 8
1.5 Why do banks exist? Theories of financial intermediation 14
1.6 The benefits of financial intermediation 16
1.7 Conclusion 17
Key terms 18
Key reading 18
Revision questions and problems 19
2 Bank activities and services 20

2.1 Introduction 20
2.2 What do banks do? 20
2.3 Banks and other financial institutions 21
2.4 Banking services 24
2.5 Banks and the FinTech revolution 39
2.6 Conclusions 43
Key terms 43
Key readings 43
Appendix 2.1 FinTech: a selected glossary 45
3 Types of banking 48
3.1 Introduction 48
3.2 Traditional versus modern banking 49
3.3 Types of banking 51
3.4 Retail or personal banking 52
3.5 Private banking 53
3.6 Corporate banking 56
vii

Contents
3.7 Investment banking 67

3.8 Types of banks 72
3.9 Conclusions 79
Key terms 79
Key readings 79
4 International banking 81
4.1 Introduction 81
4.2 What is international banking? 81
4.3 Brief history of international banking 84
4.4 Why do banks go overseas? 85
4.5 Types of bank entry into foreign markets 92
4.6 Advantages and disadvantages of international and cross-border banking 97
4.7 International banking services 98
4.8 Conclusions 113
Key terms 114
Key reading 115
Appendix 4.1 Syndicated lending: a selected glossary 116
5 Islamic banking 119

5.1 Introduction 119
5.2 A brief history 120
5.3 How an Islamic bank operates 123
5.4 Industry features 127
5.5 Balance sheet and income statement features 130
5.6 Regulating Islamic banks 132
5.7 Comparing Islamic and conventional banks 135
5.8 Conclusion 136
Key terms 136
Key reading 136
Part 2 Central banking and bank regulation
6 Central banking 141

6.2 What are the main functions of a central bank? 142
6.3 How does monetary policy work? 143
6.4 Monetary policy functions of a central bank 147
6.5 Why do banks need a central bank? 167
6.6 Should central banks be independent? 170
6.7 Conclusion 173
Key terms 173
Key reading 174
viii

Contents
7 Bank regulation and supervision 175

7.2 The rationale for regulation 176
7.3 Types of regulation 178
7.4 The financial safety net 181
7.5 Limitations of regulation 191
7.6 Causes of regulatory reform 194
7.7 Bank capital regulation 195
7.8 The 1988 Basel Capital Accord (Basel I) 197
7.9 The 1996 amendments to the 1988 Accord 201
7.10 The second Capital Accord (Basel II) 202
7.11 The third Capital Accord (Basel III) 205
7.12 Finalising Basel III 213
7.13 Conclusion 214
Key terms 214
Key reading 215
8 Bank failures and banking crises 216

8.2 The determinants of bank failure 217
8.3 Early warning systems for bank soundness 224
8.4 Bank restructuring 230
8.5 Banking crises 237
8.6 Conclusion 244
Key terms 245
Key reading 245
Part 3 Issues in bank management
9 Banks’ balance sheet and income structure 249

9.2 Retail banks’ balance sheet structure 250
9.3 Investment banks’ financial statements 264
9.4 Bank performance and financial ratio analysis 269
9.5 Conclusion 287
Key terms 288
Key reading 288
10 Bank financial management 289

10.2 Asset–liability management (ALM) 290
10.3 Liquidity management and the importance of reserves 295
10.4 Capital adequacy management 296
ix

Contents
10.5 Off-balance-sheet (OBS) business in banking 297

10.6 Loan sales and the process of securitisation 301
10.7 Derivative business in banking 304
10.8 Conclusion 321
Key terms 322
Key reading 322
11 Banking risks 324

11.2 Credit risk 324
11.3 Interest rate risk 327
11.4 Liquidity (or funding) risk 331
11.5 Foreign exchange risk 335
11.6 Market (or trading) risk 337
11.7 Country and sovereign risk 340
11.8 Operational and cyber risks 342
11.9 Off-balance-sheet risk 344
11.10 Sustainability (or ESG) risks 344
11.11 Other risks 349
11.12 Capital risk and solvency 350
11.13 Interrelation of risks 350
11.14 Conclusion 351
Key terms 352
Key reading 352
12 Bank risk management 354

12.2 General risk management 355
12.3 Credit risk management 362
12.4 Managing the lending function 365
12.5 Managing interest rate risk 372
12.6 Managing liquidity risk 379
12.7 Managing market risk 381
12.8 Managing operational risk 389
12.9 International risk assessment 393
12.10 Conclusion 399
Key terms 399
Key reading 400
Part 4 Comparative banking markets
13 Banking in the UK 403

13.2 The crisis in UK banking 404
x

Contents
13.3 Regulatory reforms and the changing face of UK banking 413

13.4 The structure of the UK banking sector 424
13.5 Profits and the financial features of UK banks 426
13.6 The UK payment system 431
13.7 Competition in UK banking 435
13.8 Conclusion 441
Key terms 442
Key reading 443
Appendix 13.1 Demutualisation of the UK building society sector 444
14 Banking in Europe 445

14.2 The European Union 446
14.3 The Single European Market for financial services 449
14.4 Building a new EU financial architecture 458
14.5 Structural features and the consolidation trend 478
14.6 Balance sheet structure and performance in European banking 489
14.7 Conclusion 494
Key terms 494
Key reading 495
15 Banking in the US 496

15.2 The financial crisis in the US 497
15.3 Structure of the US banking and financial systems 504
15.4 US payments systems 512
15.5 Balance sheet features of US commercial banks 515
15.6 Performance of US commercial banks 515
15.7 Regulation of the US banking system 521
15.8 Conclusion 530
Key terms 531
Key reading 531
16 Banking in Japan 533

16.2 Structure of banking system 534
16.3 Payment systems 542
16.4 Banking crises in Japan 547
16.5 Changing structure of the financial system 552
16.6 Conclusion 560
Key terms 561
Key reading 561
xi

Contents
17 Banking in emerging markets 563

17.2 Benchmarking financial development 564
17.3 Finance and growth 569
17.4 The macroeconomic outlook 573
17.5 Structural features and trends 579
17.6 Conclusion 593
Key terms 593
Key reading 594
Part 5 Advanced topics in banking
18 Banks and markets 597

18.2 Bank intermediation, markets and information 598
18.3 The development of the securitisation market 602
18.4 Modern securitisation process 606
18.5 The ‘new wave’ of securitisation 613
18.6 Types of securitisation 614
18.7 Securitisation, credit-rating agencies and monoline insurers 616
18.8 The future of securitisation 620
18.9 Conclusion 624
Key terms 624
Key reading 624
19 Mergers and acquisitions 626

19.2 Mergers and acquisitions: definitions and types 627
19.3 Recent trends in bank M&As 630
19.4 M&A and bank performance 639
19.5 Managerial motives for M&As 642
19.6 The impact of M&As on bank customers 643
19.7 M&As and bank diversification 644
19.8 The exploitation of safety-net subsidies and systemic risk 647
19.9 Conclusion 652
Key terms 652
Key reading 653
20 Bank competition and financial stability 654

20.2 Structure-conduct-performance (SCP) 655
20.3 Non-structural measures of banking sector competition 664
20.4 Comparing competition measures – are they consistent? 671
xii

Contents
20.5 Competition and risk in banking 673

20.6 Bank competition and stability 676
20.7 Conclusion 679
Key terms 680
Key reading 680
Appendix A1 Interest rates, bonds and yields 681

Appendix A2 Introduction to portfolio theory 691
Glossary 701
References and further reading 742
Index 775
xiii

List of figures
1.1 The intermediation function 4

1.2 Direct finance 4
1.3 Direct and indirect finance 6
1.4 Modern financial intermediation 6
1.5 Adverse selection in loan pricing 11
2.1 Classification of financial intermediaries in the UK 22
2.2 Banks’ core activities 25
2.3 Cheque transactions in the UK 26
2.4 The way we pay 27
2.5 ‘Next gen’ payment technologies 29
2.6 ATM transactions crash in the UK 30
2.7 UK goes cashless during lockdown 31
2.8 Typical current account usage 33
2.9 PPI payouts 35
2.10 Total cost of PPI per bank, including compensation and administration (£bn) 37
2.11 The FinTech tree 41
2.12 FinTech innovations by sector 41
3.1 Types of banking 52
3.2 High net worth individuals by wealth band 54
3.3 HNWI financial wealth by region (US$tn), 2011–2018 55
3.4 Breakdown of HNWI financial assets, Q1 2019 (global and regions) 56
3.5 The UK payment schemes 58
3.6 Bond features 65
3.7 Largest investment banks by revenue, 2021 70
3.8 Top commercial banks (total assets, $mil), 2012–2018 73
3.9 The decline of US savings banks, 1990–2019 74
3.10 Bank business models in Europe 78
4.1 The product life cycle 89
4.2 The role of banks in international trade 100
4.3 Syndicated lending – basic structure 102
4.4 The syndication process 105
4.5 US leveraged loans outstanding 108
4.6 European leveraged loans outstanding 109
4.7 Collateralised loan obligations outstanding ($bn) 111
5.1 A timeline of Islamic banking 122
5.2 Growth in Islamic Banking Assets 2008 to 2019 (US $bn) 128
5.3 Islamic Banking Share in Total Banking Assets by Country 2019 (%) 128
5.4 Shares of Global Islamic Banking Assets (2019) 129
5.5 Islamic Banking Assets (US $bn) and Market Share (%) (2019) 129
6.1 Dates of establishment of central banks 143
6.2 Monetary policy instruments, targets and goals 149
6.3 Open market operations: outright purchases of government securities 153
6.4 Discount window 154
xiv

List of figures
6.5 Reserve requirements 156

6.6 The key issues in monetary policy transmission 159
6.7 Channels of monetary policy transmission 160
6.8 Transmission lags of monetary policy 160
6.9 The room for monetary policy manoeuvre keeps narrowing 166
7.1 A timeline of financial regulation 176
7.2 Elements of the financial safety net 181
7.3 A timeline of DIS introduction 182
7.4 Measures of bank capital 199
7.5 Basel II: the three pillars 203
7.6 Elements of the capital ratio affected by Basel III 206
7.7 Basel III: enhancing the three-pillar approach 206
8.1 Eurozone banks’ NPLs 2015Q2–2020Q2 (€bn, %) 219
8.2 Average and distribution of CAMELS rating, 1990–2011 227
8.3 Percentage of strong and weak banks, 1990–2011 227
8.4 Banking crises 238
9.1 Breakdown of UK banks’ sterling deposits, end-year 2019 254
9.2 Barclays Bank main assets (%), end-year 2017 256
9.3 Barclays Bank main liabilities (%), end-year 2017 256
9.4 Banks vs. manufacturing firms – balance sheet composition 261
9.5 Goldman Sachs: asset composition and primary sources of funding, 2019 267
9.6 Goldman Sachs: sources of revenue, 2019 268
9.7 Goldman Sachs: net revenues by geographic regions, 2019 268
9.8 Goldman Sachs: non-interest expenses, 2019 269
9.9 Goldman Sachs: breakdown of costs, 2019 269
9.10 Who is interested in bank performance? 270
9.11 The ROE decomposition 274
9.12 CDS spreads evolution for three former large US investment banks (%),
2015–2020 277
9.13 Texas ratios by bank, 2015–2019 278
9.14 Investors braced for a rise in European bank loan losses 279
9.15 Bank stocks are underperforming the wider market 280
10.1 Forms of asset management versus liability management 291
10.2 Goals of ALM and liquidity management 291
10.3 Profit centres and the FTP process 294
10.4 Body with primary oversight over balance sheet management (a) and
ALM unit reporting line (b) 295
10.5 Simple example of a letter of credit 299
10.6 Securities underwriting syndicate 299
10.7 A default swap 306
10.8 A total-rate-of-return swap 307
10.9 A credit-spread put option 307
10.10 Global OTC derivatives market 309
10.11 Payoffs and profits on call options at expiration (from the perspective
of the buyer of the option) 316
10.12 Payoffs and profits on put options at expiration (from the perspective
of the buyer of the option) 317
11.1 Refinancing risk 330
xv

List of figures
11.2 Reinvestment risk 331

11.3 The foreign asset and liability position of a Spanish bank: a net long asset
position in US$ 337
11.4 Banking vs. trading books 339
11.5 Theoretical examples on the ESG cycle – impact of environmental and
social factors on an institution’s risk profile: (a) impact through physical risk;
(b) impact through transition risk; and (c) impact of social factors 346
11.6 Incorporation of ESG risks at the point of loan origination 347
11.7 Visualisation of the 2018 EU action plan on financing sustainable growth 348
12.1 Gender breakdown of executive functions in UK financial services 360
12.2 Corporate governance and risk in banking 362
12.3 Home repossessions in the UK 368
12.4 Probability distribution of portfolio losses 372
12.5 Rate sensitivity and positive gap 373
12.6 Strategic matrix for profit maximisation 375
12.7 Backtesting VaR (UBS), 1 January 2019–31 December 2019 386
12.8 Comparison between value-at-risk and expected shortfall 387
12.9 The three lines of defence for sound operational risk management 390
13.1 Northern Rock balance sheet growth and liability structure, June 1998–June
2007 405
13.2 Northern Rock: from nationalisation to sale 407
13.3 RBS capitalisation 411
13.4 Outstanding guarantees to the UK banking sector 413
13.5 The new ICE LIBOR arrangements 417
13.6 MiFID 2 422
13.7 UK banks – return on equity 428
13.8 Investment and retail banking profitability in the UK 429
13.9 Capital strength of UK banks 430
13.10 De-risking – major UK banks risk-weights 431
13.11 Liquid assets and short-term funding of large UK banks 432
14.1 The Lamfalussy procedure 455
14.2 Interest rates, loans to non-financial corporates 457
14.3 The three crises in the eurozone 459
14.4 Proposals for EU financial supervision – de Larosiére Report 467
14.5 The European system of financial supervision 469
14.6 The Banking Union 470
14.7 The Single Supervisory Mechanism 472
14.8 Total assets of credit institutions in the EU-27, 2018 479
14.9 Number of MFIs in the EU and euro area, enlargement period 481
14.10 Number of MFIs (by country and category), February 2021 482
14.11 Size of selected EU banks, 2020 (assets in €bn and as % of national GDP) 487
14.12 Funding base stability ratio and interbank market dependency ratio 491
14.13 EU non-performing loans, trends and volumes, 2014–2019 493
14.14 Tier 1 capital ratio, 2015–2020 493
15.1 US mortgage-related issuance 499
15.2 TARP funds outstanding 502
15.3 Number of commercial banks and branches in the US (1935–2019) 505
15.4 Share of industry assets according to bank size (%), 1984–2020 506
15.5 Performance of US commercial banks – return on equity (ROE), 1984–2020 518
xvi

List of figures
15.6 Performance of US commercial banks – return on assets (ROA), 1984–2020 519

16.1 Structure of the Co-operative system 540
16.2 Changes to the structure of the Japan Post Group 543
16.3 World’s largest banks by total deposits 543
16.4 Banknotes and coins in circulation as percentage of GDP 547
16.5 The performance of Japanese banks – some international comparisons 557
16.6 Capitalisation of Japanese banks 560
17.1 The uneven sizes of financial systems 568
17.2 Banking and economic growth 573
17.3 Economic growth in advanced and emerging economies 579
17.4 Total assets of state-owned banks in selected central European countries 581
17.5 Trends in government ownership of banks 585
17.6 Government ownership across developing regions, 1970–2009 585
17.7 Foreign bank presence, 2009 590
18.1 How the US mortgage market works 604
18.2 Securitisation rates by type of mortgage, 2001 and 2006 606
18.3 Creation of an ABS security: participants and functions 608
18.4 Capital structure and prioritisation 612
18.5 Example of tranching and credit enhancement 613
18.6 US Mortgage-Backed Securities issuance ($ billion) 1996–2020 621
18.7 US Asset-Backed Securities issuance, by asset classes ($ million), 1990–2020 621
18.8 European Securitisation Issuance (€ Billions) 2010–2020 622
19.1 Bank M&As in Europe and the US (value of transactions $bn), 1985–2006 631
19.2 JPMorgan’s US acquisitions 633
19.3 Real assets of US banking organisations, 1990–2016 634
19.4 EU Bank M&A number and value of transactions 635
19.5 Average deal size between Europe’s banks at 12-year high 636
19.6 Banks diversify and multiply, 1998–2008 645
20.1 The structure-conduct-performance (SCP) paradigm 657
20.2 Herfindahl index: foreign exchange derivatives markets 661
20.3 Concentration levels in UK retail banking (measured by HHI) 663
xvii
A01 Introduction to Banking 40336.indd 17 29/09/21 1:44 PM

List of tables
2.1 A simplified bank balance sheet 21

2.2 A cashless society: advantages and disadvantages 29
2.3 Top ten financial scandals in UK retail banking 38
3.1 Traditional versus modern banking 50
3.2 Top ten global private banks by assets under management 55
3.3 The end of an era for US investment banks 68
3.4 Top 15 commercial banks (by Tier 1 capital) 73
3.5 Credit unions in the world, 2018 76
4.1 Type of entry in foreign markets 96
4.2 Opportunities and challenges of cross-border banking 98
4.3 Letters of credit 101
4.4 Credit risk ratings – Moody’s and Standard & Poor’s 106
5.1 Key instruments and concepts in Islamic banking and finance 125
5.2 Breakdown of Islamic Financial Services Industry by Sector and Region
(US $bn and %, 2019) 127
5.3 Top Islamic banks by assets size (US$mil), 2018 130
5.4 Dubai Islamic Bank PJSC balance sheet 131
5.5 Dubai Islamic Bank PJSC profit and loss statement 132
6.1 A simplified central bank balance sheet 150
6.2 Balance sheet, Bank of England 151
6.3 Eurosystem monetary policy operation 155
6.4 Pros and cons of discretion vs. fixed rules in monetary policy 161
6.5 UK and US asset purchase programmes (in figures) 164
6.6 Central bank independence (CBI) 172
7.1 Bank regulation: key concepts 178
7.2 Micro- and macro-prudential policy tools 180
7.3 DIS cross-country comparison 186
7.4 Bank resolution authorities: a cross-country comparison 189
7.5 Bank Greedy balance sheet 196
7.6 Bank Greedy balance sheet after £4 billion loans go bad 196
7.7 Bank Greedy balance sheet after £7 billion loans go bad 196
7.8 Rationale for Basel II: more flexibility and risk sensitivity 202
7.9 Components of regulatory capital 208
7.10 G-SIBs and additional capital requirements 212
7.11 Finalising Basel III: a roadmap 213
8.1 CAMELS rating 226
8.2 Bank resolution terminology 231
8.3 Bank resolution methods 235
8.4 Regulatory initiatives 236
8.5 The costs of banking crises 239
8.6 Comparing the costs of the Asian and global crises 240
xviii

List of tables
9.1 Simplified commercial bank balance sheet 250

9.2 Bank of England aggregate assets of UK banks (end-year 2019, £bn
amounts) 252
9.3 Bank of England aggregate liabilities of UK banks (end-year 2019, £bn
amounts) 255
9.4 Barclays Bank assets, 2013–2017 (£mil) 257
9.5 Barclays Bank liabilities, 2003–2017 (£mil) 258
9.6 Bank ABC: shares fair value vs historical cost 258
9.7 Banks vs. manufacturing firms – balance sheet composition 260
9.8 A simplified bank income statement 262
9.9 Barclays Bank PLC profit and loss account, 2013–2017 (£mil) 263
9.10 A simplified investment bank balance sheet 265
9.11 Key performance indicators (KPIs) 271
9.12 Australian major banks’ (the ‘Majors’) performance at a glance, 2020 275
9.13 Selected ratios for three former large US investment banks (%) 276
9.14 Cost of equity capital for RBS, HSBC, Barclays and Lloyds in 2021 284
9.15 Cost of equity capital for selected US and EU banks in 2021 285
9.16 An illustration of the trade-off between solvency and profitability 286
10.1 Profit centres and FTP process: a simple example 294
10.2 Simplified bank balance sheet before and after loan sales (in £mil) 301
10.3 Simplified bank balance sheet before and after securitisation (in £mil) 303
10.4 Eurodollar interest rate futures 311
10.5 Example of long hedge using Eurodollar futures 312
10.6 Fixed–floating rate currency swap (millions) 321
11.1 Selected sovereign foreign currency ratings 342
11.2 Operational risk event types 343
12.1 Selected definitions of risk culture 358
12.2 Maturity bucket gap (£mil) 374
12.3 Selected elements of internal and standard models approaches in the
January 2016 revised market risk framework 382
12.4 Value-at-risk at UBS (1-day, 95% confidence, 5 years of historical data) 385
12.5 Example of OECD country risk classification of the participants to the
arrangement on officially supported export credits (as of 16 October
2020) 398
13.1 Government support to UK banks, 2007–2012 409
13.2 HSBC Bank Plc: consolidated income statement 2019–2020 (£mil) 427
14.1 The European Union: a timeline 447
14.2 Macroeconomic outlook 448
14.3 Euro area member states 451
14.4 Regulatory measures affecting the EU banking and financial sectors 452
14.5 Obstacles to full integration of EU financial retail markets 456
14.6 The development of Dexia’s balance sheet and income (in €bn) 462
14.7 Financial assistance facilities for euro area countries 465
14.8 Towards a banking union: timeline and milestones 467
14.9 Number of credit institutions in the euro area, 1999–2019 480
14.10 Number of MFIs by country and percentage change 483
14.11 European Union Indicators of banking sector capacity, 2019 484
14.12 Number and total assets of foreign branches and subsidiaries in the euro
area, 2012–2019 485
xix

List of tables
14.13 Five-firm concentration ratio as percentage of total banking sector assets and
Herfindahl index, 2008 to 2019 487
14.14 Selected balance sheet items (€bn and as % of total assets), 2013 490
14.15 Selected income statement items (EU banks), crisis period (2008–2013) 492
15.1 Sub-prime home purchase loans (%) pre-crisis period 499
15.2 Ten largest US banking companies, ranked by assets ($mil) 507
15.3 Leading US property and casualty insurance companies, March 2020 509
15.4 Leading US life insurance companies, 2019 509
15.5 US financial intermediaries (market share, total assets) 512
15.6 Number of non-cash payments ($bn), 2000–2019 514
15.7 Assets of US commercial banks, 1995–2019 ($bn) 516
15.8 Liabilities and equity capital of US commercial banks, 1995–2019 ($bn) 517
15.9 Bank profitability by state, 2019 520
15.10 US financial regulators 522
15.11 Supervisors and regulators of US banks 525
16.1 Japanese domestic banking groups 535
16.2 Licensed financial institutions in Japan (as of early 2021) 537
16.3 Payments processed by selected interbank funds transfer systems 546
16.4 Japan’s 1998 banking crisis – major events 549
16.5 Financial assets of Japan by sectors 2015 and 2016 (billion yen) 552
16.6 Regulation and supervision by bank type 554
16.7 Performance indicators of Japanese banking sector (2014–2016, Sept) 555
16.8 Balance sheet (September 2017, values in million yen) 558
16.9 Income statement (September 2017, values in million yen) 559
17.1 The World Bank’s ‘4 × 2 matrix of financial system characteristics’ 566
17.2 Financial institution characteristics by country, 2008–2010 average 568
17.3 Finance and growth: a review of the literature 571
17.4 Emerging economies – geographical region 574
17.5 Emerging economies – income classification 575
17.6 Nominal GDP growth (at constant prices) (%) – emerging and other economies 578
17.7 Banking in Asia 580
17.8 Number of banks by host country, aggregates by income level and regions 591
17.9 Foreign ownership limits in South East Asian banking 592
18.1 True sale vs. synthetic securitisation 615
19.1 Motives for bank M&As 631
19.2 Major US bank mergers & acquisitions since 2000 632
19.3 European banks M&As, 2007–2013 637
19.4 Bank acquisition of FinTech companies, 2010–2018 638
20.1 Bank size and concentration 658
20.2 Herfindahl index and 5-bank concentration ratio (by assets) 660
20.3 H-statistics: interpretation 665
20.4 Panzar–Rosse H-statistic 667
20.5 Interpretation of the CV parameter (λ) 668
20.6 Lerner index – Banks in Asia Pacific (average figures, 2003–2010) 669
20.7 Competition measures and ranks for selected EU countries (average values,
2000–2009) 672
20.8 Correlation matrix for the competition measures 672
20.9 Empirical evidence of the competition-stability relationship 677
xx

List of boxes
2.1 Universal banking: an optimal model of banking? 23

2.2 Coronavirus accelerates shift away from cash 30
2.3 After PPI, what could be the next banking mis-selling scandal? 35
3.1 Recent trends in wealth management and private banking 55
3.2 The end of an era: US investment banks and the conversion into BHCs 69
3.3 For today’s investment bankers, job cuts are a one-way street 71
3.4 Diversity in the banking ecosystem 77
4.1 From international to multinational banking? 82
4.2 Some definitions 83
4.3 Trade barriers and banking 87
4.4 Correspondent banking and cross-border payments 94
4.5 Leveraged loans 108
4.6 Designers of CLOs say that structures are much safer than crises-era cousins 111
4.7 Banks complete first syndicated loan on blockchain 112
5.1 Timeline of the Development of Islamic Banking and Finance 122
5.2 How an Islamic bank works 124
5.3 Frequently asked questions about Islamic banking 126
5.4 Ensuring financial stability in countries with Islamic banking – country case
studies – overall findings 133
6.1 The concept and functions of money and monetary aggregates 144
6.2 Monetary policy objectives 147
6.3 Bank of England and the official interest rate 152
6.4 Quantitative easing in Japan 162
6.5 Relationship between liquidity and solvency 168
6.6 Who owns the central bank? 171
7.1 Core principles for effective deposit insurance systems 183
7.2 Moral hazard and government safety net arrangements 192
7.3 Details of capital elements (established 1988 and applied in 1992) 198
7.4 RAR (risk-asset ratio) approach 199
7.5 Five capital-adequacy categories of banks 201
8.1 EU banks urged to prepare for bad loans as pandemic hits economy 220
8.2 Rogue traders and bank losses 222
8.3 The European Banking Authority and EU-wide stress tests 228
8.4 Aims of an effective bank resolution regime 232
8.5 The Icelandic meltdown 241
9.1 Assets and liabilities valuation in banking 258
9.2 Typical capital structure of a manufacturing firm versus a retail bank 260
9.3 Goldman Sachs financial statements (2019) 267
9.4 What are key performance indicators (KPIs)? 271
9.5 The ROE decomposition 273
9.6 Banks across Europe braced for further heavy loan loss charges 278
9.7 Value maximisation for the banking firm 281
xxi

List of boxes
9.8 What is EVA? 283

9.9 Calculating the cost of equity capital 284
10.1 Asset–liability management in practice 292
10.2 The ‘bank within the bank’ and the fund transfer pricing (FTP) process 293
10.3 The process of deconstruction of lending activity 300
10.4 European loan sales on course for 30 per cent fall in 2019 to €140.8 billion 303
10.5 Financial derivatives from off to on the balance sheet 305
10.6 How can credit derivatives be used in bank financial management? 306
10.7 Derivative products: official exchanges and OTC markets 307
10.8 Example of three-month Eurodollar time deposit futures 310
10.9 Example of forward rate agreement 314
10.10 Option contracts: payoff and profit profiles 316
10.11 Example of interest rate swap 319
10.12 Example of fixed–floating currency swap 320
11.1 Credit culture and equity culture in banking 326
11.2 US banks trim expectations in era of low interest rates 329
11.3 Liquidity risk and information asymmetries 332
11.4 The Federal Reserve has gone well past the point of ‘QE infinity’ 333
11.5 Exchange rates and foreign exchange markets 335
11.6 A revised framework for market risk 339
11.7 European banks load up on government bonds, raising concerns over
‘doom loop’ 341
11.8 The vision for sustainable finance in the EU 347
11.9 Examples of the social impacts of the Covid-19 pandemic 351
12.1 The corporate governance of banks 358
12.2 Mortgage market, equity withdrawal and negative equity 367
12.3 Credit scoring: how to score high 369
12.4 Example of Macaulay duration 376
12.5 Example of duration gap 377
12.6 Example of VaR 384
12.7 Investors bet vaccine-led recovery will lift emerging markets 388
12.8 Structure of the internal measurement approach 392
12.9 Factors affecting country risk 396
12.10 OECD country risk-weighting calculations 397
13.1 The failure and resolution of Northern Rock 405
13.2 Why did RBS fail? 410
13.3 LIBOR fixing 415
13.4 Just the facts: the Vickers Report 418
13.5 Europe’s banks told to keep planning for full Brexit in 2019 423
13.6 A brief history of TSB 426
13.7 Components of bank profits 427
13.8 TSB customers suffer fifth day of IT problems as payday looms 434
13.9 UK challenger banks braced for fresh wave of consolidation 435
14.1 The creation of a single market for financial services in the European Union 450
14.2 The Lamfalussy procedure 454
14.3 The failure of cross-border banks: the case of Fortis and Dexia 461
14.4 European System of Financial Supervision (ESFS) 469
14.5 EU reaches deal on final piece of Banking Union 474
14.6 EU agrees Deposit Guarantee Scheme deal 477
15.1 US mortgage basics 497
xxii

List of boxes
15.2 Key events in the US credit crisis 500

15.3 Volcker rule comes of age in spite of protests 527
15.4 Failures of the Dodd–Frank Act 529
16.1 Japan Post Bank plans $1.5bn in-house hedge fund 544
16.2 Japan’s regional banks warned of ‘grave’ situation 551
17.1 China banking war heats up with launch of online investment app 583
17.2 Two views on the role of state banks 587
18.1 A history of Freddie Mac and Fannie Mae 603
18.2 What is credit enhancement? 610
18.3 CDS: modern day weapons of mass destruction 617
18.4 AIG saga shows dangers of credit default swaps 619
19.1 The emergence of financial conglomerates 629
19.2 European bank dealmaking raises hopes for cross-border M&A 636
19.3 How to perform an event study 640
19.4 A winner’s curse that haunts the banking behemoths 641
19.5 Bank diversification 645
19.6 Out to break the banks 648
20.1 Competition in UK banking 663
xxiii

Preface
It is well enough that people of the nation do not understand our banking and monetary
system, for if they did, I believe there would be a revolution before tomorrow morning.
Henry Ford
The aim of this textbook is to provide a comprehensive introduction to theoretical and applied
issues relating to the global banking industry. Despite the fears of Henry Ford, we do not
think reading this book will cause a revolution but we do hope it will at least provide you
with an enjoyable and interesting insight into the business of banking.
A major motivation for writing this text has been to fill a gap in the market. For a number of
years we have all taught banking courses and we have become aware of students’ frustration
about the lack of a comprehensive yet accessible textbook that deals with a broad spectrum
of introductory banking issues. Most introductory texts that cover banking issues tend to be
broad-based, focusing on economics and finance, and these (in our view) do not provide
sufficient detail or coverage of the theoretical and institutional detail that is essential for an
accurate understanding of critical banking issues. While there are textbooks that provide
such coverage targeted at advanced undergraduates and the postgraduate market, there is
no text that has comprehensive coverage of such issues for those new to the study of banking.
In addition, many textbooks that cover banking as part of broadly based money and banking
courses tend to provide only limited attention to international experiences. As such, we have
written this text to provide (we hope) an essential teaching and learning resource for anyone
who has to lecture introductory undergraduates as well as professional banking courses.
The first edition of this book (2006) described a world where the banking industry expe-
rienced marked changes and deregulation allowed banking firms to diversify into broader
financial services areas. Commercial banks became full-service financial firms, offering a
range of non-traditional financial services including insurance, securities business, pensions
and the like. Many banks dropped the word ‘Bank’ from their titles to emphasise their much
broader role in the provision of financial services to households and corporations. In addi-
tion, various trends such as industry consolidation, securitisation and disintermediation
were having a significant effect resulting in a smaller number of major players operating in
credit, capital and money markets business that increasingly overlapped. As banking systems
opened up, many institutions were pursuing international strategies thereby changing the
traditional focus on banking as a mainly domestic business. This rapidly evolving environ-
ment posed both threats and opportunities to bank managers and owners. The former had
to be increasingly aware of both domestic and international developments in the manage-
ment process and in particular of the various risk–return trade-offs in all areas of a bank’s
activities. Capital needed to be managed effectively, so as to adhere to minimum regulatory
requirements and also to generate returns in excess of the cost of capital to boost sharehold-
ers returns. The market pressure on banks to generate good returns for shareholders was
a key element of bank strategy – bankers were forced to cut costs, boost revenues (mainly
through fee and commission income sources) and to manage their capital resources much
more efficiently.
xxiv

Preface
This golden era of banking came to an abrupt end in the summer of 2007, when the demise
of the US sub-prime mortgage lending market led to financial losses, government bailouts
of banks (and other financial institutions), a credit crunch and a prolonged economic reces-
sion, mainly in developed countries, ensued. Since the onset of the crisis in 2007, there has
been a large body of research investigating its causes and consequences. What had started as
trouble in a small segment of the US financial markets became a fully-fledged global financial
crisis, following the demise of the US investment bank Lehman Brothers in September 2008.
The unfolding of the sub-prime crisis and how it became a financial crisis, and its impact on
European countries in the form of a sovereign debt crisis, can be described in various phases
or waves that include the: (i) US sub-prime crisis (August 2007 to September 2008); (ii)
systemic or global crisis (September 2008 to March 2009); (iii) economic crisis (March 2009
to January 2010); and (iv) the sovereign debt crisis (January 2010 to June 2012). In this
textbook, we will refer to the sub-prime crisis period as the 2007 crisis; to the global financial
crisis period as the 2008–2009 crisis and to the sovereign debt crisis or eurozone crisis as the
period 2010–2012. These crises years have had a tremendous impact on the world of banking
and have brought about dramatic changes in the global financial architecture. Against this
background of global changes, the second edition (2015) was published.
As the dust has begun to settle on the crises period and the new shape of the world’s bank-
ing markets has started to take form, we have thoroughly revised this textbook to account
for more recent changes. In the decade since the global financial crisis, the banking industry
has faced renewed challenges. Increased competition from non-bank financial providers has
intensified, as the FinTech industry boomed. The digitalisation of banking is transforming
the provision of financial services. Big Tech’s entry into financial services has also increased,
focusing mostly on the customers’ experience.
The coronavirus pandemic also poses challenges for banks, but also shows that they still
play a key role in helping the real economy deal with the crisis. The industry has shown
resilience and it is in a much better health than it was a decade ago. It has also benefited
from extraordinary measures taken by governments to support their economies, including
monetary, fiscal and regulatory actions. For example, in the Spring of 2020, the European
Central Bank (ECB) introduced a €1,850 billion Pandemic Emergency Purchase Programme
of public and private sector assets (PEPP), enhanced its long-term refinancing operations,
and kept key interest rates at historically low levels. As countries move towards an exit from
the global health crisis, national and international regulators and supervisors are working
on potential strategies that will not result in increased systemic risk.
Banks are also grappling with other complex issues, from climate change to green finance
opportunities. The attention to environmental, social and governance (ESG) concerns is
likely to increase as the global economy recovers from the COVID-19 pandemic, and aspects
of sustainability are crucial for banks’ business models.
The new edition of this textbook introduces and discusses many of these emerging issues,
offering a detailed insight into a fast-changing industry.
The text is organised into five main parts:
● Part 1: Introduction to banking
– Chapter 1 What is special about banks?
– Chapter 2 Bank activities and services
– Chapter 3 Types of banking
– Chapter 4 International banking
– Chapter 5 Islamic banking
xxv

Preface
This part of the text provides an introduction to the nature of financial intermediation, cov-
ers the main reasons proposed as to why banks exist, focusing on key issues such as adverse
selection, moral hazard and delegated monitoring. It also covers the information produc-
tion, liquidity transformation and consumption smoothing role of banks as well as various
other issues relating to the bank intermediation process. We then go on to provide a detailed
account of the main activities and services provided by banks, changes in the payment sys-
tems and the growing importance of ethical investments and sustainable banking strategies.
As the financial sector in many countries comprises a wide range of different types of banking
firms, these are then explained covering commercial banks, mutual banks, investment banks,
private banks as well as different forms of banking activity such as universal versus specialist
banking. Given the increasing role of banks on the global scene, Chapter 4 looks at the main
features of international banking highlighting the reasons as to why banks locate overseas or
conduct international activity. We also outline the main services provided by international
banks covering payments, credit, money and capital markets activity highlighting the role
of the Euromarkets – Eurobonds and Eurocurrency activity – and also syndicated lending.
Finally, Chapter 5 provides an introduction to Islamic banking, given the growing importance
of Islamic banking and finance in many countries. This chapter is new in this edition of the
textbook.
The main aim of Part 1 is to familiarise students with the reasons why banks exist, the
main services they offer, recent trends impacting on business areas, types of banking firms
and the differences between domestic and international banking business. This part provides
the reader with the relevant knowledge of global banking business and should also heighten
awareness of contemporary banking issues that put the following parts into context.
● Part 2: Central banking and bank regulation

– Chapter 6 Central banking
– Chapter 7 Bank regulation and supervision
– Chapter 8 Bank failures and banking crises
As the banking system is the main conduit of monetary policy, it is important that students
of banking are aware of the main roles of a central bank, its monetary policy role and its
other functions. The first chapter of Part 2 deals with the theory of central banking outlin-
ing the roles and functions of central banks, as well as the rationale for their existence. We
also discuss the conduct of monetary policy, distinguishing between instruments, targets
and goals, as well as the benefits of central bank independence. We also cover how central
banks conduct monetary policy and the role of banks in this process. Chapter 7 focuses on
bank regulation and supervision. We discuss the pivotal role played by banks in the economy
to understand the rationale for regulation, outline the aims and objectives of regulation
and different types of regulation. We next discuss the elements of the financial safety next
as well as the limitations of regulation and the possible reasons behind regulatory failure.
In this chapter we also review the causes for regulatory reform and discuss key interna-
tional policy initiatives, such as the Basel Capital Adequacy Accords. The final chapter of
Part 2 focuses on bank failures and banking crises. The impact of the global financial and
eurozone crises on the world’s banking markets made it all the more relevant to include
a detailed discussion of the determinants of bank failure. We then discuss the main strat-
egies used to identify problem banks, with a focus on early warning systems (EWS) for
bank soundness and the recently introduced stress tests. We also outline the key issues of
xxvi

Preface
bank restructuring and the regulatory toolkits to intervene in the banking sector. Finally, we
discuss the causes and consequences of banking and financial crises.
By the end of Part 2 students should be aware of the pivotal role played by monetary
policy and supervisory regulation and their impact on the banking sector (and economy as a
whole). The reader should be familiar with the rationale for central banking, the main tools
and instruments of monetary policy and how various major central banks undertake their
operations. Students should be able to identify the reasons as to why banks are so heavily
regulated and why having adequate solvency and liquidity is critical to maintain a safe and
sound banking system. In particular, readers should understand the important role played
by capital in the banking sector as well as the relevance of the Basel Capital Accords. Readers
should become aware of the determinants of bank failure as well as the toolkits at regulators’
disposal to supervise bank risk-taking. Readers should also become familiar with the causes
of banking and financial crises as well as effective crisis-management mechanisms.
● Part 3: Issues in bank management

– Chapter 9 Banks’ balance sheet and income structure
– Chapter 10 Bank financial management
– Chapter 11 Banking risks
– Chapter 12 Bank risk management
Part 3 of the text provides a detailed insight into the financial features of banking firms.
The first chapter focuses on the balance sheet and income features of both commercial and
investment banks, highlighting the main differences between the two types of institutions.
Substantial attention to detail is paid to the components of the financial statements of these
types of banks. In addition, we outline the role of traditional ratio analysis for evaluating
bank performance and asset quality as well as performance indicators relating to shareholder
value creation. Chapter 10 provides a detailed introduction to bank financial management
issues, covering asset and liability management, capital management, liquidity management
and off-balance-sheet management. The important role played by derivative business is intro-
duced, together with a discussion of loan sales and securitisation. We then go on to discuss
the various forms of risks faced by banks (including credit, interest rate, foreign exchange,
market, operational, sustainability and other risk types). The final chapter in the part intro-
duces a number of key approaches to bank risk management. It also includes a discussion of
the growing importance of banks’ corporate governance frameworks in setting the standards
of good practice and risk culture within banking organisations.
By the end of Part 3 students should be familiar with the main components of banks’ bal-
ance sheet and income statements, be aware of off-balance-sheet activity and should be able
to analyse bank performance and other issues using traditional ratio analysis. In addition,
they should have an insight into how banks manage their on- and off-balance-sheet positions
and be familiar with the main risks faced in banking operations. After reading this part, stu-
dents should be familiar with the main risk management approaches undertaken in banking.
● Part 4: Comparative banking markets

– Chapter 13 Banking in the UK
– Chapter 14 Banking in Europe
– Chapter 15 Banking in the US
– Chapter 16 Banking in Japan
– Chapter 17 Banking in emerging markets
xxvii

Preface
Part 4 focuses on the features of various banking systems, highlighting the main institutional
features of these systems (types of banks, non-bank deposit firms, role of other financial
firms) as well as various structural trends (number of banks, branches, M&A activity, market
concentration and such like). We have tried to cover systems that (we hope) will be of interest
to as wide an audience as possible covering the UK, Europe, US, Japan and various emerging
banking markets. We have paid particular attention to regulatory developments in the wake
of the global financial and eurozone crises. The emerging regulatory financial architecture
is discussed in detail for the UK, the European Union and the United States. It is interesting
to note that similar trends are apparent in most of these systems, namely, a decline in the
number of banks, consolidation and concentration, the increased role of foreign banks, the
broadening of banks’ business into other financial services areas, greater disintermediation
and the ongoing and omnipresent role of regulatory change. The final chapter provides a
discussion of the relationship between finance and growth, illustrating how a sound and
efficient financial system can aid economic development. We also provide a detailed insight
into various emerging banking systems which we hope will be of interest and also of practi-
cal use for anyone wishing to be aware of banking sector features and developments across
the globe. These include a discussion of the main forces of change and how these have influ-
enced the structure of the banking industries in emerging and transition economies in terms
of deregulation and the liberalisation process, the role of the state, M&As and the entry of
foreign banks.
By the end of Part 4 students should be familiar with the institutional features of the
banking/financial systems of the UK, US, Europe, Japan and various emerging markets and
transition economies. They should be aware of how the institutional features of the different
banking systems are changing and the trends that are common to all systems. A full under-
standing of these characteristics will provide students with the relevant framework to analyse
and discuss the structural and performance features of these (and other) banking systems.
● Part 5: Advanced topics in banking

– Chapter 18 Banks and markets
– Chapter 19 Mergers and acquisitions
– Chapter 20 Bank competition and financial stability
Part 5 focuses on some key issues in banking markets. Specifically, in the first chapter of this
part we focus on the bank intermediation process, on the increasing integration of banks
and markets and discuss the growth of the ‘shadow banking’ system. The aim of this chapter
is to outline the key linkages between banks and markets with a particular focus on the rise
and fall of securitisation. We then move on to explain the main processes involved in issu-
ing mortgage-backed securities (MBS) (and other asset-backed securities, ABS). We note
the broad impact of securitisation on bank activities and highlight how it has come under
increased regulatory scrutiny. The next chapter in this part focuses on mergers and acquisi-
tions (M&As) in banking markets, providing a classification of the different types of bank
mergers as well as a summary of the main reasons as to why banks merge. We outline the
trends in bank M&A activity as well as the impact of M&As on bank performance. The final
chapter focuses on the possible trade-off between banking sector competition and stabil-
ity. We provide a comparative analysis of the different measures of competition in banking
markets. Next we discuss different indicators of bank risk, including accounting indicators
and market-based measures of risk. We then explore the link between competition and risk
xxviii

Preface
in banking systems and outline the competition-fragility view (which posits that competition
induces increased risk-taking and therefore is detrimental for stability) and the competition-
stability view, which argues that competition promotes financial stability.
By the end of Part 5 students should be familiar with some of the current issues in bank-
ing and with the academic literature that has sought to investigate these issues empirically.
We have written this text to provide an introductory grounding to the theory and practice
of banking which we hope will serve as a useful guide for anyone studying banking subjects
at an introductory level and for those who are perhaps considering a career in the banking/
financial services industry.
We hope you enjoy reading the text and we encourage correspondence regarding any
omissions or any recommendations regarding improvement of the content.
Barbara Casu (Bayes Business School, City, University of London)
Claudia Girardone (Essex Business School, University of Essex)
Philip Molyneux (Bangor Business School, Bangor University)
xxix

Acknowledgements
This text could never have been completed without the direct and indirect help and support
of a wide range of individuals. First and foremost, we must acknowledge the role of our stu-
dents in helping to develop our course and lecture material which has been a critical element
in encouraging us to write this text. In addition, numerous discussions with fellow banking
researchers and professionals have also helped us greatly. We also want to acknowledge the
support of our home institutions: Bayes Business School, City University London; Essex Busi-
ness School, University of Essex; and Bangor Business School, Bangor University.
Particular thanks must go to members of the European Association of Banking and Finance
Professors (known as the Wolpertinger Club), who have emphasised the need for a compre-
hensive introductory book on banking issues – we hope this text goes some way to meet this
objective.
We would also like to offer a tribute to the late Shelagh Heffernan, an outstanding banking
scholar, a great teacher and a good friend.
In compiling this textbook, we would like to acknowledge the comments and discussions
provided by various individuals with whom we have undertaken collaborative banking
research in the past. In addition, thanks also to the many colleagues who have discussed
teaching and other matters relating to the study of banking and also to those who have
given us valuable feedback on the text including outside referees. We would like to thank a
number of individuals who have given us help and suggestions and provided feedback on
draft chapters currently and in the past. Yener Altunbas, Francesca Arnaboldi, Rym Ayadi,
Elena Beccalli, Thorsten Beck, Allen N. Berger, Paola Bongini, Laura Chiaramonte, Dimitris
Chronopoulos, Ettore Croci, Doriana Cucinelli, Marta Degl’Innocenti, Bob DeYoung, Dan-
iela Fabbri, Alessandra Ferrari, Franco Fiordelisi, Angela Gallo, Ted Gardener, John God-
dard, Jens Hagendorff, Iftekhar Hasan, Elena Kalotychou, Hong (Frank) Liu, David Maude,
David Marquez-Ibanez, Donal McKillop, Anna Sarkisyan, Steven Ongena, Fotios Pasiouras,
Nemanja Radic, Francesc Rodriguez Tous, Amine Tarazi, Alexia Ventouri, Dmitri Vinogradov,
Jonathan Williams, John O.S. Wilson.
Finally, thanks also to our families for the encouragement and support in accommodating
our academic foibles and helping us to complete a large project of this kind.
Barbara Casu thanks her husband, Martin, for endless patience and support (and lots
of hours on child-minding duties, particularly during the pandemic and home-schooling
period). And her children, despite their best attempts to make sure this third edition was
never completed, they are all very proud of it.
xxx

Acknowledgements
Claudia Girardone thanks her husband Marc for his encouragement and patience, her
wonderful sons Matteo and Leonardo for motivating her to always move forward with energy
and enthusiasm, and her parents, Nieves and Sandro, for being a constant source of strength
and inspiration. She also thanks Annie and Jean for their continued support.
Philip Molyneux thanks his children (who are now no longer children!) and his wife Del,
for their kind and generous support during the completion of this text. They still cannot
understand how he finds the subject of banking of any interest – we are sure they will ‘see
the light’ soon?
xxxi

List of acronyms and abbreviations
$bn billions of United States dollars

£bn billions of Great Britain pounds
€bn billions of euros
$mil millions of United States dollars
£mil millions of Great Britain pounds
€mil millions of euros
2-BCD EU Second Banking Co-ordination Directive
AAOIFI Accounting and Auditing Organization for Islamic Financial Institutions
ABCP asset-backed commercial paper
ABS asset-backed securities
ACH automated clearing house
ACP Autorité de contrôle prudentiel
AES advanced execution services
AGP asset guarantee programme
AI artificial intelligence
AIG American International Group
AIM Alternative Investment Market
ALCO asset and liability committee
ALM asset–liability management
AMA advanced measurement approach
AML anti-money laundering
ANZ Australia and New Zealand Banking Group Ltd
APACS Association for Payment Clearing Services
APF asset purchase facility
API application programming interface
APRA Australian Prudential Regulation Authority
ARM adjustable-rate mortgage
ASEAN Association of Southeast Asian Nations
ASF American Securitisation Forum
ATM automated teller machine
B2B business-to-business
Bacs Banks Automated Clearing System
BBA British Bankers’ Association
BBAA British Business Angels Association
BBVA Banco Bilbao Vizcaya Argentaria
BCB Banco Central do Brasil
BCBS Basel Committee on Banking Supervision
BCCSs bill and cheque clearing systems
BCRA Banco Central de la Republica Argentina
BFP Business Finance Partnership
xxxii

BHC bank holding company

BHCA Bank Holding Company Act
BIP Bank Insolvency Procedure
BIS Bank for International Settlements
BNM Bank Negara Malaysia
BoE Bank of England
BOJ-NET Bank of Japan Financial Network System
bps basis points
BRRD Bank Recovery and Resolution Directive
BSC Banking Supervision Committee
BTS Binding Technical Standards
BU Banking Union
BU bottom-up approach
BVCA British Private Equity & Venture Capital Association
C&CC cheque and clearing company
C/I cost-to-income ratio
CAD EU Capital Adequacy Directive
CAGR compound annual growth rate
CAMELS Capital, Asset, Management, Earnings, Liquidity, Sensitivity to Market Risk
CAP Capital Assistance Programme
CAPM capital asset pricing model
CBA Commonwealth Bank of Australia
CBFA Commission Bancaire, Financière et des Assurances
CBO collateralised bond obligations
CBPP covered bond purchase programme
CBR Central Bank of the Russian Federation
CBRC China Banking Regulatory Commission
CC Competition Commission
CCAR comprehensive capital analysis and review
CCB China Construction Bank
CCBM Correspondent Central Banking Model
CCBS Centre for Central Banking Studies
CCCL Cheque and Credit Clearing Company Limited
CD certificate of deposit
CDCI Community Development Capital Initiative
CDFIs Community Development Financial Institutions
CDIC Canada Deposit Insurance Corporation
CDO collateralised debt obligations
CDS credit default swaps
CEBS Committee of European Banking Supervisors
CEE Central and Eastern Europe
CEIOPS Committee of European Insurance and Occupational Pensions Supervisors
CEO chief executive officer
CESR Committee of European Securities Regulators
CFO chief financial officer
CFPB Consumer Financial Protection Bureau
CGFS Committee on the Global Financial System
xxxiii

CGS credit guarantee scheme

CHAPS Clearing House Automated Payments System
CHIPS Clearing House Interbank Payments System
CI credit institutions
CIBC Canadian Imperial Bank of Commerce
CLO collateralised loan obligations
CLS Continuous Linked Settlement
CMA Competition and Markets Authority
CME Chicago Mercantile Exchange
CMGs crisis management groups
CML Council of Mortgage Lenders
CMU Capital Markets Union
COAGs cross-border co-operation agreements
CORF corporate operational risk function
CP commercial paper
CPP Capital Purchase Programme
CPSS Committee on Payment and Settlement Systems
CRA credit-rating agencies
CRAM country risk assessment model
CRD Capital Requirements Directive
CRDs cash ratio deposits
CRIS control risks information services
CR-n n-firms concentration ratio
CRR Capital Requirements Regulation
CTF counter-terrorism financing
CV conjectural variations
CVF competing values framework
DD distance to default
DEFRA Department for Environment, Food & Rural Affairs
DFAST Dodd–Frank Act stress tests
DG duration gap
DGS deposit guarantee scheme
DIS deposit insurance scheme
DLT distributed ledger technology
DMO debt management office
DNB De Nederlandsche Bank
DTI debt-to-income ratio
DTIs deposit-taking institutions
DWF discount window facility
EBA European Banking Authority
EBC European Banking Committee
ECB European Central Bank
ECOFIN Economic and Financial Affairs Council
ECSC European Coal and Steel Community
ECTR extended collateral term repo facilities
EDF expected default frequency
EDI electronic data interchange
xxxiv

EDP excessive deficit procedure

EEA European Economic Area
EEC European Economic Community
EFDI European Forum of Deposit Insurers
EFN European Forecasting Network
EFSF European Financial Stability Facility
EFTPOS electronic funds transfer at point of sale
EGD European Green Deal
EIOPA European Insurance and Occupational Pensions Authority
EIOPC European Insurance and Occupational Pensions Committee
EIRIS Ethical Investing Research Service
EIU Economist Intelligence Unit
EL expected loss
ELs eligible liabilities
ELA emergency liquidity assistance
EM equity multiplier
EMI European Monetary Institute
EMS European Monetary System
EMU economic and monetary union
EPS earnings per share
ERM Exchange Rate Mechanism
ERM II Exchange Rate Mechanism II
ES expected shortfall
ESAs European Supervisory Authorities
ESC European Securities Committee
ESCB European System of Central Banks
ESF European Securitisation Forum
ESFS European System of Financial Supervision
ESFS European System of Financial Supervisors
ESG environmental, social and governance
ESM European Stability Mechanism
ESMA European Securities and Markets Authority
ESRB European Systemic Risk Board
ESRC European Systemic Risk Council
ESS efficient scale hypothesis
ESX efficient structure hypothesis (x-efficiency)
EU European Union
euro area EU member states that have adopted the euro
eurozone EU member states that have adopted the euro
EVA economic value added
EVCA European Private Equity & Venture Capital Association
EVE economic value of equity
EWS early warning systems
F gap financing gap
FAC Federal Advisory Council
FCA Financial Conduct Authority
FCC Financial Conglomerates Committee
xxxv

FDI foreign direct investment

FDIC Federal Deposit Insurance Corporation
Fed Federal Reserve Bank
FEDNET Federal Reserve’s national communications network
FFIEC Federal Financial Institutions Examination Council
FHFA Federal Housing Finance Agency
FHLMC Federal Home Loan Mortgage Corporation (Freddie Mac)
FICC Fixed Income, Currencies and Commodities Department
FINMA Swiss Financial Market Supervisory Authority
FLS Funding for Lending Scheme
FMSA Federal Agency for Financial Market Stabilisation
FNMA Federal National Mortgage Association (Fannie Mae)
FOMC Federal Open Market Committee
FPC Financial Policy Committee
FPS Faster Payments Service
FR Federal Reserve
FRA forward rate agreement
FRB Federal Reserve Board
FRNs floating rate notes
FROB Fondo de Reestructuración Ordenada Bancaria
FRS Federal Reserve System
FSA Financial Services Agency (Japan)
FSA Financial Services Authority (UK)
FSAP Financial Services Action Plan
FSB Financial Stability Board
FSCS Financial Services Compensation Scheme
FSF Financial Stability Forum
FSMA Financial Services and Markets Act 2000
FSOC Financial Stability Oversight Council
FSU Former Soviet Union
FTP fund transfer pricing
FXYCS Foreign Exchange Yen Clearing System
G10 Group of Ten
GAFA Google, Amazon, Facebook, Apple
GAFAA Google, Amazon, Facebook, Apple, Alibaba
GAO Government Accountability Office
GCC Gulf Cooperation Council
GDP gross domestic product
GNI gross national income
GNMA Government National Mortgage Association (Ginnie Mae)
GSE government-sponsored enterprise
G-SIBs global systemically important banks
G-SIFIs global systemically important financial institutions
HHI Herfindahl–Hirschman index
HICP Harmonised Index of Consumer Prices
HKMA Hong Kong Monetary Authority
HNWI high net worth individual
xxxvi

HQLA high-quality liquid assets

HTBEL Help to Buy equity loan scheme
IADI International Association of Deposit Insurers
IAIS International Association of Insurance Supervisors
IASB International Accounting Standards Board
IB Islamic bank
IBFs international banking facilities
ICAEW Institute of Chartered Accountants in England and Wales
ICB Independent Commission on Banking
ICBC Industrial and Commercial Bank of China
ICICI Industrial Credit and Investment Corporation of India
ICRG International Country Risk Guide
IDB Islamic Development Bank
IDIC Indonesia Deposit Insurance Corporation
IFC International Finance Corporation
IFI Islamic financial institution
IFRS International Financial Reporting Standards
IFSB Islamic Financial Services Board
IIFM International Islamic Financial Market
ILTROs indexed long-term repo open market operations
IM information memo
IMA Investment Management Association
IMF International Monetary Fund
IMM International Money Market
IOSCO International Accounting Standards Board
IoT Internet of Things
IPAB Instituto para la Protección al Ahorro Bancario
IPO initial public offering
IRB internal ratings based
IRR investment risk reserve
IRS interest rate swap
ISAs individual savings accounts
ISD Investment Services Directive
ISP internet service provider
KA key attributes
KDIC Korea Deposit Insurance Corporation
KPIs key performance indicators
KYC know your customer
L gap liquidity gap
LBO leveraged buyouts
LBS RMS London Business School Risk Measurement Service
LCBGs large and complex banking groups
LCDS loan credit default swaps
LCFIs large and complex financial institutions
LCR least-cost resolution
LCR liquidity coverage ratio
LDA loss distribution approach
xxxvii

LGD loss given default

LGE loss given event
LIBOR London Interbank Offered Rate
LOC letter of credit
LOLR lender of last resort
LPFCs limited-purpose finance companies
LRAC long-run average cost
LRMC long-run marginal cost
LSAPs large-scale asset purchases
LTRO longer-term refinancing operation
LTV loan-to-value ratio
M gap maturity gap
M&As mergers and acquisitions
M1 narrow money
M2 intermediate money
M3 broad money
MAC material adverse change
MAS Monetary Authority of Singapore
MBBGs Major British Banking Groups
MBS mortgage-backed securities
MC marginal cost
MCOB mortgage conduct of business
MENA Middle East and North Africa
MEW mortgage equity withdrawal
MFIs monetary financial institutions
MHFG Mizuho Financial Group
MiFID Markets in Financial Instruments Directive
MIP macroeconomic imbalance procedure
ML machine learning
MLA mandated lead arranger
MMF money market fund
MMOLR market maker of last resort
MNC multinational company
MPC Monetary Policy Committee
MPs Members of Parliament
MROs main refinancing operations
MTFG Mitsubishi Tokyo Financial Group
MUFJ Mitsubishi UFJ Financial Group
MVE market value of equity
NAB National Australia Bank
NBB National Bank of Belgium
NCAs national competent authorities
NCB national central bank
NCUA National Credit Union Administration
NDTI non-deposit taking institution
NEIO new empirical industrial organisation
NIF note issuance facilities
xxxviii

NII net interest income

NIM net interest margin
NIM-8 five Central and Eastern European countries and three Baltic States
NMSs new member states
NOPAT net operating profit after tax
NPLs non-performing loans
NPLS non-profit and loss sharing
NRAM Northern Rock Asset Management
NSFR net stable funding ratio
NYSE New York Stock Exchange
OBA open bank assistance
OBS off-balance-sheet
OCC Office of the Comptroller of the Currency
OECD Organisation for Economic Co-operation and Development
OFHEO Office of Federal Housing Enterprise Oversight
OFT Office of Fair Trading
OIC Organization of Islamic Cooperation
OIS overnight index swap
OLA Orderly Liquidation Authority
OMOs open market operations
OMT Outright Monetary Transactions
OSFs operational standing facilities
OTC over the counter
OTS Office of Thrift Supervision
P&A purchase and assumption
P&L profit and loss
P2P peer-to-peer
P/B price to book value
PBC People’s Bank of China
PC personal computer
PD probability of default
PER profit equalisation reserves
PIN personal identification number
PISP payment initiation services provider
PLL provision for loan losses
PLS profit and loss sharing
POP persistence of profits
PPI payment protection insurance
PPIP public–private investment programme
PPT partial property transfers
PRA Prudential Regulation Authority
PSIA profit-sharing investment accounts
PSPs private sector purchasers
PwC PricewaterhouseCoopers
QE quantitative easing
QR quick response
R&D research and development
xxxix

RAMSI Risk Assessment Model of Systemic Institutions

RAP resolvability assessment process
RAPM risk-adjusted performance measurement
RAR risk–asset ratio
RAROC risk-adjusted return on capital
RBI Reserve Bank of India
RBS Royal Bank of Scotland
RBSG Royal Bank of Scotland Group
REPO repurchase agreement
RMBS residential mortgage-backed securities
RMP relative market power
ROA return on assets
ROCHs recognised overseas clearing houses
ROE return on equity
ROIEs recognised overseas investment exchanges
RPD relative profit differences
RSA rate-sensitive assets
RSL rate-sensitive liabilities
RTGS real-time gross settlement
S&LA Savings and Loan Association
S&Ls savings and loans
S&P Standard & Poor’s
SAMA Saudi Arabian Monetary Agency
SBA scenario-based approach
SCAP Supervisory Capital Assessment Programme
SCDIS Shariah-compliant deposit insurance schemes
SCP structure-conduct-performance
SDG sustainable development goals
SDGS Single Deposit Guarantee Scheme
SDM Single Deposit Guarantee Mechanism
SEE South-Eastern Europe
SEPA Single Euro Payments Area
SFT securities financing transaction
SGP Stability and Growth Pact
SHIBOR Shanghai Interbank Offered Rate
SIFIs systemically important financial institutions
SIFMA Securities Industry and Financial Markets Association
SIVs structured investment vehicles
SLS special liquidity scheme
SMEs small and medium enterprises
SMFG Sumitomo Mitsui Financial Group
SMP Securities Markets Programme
SMTB Sumitomo Mitsui Trust Bank Ltd
SPV special-purpose vehicle
SRB Single Resolution Board
SRF Single Bank Resolution Fund
SRM Single Resolution Mechanism
xl

SRR special resolution regime

SRU Special Resolution Unit
SSM Single Supervisory Mechanism
SWIFT Society for Worldwide Interbank Financial Telecommunication
TAF term auction facility
TARGET Trans-European Automated Real-time Gross settlement Express Transfer
system
TARP Troubled Asset Relief Program
T-bills Treasury bills
T-bonds Treasury bonds
TBTDA too big to discipline adequately
TBTF too big to fail
TD top-down approach
TIP targeted investment programme
TITF too important to fail
TITF too interconnected to fail
TLAC Total Loss-Absorbing Capacity
TPO temporary public ownership
TRS total-return swaps
TSTF too systemic to fail
UCITS Directive Undertaking for Collective Investment in Transferable Securities
UKFI UK Financial Investments Limited
UKPA UK Payments Administration Ltd
URIA unrestricted investment account
VaR value at risk
WBC Westpac Banking Corporation
WOCCU World Council of Credit Unions
WSE Warsaw Stock Exchange
WTO World Trade Organization
YTD year to date
YTM yield to maturity
AT Austria
BE Belgium
BG Bulgaria
CY Cyprus
CZ Czech Republic
DE Germany
DK Denmark
EE Estonia
ES Spain
FI Finland
FR France
GB Great Britain (which consists of England, Wales and Scotland)
GR Greece
HR Croatia
HU Hungary
xli

IE Ireland
IT Italy
LT Lithuania
LV Latvia
MT Malta
NL the Netherlands
PL Poland
PT Portugal
RO Romania
SE Sweden
SI Slovenia
SK Slovakia
UAE United Arab Emirates
UK United Kingdom (which consists of Great Britain together with Northern Ireland)
US United States (of America)
xlii

PART 1
Introduction to banking
1 What is special about banks? 3

2 Bank activities and services 20
3 Types of banking 48
4 International banking 81
5 Islamic banking 119
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M01 Introduction to Banking 40336.indd 2 15/09/2021 10:52
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falsehood shock the delicacy of his perceptions, as much as it would
shock the finest artist to be obliged to daub in a signpost, or scrawl a
caricature. He cannot make up his mind to derive any benefit from so
pitiful and disgusting a source. Tell me that a man is a
metaphysician, and at the same time that he is given to shallow and
sordid boasting, and I will not believe you. After striving to raise
himself to an equality with truth and nature by patient investigation
and refined distinctions (which few can make)—whether he succeed
or fail, he cannot stoop to acquire a spurious reputation, or to
advance himself or lessen others by paltry artifice and idle
rhodomontade, which are in every one’s power who has never known
the value or undergone the labour of discovering a single truth. Gross
personal and local interests bear the principal sway with the ignorant
or mere man of the world, who considers not what things are in
themselves, but what they are to him: the man of science attaches a
higher importance to, because he finds a more constant pleasure in
the contemplation and pursuit of general and abstracted truths.
Philosophy also teaches self-knowledge; and self-knowledge strikes
equally at the root of any inordinate opinion of ourselves, or wish to
impress others with idle admiration. Mathematicians have been
remarked for persons of strict probity and a conscientious and
somewhat literal turn of mind.[16] But are poets and romance-writers
equally scrupulous and severe judges of themselves, and martyrs to
right principle? I cannot acquit them of the charge of vanity, and a
wish to aggrandise themselves in the eyes of the world, at the
expense of a little false complaisance (what wonder when the world
are so prone to admire, and they are so spoiled by indulgence in self-
pleasing fancies?)—but in general they are too much taken up with
their ideal creations, which have also a truth and keeping of their
own, to misrepresent or exaggerate matters of fact, or to trouble their
heads about them. The poet’s waking thoughts are dreams: the liar
has all his wits and senses about him, and thinks only of astonishing
his hearers by some worthless assertion, a mixture of impudence and
cunning. But what shall we say of the clergy and the priests of all
countries? Are they not men of learning? And are they not, with few
exceptions, noted for imposture and time-serving, much more than
for a love of truth and candour? They are good subjects, it is true;
bound to keep the peace, and hired to maintain certain opinions, not
to inquire into them. So this is an exception to the rule, such as
might be expected. I speak of the natural tendencies of things, and
not of the false bias that may be given to them by their forced
combination with other principles.
The worst effect of this depression of spirits, or of the ‘scholar’s
melancholy,’ here spoken of, is when it leads a man, from a distrust
of himself, to seek for low company, or to forget it by matching below
himself. Gray is to be pitied, whose extreme diffidence or
fastidiousness was such as to prevent his associating with his fellow
collegians, or mingling with the herd, till at length, like the owl,
shutting himself up from society and daylight, he was hunted and
hooted at like the owl whenever he chanced to appear, and was even
assailed and disturbed in the haunts in which ‘he held his solitary
reign.’ He was driven from college to college, and subjected to a
persecution the more harassing to a person of his indolent and
retired habits. But he only shrunk the more within himself in
consequence—read over his favourite authors—corresponded with
his distant friends—was terrified out of his wits at the bare idea of
having his portrait prefixed to his works; and probably died from
nervous agitation at the publicity into which his name had been
forced by his learning, taste, and genius. This monastic seclusion and
reserve is, however, better than a career such as Porson’s; who from
not liking the restraints, or not possessing the exterior
recommendations of good society, addicted himself to the lowest
indulgences, spent his days and nights in cider-cellars and pot-
houses, cared not with whom or where he was, so that he had
somebody to talk to and something to drink, ‘from humble porter to
imperial tokay’ (a liquid, according to his own pun), and fell a
martyr, in all likelihood, to what in the first instance was pure
mauvaise honte. Nothing could overcome this propensity to low
society and sotting, but the having something to do, which required
his whole attention and faculties; and then he shut himself up for
weeks together in his chambers, or at the University, to collate old
manuscripts, or edite a Greek tragedy, or expose a grave pedant,
without seeing a single boon-companion, or touching a glass of wine.
I saw him once at the London Institution with a large patch of coarse
brown paper on his nose, the skirts of his rusty black coat hung with
cobwebs, and talking in a tone of suavity approaching to
condescension to one of the Managers. It is a pity that men should so
lose themselves from a certain awkwardness and rusticity at the
outset. But did not Sheridan make the same melancholy ending, and
run the same fatal career, though in a higher and more brilliant
circle? He did; and though not from exactly the same cause (for no
one could accuse Sheridan’s purple nose and flashing eye of a
bashfulness—‘modest as morning when she coldly eyes the youthful
Phœbus!’)—yet it was perhaps from one nearly allied to it, namely,
the want of that noble independence and confidence in its own
resources which should distinguish genius, and the dangerous
ambition to get sponsors and vouchers for it in persons of rank and
fashion. The affectation of the society of lords is as mean and low-
minded as the love of that of coblers and tapsters. It is that coblers
and tapsters may admire, that we wish to be seen in the company of
their betters. The tone of literary patronage is better than it was a
hundred or a hundred and fifty years ago. What dramatic author
would think now of getting a lady of quality to take a box at the first
night of a play to prevent its being damned by the pit? Do we not
read the account of Parson Adams taking his ale in Squire Booby’s
kitchen with mingled incredulity and shame? At present literature
has, to a considerable degree, found its level, and is hardly in danger,
‘deprived of its natural patrons and protectors, the great and noble,
of being trodden in the mire, and trampled under the hoofs of a
swinish multitude’—though it can never again hope, to be what
learning once was in the persons of the priesthood, the lord and
sovereign of principalities and powers. Fool that it was ever to forego
its privileges, and loosen the strong hold it had on opinion in bigotry
and superstition!
I remember hearing a lady of great sense and acuteness speak of it
as a painful consequence of the natural shyness of scholars, that from
the want of a certain address, or an acquaintance with the common
forms of society, they despair of making themselves agreeable to
women of education and a certain rank in life, and throw away their
fine sentiments and romantic tenderness on chambermaids and
mantua-makers. Not daring to hope for success where it would be
most desirable, yet anxious to realise in some way the dream of
books and of their youth, they are willing to accept a return of
affection which they count upon as a tribute of gratitude in those of
lower circumstances, (as if gratitude were ever bought by interest),
and take up with the first Dulcinea del Toboso that they meet with,
when, would they only try the experiment, they might do much
better. Perhaps so: but there is here also a mixture of pride as well as
modesty. The scholar is not only apprehensive of not meeting with a
return of fondness where it might be most advantageous to him; but
he is afraid of subjecting his self-love to the mortification of a
repulse, and to the reproach of aiming at a prize far beyond his
deserts. Besides, living (as he does) in an ideal world, he has it in his
option to clothe his Goddess (be she who or what she may) with all
the perfections his heart doats on; and he works up a dowdy of this
ambiguous description à son gré, as an artist does a piece of dull
clay, or the poet the sketch of some unrivalled heroine. The contrast
is also the greater (and not the less gratifying as being his own
discovery,) between his favourite figure and the back-ground of her
original circumstances; and he likes her the better, inasmuch as, like
himself, she owes all to her own merit—and his notice!
Possibly, the best cure for this false modesty, and for the
uneasiness and extravagances it occasions, would be, for the retired
and abstracted student to consider that he properly belongs to
another sphere of action, remote from the scenes of ordinary life, and
may plead the excuse of ignorance, and the privilege granted to
strangers and to those who do not speak the same language. If any
one is travelling in a foreign Diligence, he is not expected to shine
nor to put himself forward, nor need he be out of countenance
because he cannot: he has only to conform as well as he can to his
new and temporary situation, and to study common propriety and
simplicity of manners. Every thing has its own limits, a little centre
of its own, round which it moves; so that our true wisdom lies in
keeping to our own walk in life, however humble or obscure, and
being satisfied if we can succeed in it. The best of us can do no more,
and we shall only become ridiculous or unhappy by attempting it. We
are ashamed, because we are at a loss in things to which we have no
pretensions, and try to remedy our mistakes by committing greater.
An overweening vanity or self-opinion is, in truth, often at the
bottom of this weakness; and we shall be most likely to conquer the
one by eradicating the other, or restricting it within due and
moderate bounds.
THE MAIN-CHANCE
The New Monthly Magazine.]

[February, 1828.
‘Search then the ruling passion: there alone,
The wild are constant, and the cunning known;
The fool consistent, and the false sincere;
Priests, princes, women, no dissemblers here.
This clue once found unravels all the rest,
The prospect clears, and Wharton stands confest.’
Pope.
I am one of those who do not think that mankind are exactly

governed by reason or a cool calculation of consequences. I rather
believe that habit, imagination, sense, passion, prejudice, words
make a strong and frequent diversion from the right line of prudence
and wisdom. I have been told, however, that these are merely the
irregularities and exceptions, and that reason forms the rule or basis;
that the understanding, instead of being the sport of the capricious
and arbitrary decisions of the will, generally dictates the line of
conduct it is to pursue, and that self-interest, or the main-chance, is
the unvarying load-star of our affections, or the chief ingredient in all
our motives, that, thrown in as ballast, gives steadiness and direction
to our voyage through life. I will not take upon me to give a verdict in
this cause as judge; but I will try to plead one side of it as an
advocate, perhaps a biassed and feeble one.
As the passions are said to be subject to the control of reason, and
as reason is resolved (in the present case) into an attention to our
own interest, or a practical sense of the value of money, it will not be
amiss to inquire how much of this principle itself is founded in a
rational estimate of things, or is calculated for the end it proposes, or
how much of it will turn out (when analysed) to be mere madness
and folly or a mixture, like all the rest, of obstinacy, whim, fancy,
vanity, ill-nature, and so forth, or a nominal pursuit of good. This
passion, or an inordinate love of wealth, shows itself, when it is
strong, equally in two opposite ways, in saving or in spending—in
avarice (or stinginess) and in extravagance. To examine each of their
order. That lowest and most familiar form of covetousness,
commonly called stinginess, is at present (it must be owned) greatly
on the wane in civilised society; it has been driven out of fashion
either by ridicule and good sense, or by the spread of luxury, or by
supplying the mind with other sources of interest, besides those
which related to the bare means of subsistence, so that it may almost
be considered as a vice, or absurdity, struck off the list, as a set-off to
some that, in the change of manners and the progress of dissipation
have been brought upon the stage. It is not, however, so entirely
banished from the world, but that examples of it may be found to our
purpose. It seems to have taken refuge in the petty provincial towns,
or in old baronial castles in the North of Scotland, where it is still
triumphant. To go into this subject somewhat in detail, as a study of
the surviving manners of the last age.—Nothing is more common in
these half-starved, barren regions, than to stint the servants in their
wages, to allowance them in the merest necessaries, never to indulge
them with a morsel of savoury food, and to lock up every thing from
them as if they were thieves, or common vagabonds, broke into the
house. The natural consequence is, that the mistresses live in
continual hot water with their servants, keep watch and ward over
them—the pantry is in a state of siege—grudge them every mouthful,
every appearance of comfort, or moment of leisure, and torment
their own souls every minute of their lives about what, if left wholly
to itself, would not make a difference of five shillings at the year’s
end. There are families so notorious for this kind of surveillance and
meanness, that no servant will go to live with them; for, to clench the
matter, they are obliged to stay if they do; as, under these amiable
establishments, and to provide against an evasion of their signal
advantages, domestics are never hired but by the half-year. Instances
have been known where servants have taken a pleasant revenge on
their masters and mistresses without intending it; but where the
example of sordid saving and meanness set to them, having taken
possession of those even who were victims to it, they have
conscientiously applied it to the benefit of all parties, and scarcely
suffered a thing to enter the house for the whole six months they
stayed in it. To pass over, however, those cases which may plead
poverty as their excuse, what shall we say to a lady of fortune (the
sister of one of their old-fashioned lairds) allowing the fruit to rot in
the gardens and hot-houses of a fine old mansion in large quantities,
sooner than let any of it be given away in presents to the neighbours;
and, when peremptorily ordered by the master of the house to send a
basket-full every morning to a sick friend, purchasing a small pottle
for the purpose, and satisfying her mind (an intelligent and well-
informed one) with this miserable subterfuge? Nay, farther, the same
person, whenever they had green-peas, or other rarities, served up at
table, could hardly be prevailed on to help the guests to them, but, if
possible, sent them away, though no other use could now be made of
them, and she would never see them again! Is there common sense
in this; or is it not more like madness? But is it not, at the same time,
human nature? Let us stop to explain a little. In my view, the real
motive of action in this and other similar cases of grasping
penuriousness has no more reference to self-love (properly so called)
than artificial fruit and flowers have to natural ones. A certain form
or outside appearance of utility may deceive the mind, but the
natural, pulpy, wholesome, nutritious substance, the principle of
vitality is gone. To this callous, frigid habit of mind, the real uses of
things harden and crystallise; the pith and marrow are extracted out
of them, and leave nothing but the husk or shell. By a regular
process, the idea of property is gradually abstracted from the
advantage it may be of even to ourselves; and to a well-drilled,
thorough-bred, Northern housekeeper (such as I have supposed), the
fruits, or other produce of her garden, would come at last to be
things no more to be eaten or enjoyed, than her jewels or trinkets of
any description, which are, professedly, of no use but to be kept as
symbols of wealth, to be occasionally looked at, and carefully
guarded from the approach of any unhallowed touch. The calculation
of consequences, or of benefit to accrue to any living person, is so far
from being the mainspring in this mechanical operation that it is
never once thought of, or regarded with peevishness and impatience
as an unwelcome intruder, because it must naturally divert the mind
from the warped and false bias it has taken. The feeling of property is
here, then, removed from the sphere of practice to a chimerical and
fictitious one. In the case of not sending the fruit out of the house,
there might be some lurking idea of its being possibly wanted at
home, that it might be sent to some one else, or made up into
conserves: but when different articles of food are actually placed on
the table, to hang back from using or offering them to others, is a
deliberate infatuation. They must be destroyed, they could not
appear again; and yet this person’s heart failed her, and shrank back
from the only opportunity of making the proper use of them with a
petty, sensitive apprehension, as if it were a kind of sacrilege done to
a cherished and favourite object. The impulse to save was become, by
indulgence, a sort of desperate propensity and forlorn hope, no
longer the understood means, but the mistaken end: habit had
completely superseded the exercise and control of reason, and the
rage of making the most of every thing by making no use of it at all,
resisted to the last moment the shocking project of feasting on a
helpless dish of green-peas (that would fetch so much in the market)
as an outrage against the Goddess of stinginess, and torture to the
soul of thrift! The principle of economy is inverted; and in order to
avoid the possibility of wasting any thing, the way with such
philosophers and housewives is to abstain from touching it
altogether. Is not this a common error? Or are we conscious of our
motives in such cases? [Or do we not flatter ourselves by imputing
every such act of idle folly to the necessity of adopting some sure and
judicious plan to shun ruin, beggary, and the most profligate abuse of
wealth? An old maid in the same northern school of humanity calling
upon some young ladies, her neighbours, was so alarmed and
scandalized at finding the safe open in their absence, that she
engaged herself to drink tea the same afternoon, for the express
purpose of reading them a lecture on the unheard-of imprudence
and impropriety of such an example, and was mobbed on her way
home by the poor servant-girl (who had been made the subject of her
declamation) in return for her uncalled-for interference. She had
nothing to fear, nothing to lose: her safe was carefully locked up.
Why then all this flutter, fidgetty anxiety, and itch of meddling? Out
of pure romantic generosity—because the idea of any thing like
comfort or liberality to a servant shocked her economical and
screwed-up prejudices as much as the impugning any article of her
religious or moral creed could have done. The very truisms and
literal refinements of this passion are then sheer impertinence. The
housekeeper came into the parlour of a ‘big ha’ house,’ in the same
land of cakes and hospitality, to say that the workmen had refused to
eat their dinner.—‘Why so?’—Because there was nothing but sowins
and sour milk.—‘Then they must go without a dinner,’ said the young
mistress delighted; ‘there is nothing else in the house for them.’ Yet
the larder at that time groaned with cold rounds of beef, hams,
pasties, and the other plentiful remains of a huge entertainment the
day before. This was flippancy and ill-nature, as well as a wrong
notion of self-interest. Is it at all wonderful that a decent servant-girl,
when applied to to go to this place, laughed at the idea of a service
where there was nothing to eat? Yet this attention to the main-
chance on her part, had it come to the lady’s knowledge, would have
been treated as a great piece of insolence. So little conception have
such people of their own obligations on the claims of others! The
clergyman of the parish (prolific in this sort of anecdote), a hearty,
good sort of man enough, but irritable withal, took it into his head to
fly into a violent passion if ever he found the glasses or spoons left
out in the kitchen, and he always went into the kitchen to look after
this sort of excitement. He pretended to be mightily afraid that the
one would be broken (to his irreparable loss) and the other stolen,
though there was no danger of either: he wanted an excuse to fret
and fume about something. On the death of his wife he sent for her
most intimate friend to condole and consult with, and having made
some necessary arrangements, begged as a peculiar favour that she
would look into the kitchen to see if the glasses and silver spoons
were in their places. She repressed a smile at such a moment out of
regard to his feelings, which were serious and acute; but burst into a
fit of unrestrained laughter as soon as she got home. So ridiculous a
thing is human nature, even to ourselves! Either our actions are
absurd, or we are absurd in our constant censure and exposure of
others. I would not from choice go into these details, but I might be
required to fill up a vague outline; and the examples of folly, spite,
and meanness are unfortunately ‘sown like a thick scurf o’er life!’]
Let us turn the tables and look at the other side of this sober, solid,
ingrossing passion for property and its appendages. A man lays out a
thousand, nay, sometimes many thousand pounds in purchasing a
fine picture. This is thought, by the vulgar, a very fantastical folly,
and unaccountable waste of money. Why so? No one would give such
a sum for a picture, unless there were others ready to offer nearly the
same sum, and who are likely to appreciate its value, and envy him
the distinction. It is then a sign of taste, a proof of wealth to possess
it, it is an ornament and a luxury. If the same person lays out the
same sum of money in building or purchasing a fine house, or
enriching it with costly furniture, no notice is taken—this is supposed
to be perfectly natural and in order. Yet both are equally gratuitous
pieces of extravagance, and the value of the objects is, in either case,
equally ideal. It will be asked, ‘But what is the use of the picture?’
And what, pray, is the use of the fine house or costly furniture, unless
to be looked at, to be admired, and to display the taste and
magnificence of the owner? Are not pictures and statues as much
furniture as gold plate or jasper tables; or does the circumstance of
the former having a meaning in them, and appealing to the
imagination as well as to the senses, neutralize their virtue, and
render it entirely chimerical and visionary? It is true, every one must
have a house of some kind, furnished somehow, and the superfluity
so far grows imperceptibly out of the necessary. But a fine house, fine
furniture, is necessary to no man, nor of more value than the
plainest, except as a matter of taste, of fancy, of luxury and
ostentation. Again, no doubt, if a person is in the habit of keeping a
number of servants, and entertaining a succession of fashionable
guests, he must have more room than he wants for himself,
apartments suitably decorated to receive them, and offices and
stables for their horses and retinue. But is all this unavoidably
dictated as a consequence of his attention to the main-chance, or is it
not sacrificing the latter, and making it a stalking-horse to his vanity,
dissipation, or love of society and hospitality? We are at least as fond
of spending money as of making it. If a man runs through a fortune
in the way here spoken of, is it out of love to himself? Yet who
scruples to run through a fortune in this way, or accuses himself of
any extraordinary disinterestedness or love of others? One bed is as
much as any one can sleep in, one room is as much as he can dine in,
and he may have another for study or to retire to after dinner—but he
can only want more than this for the accommodation of his friends,
or the admiration of strangers. At Fonthill Abbey (to take an extreme
illustration), there was not a single room fit to sit, lie, or stand in: the
whole was cut up into pigeon holes, or spread out into long endless
galleries. The building this huge, ill-assorted pile cost, I believe,
nearly a million of money; and if the circumstance was mentioned, it
occasioned an expression of surprise at the amount of the wealth that
had been thus squandered—but if it was said that a hundred pounds
had been laid out on a highly-finished picture, there was the same
astonishment expressed at its misdirection. The sympathetic auditor
makes up his mind to the first and greatest loss, by reflecting that in
case of the worst the building materials alone will fetch something
considerable; or, in the very idea of stone-walls and mortar there is
something solid and tangible, that repels the charge of frivolous
levity or fine sentiment. This quaint excrescence in architecture,
preposterous and ill-contrived as it was, occasioned, I suspect, many
a heart-ache and bitter comparison to the throng of fashionable
visitants; and I conceive it was the very want of comfort and
convenience that enhanced this feeling, by magnifying, as it were
from contrast, the expense that had been incurred in realising an idle
whim. When we judge thus perversely and invidiously of the
employment of wealth by others, I cannot think that we are guided in
our own choice of means to ends by a simple calculation of
downright use and personal accommodation. The gentleman who
purchased Fonthill, and was supposed to be possessed of wealth
enough to purchase half a dozen more Fonthills, lived there himself
for some time in a state of the greatest retirement, rose at six and
read till four, rode out for an hour for the benefit of the air, and
dined abstemiously for the sake of his health. I could do all this
myself. What then became of the rest of his fortune? It was lying in
the funds, or embarked in business to make it yet greater, that he
might still rise at six and read till four, &c.—it was of no other earthly
use to him; for he did not wish to make a figure in the world, or to
throw it away on studs of horses, on equipages, entertainments,
gaming, electioneering, subscriptions to charitable institutions,
[mistresses,] or any of the usual fashionable modes of squandering
wealth for the amusement and wonder of others and our own fancied
enjoyment. Mr. F. did not probably lay out five hundred a-year on
himself: it cost Mr. Beckford, who led a life of perfect seclusion,
twenty thousand a-year to defray the expenses of his table and of his
household establishment. When I find that such and so various are
the tastes of men, I am a little puzzled to know what is meant by self-
interest, of which some persons talk so fluently, as if it was a Jack-in-
a-Box which they could take out and show you, and which they tell
you is the object that all men equally aim at. If money, is it for its
own sake or the sake of other things? Is it to hoard it or to spend it,
on ourselves or others? In all these points, we find the utmost
diversity and contradiction both of feeling and practice. Certainly, he
who puts his money into a strong-box, and he who puts it into a dice-
box must be allowed to have a very different idea of the main-
chance. If by this phrase be understood a principle of self-
preservation, I grant that while we live, we must not starve, and that
necessity has no law. Beyond this point, all seems nearly left to
chance or whim; and so far are all the world from being agreed in
their definition of this redoubtable term, that one half of them may
be said to think and act in diametrical opposition to the other.
Avarice is the miser’s dream, as fame is the poet’s. A calculation of
physical profit or loss is almost as much out of the question in the
one case as in the other. The one has set his mind on gold, the other
on praise, as the summum bonum or object of his bigoted idolatry
and darling contemplation, not for any private and sinister ends. It is
the immediate pursuit, not the remote or reflex consequence that
gives wings to the passion. There is, indeed, a reference to self in
either case that fixes and concentrates it, but not a gross or sordid
one. Is not the desire to accumulate and leave a vast estate behind us
equally romantic with the desire to leave a posthumous name behind
us? Is not the desire of distinction, of something to be known and
remembered by, the paramount consideration? And are not the
privations we undergo, the sacrifices and exertions we make for
either object, nearly akin? A child makes a huge snow-ball to show
his skill and perseverance and as something to wonder at, not that he
can swallow it as an ice, or warm his hands at it, and though the next
day’s sun will dissolve it; and the man accumulates a pile of wealth
for the same reason principally, or to find employment for his time,
his imagination, and his will. I deny that it can be of any other use to
him to watch and superintend the returns of millions, than to watch
the returns of the heavenly bodies, or to calculate their distances, or
to contemplate eternity, or infinity, or the sea, or the dome of St.
Peter’s, or any other object that excites curiosity and interest from its
magnitude and importance. Do we not look at the most barren
mountain with thrilling awe and wonder? And is it strange that we
should gaze at a mountain of gold with satisfaction, when we can
besides say, ‘This is ours, with all the power that belongs to it?’ Every
passion, however plodding and prosaic, has its poetical side to it. A
miser is the true alchemist, or, like the magician in his cell, who
overlooks a mighty experiment, who sees dazzling visions, and who
wields the will of others at his nod; but to whom all other hopes and
pleasures are dead, and who is cut off from all connexion with his
kind. He lives in a splendid hallucination, a waking trance, and so far
it is well: but if he thinks he has any other need or use for all this
endless store (any more than to swill the ocean) he deceives himself,
and is no conjuror after all. He goes on, however, mechanically
adding to his stock, and fancying that great riches is great gain, that
every particle that swells the heap is something in reserve against the
evil day, and a defence against that poverty which he dreads more,
the farther he is removed from it; as the more giddy the height to
which we have attained, the more frightful does the gulph yawn
below—so easily does habit get the mastery of reason, and so nearly
is passion allied to madness! ‘But he is laying up for his heirs and
successors.’ In toiling for them, and sacrificing himself, is he
properly attending to the main-chance?
This is the turn the love of money takes in cautious, dry, recluse,
and speculative minds. If it were the pure and abstract love of
money, it could take no other turn but this. But in a different class of
characters, the sociable, the vain, and imaginative, it takes just the
contrary one, viz. to expense, extravagance, and ostentation. It then
loves to display itself in every fantastic shape and with every
reflected lustre, in houses, in equipage, in dress, in a retinue of
friends and dependants, in horses, in hounds—to glitter in the eye of
fashion, to be echoed by the roar of folly, and buoyed up for a while
like a bubble on the surface of vanity, to sink all at once and
irrecoverably into an abyss of ruin and bankruptcy. Does it foresee
this result? Does it care for it? What then becomes of the calculating
principle that can neither be hoodwinked nor bribed from its duty?
Does it do nothing for us in this critical emergency? It is blind, deaf,
and insensible to all but the noise, confusion, and glare of objects by
which it is fascinated and lulled into a fatal repose! One man ruins
himself by the vanity of associating with lords, another by his love of
low company, one by his fondness for building, another by his rage
for keeping open house and private theatricals, one by philosophical
experiments, another by embarking in every ticklish and fantastic
speculation that is proposed to him, one throws away an estate on a
law-suit, another on a die, a third on a horse-race, a fourth on virtù,
a fifth on a drab, a sixth on a contested election, &c. There is no
dearth of instances to fill the page, or complete the group of
profound calculators and inflexible martyrs to the main-chance. Let
any of these discreet and well-advised persons have the veil torn
from their darling follies by experience, and be gifted with a double
share of wisdom and a second fortune to dispose of, and each of
them, so far from being warned by experience or disaster, will only
be the more resolutely bent to assert the independence of his choice,
and throw it away the self-same road it went before, on his vanity in
associating with lords, on his love of low company, on his fondness
for building, on his rage for keeping open house or private
theatricals, on philosophical experiments, on fantastic speculations,
on a law-suit, on a dice-box, on a favourite horse, on a picture, on a
mistress, or election contest, and so on, through the whole of the
chapter of accidents and cross-purposes. There is an admirable
description of this sort of infatuation with folly and ruin in Madame
D’Arblay’s account of Harrel in ‘Cecilia;’ and though the picture is
highly wrought and carried to the utmost length, yet I maintain that
the principle is common. I myself have known more than one
individual in the same predicament; and therefore cannot think that
the deviations from the line of strict prudence and wisdom are so
rare or trifling as the theory I am opposing represents them, or I
must have been singularly unfortunate in my acquaintance. Out of a
score of persons of this class I could mention several that have
ruined their fortunes out of mere freak, others that are in a state of
dotage and imbecility for fear of being robbed of all they are worth.
The rest care nothing about the matter. So that this boasted and
unfailing attention to the main-chance resolves itself, when strong,
into mad profusion or griping penury, or if weak, is null and yields to
other motives. Such is the conclusion, to which my observation of life
has led me: if I am quite wrong, it is hard that in a world abounding
in such characters I should not have met with a single practical
philosopher.[17]
A girl in a country-town resolves never to marry any one under a
duke or a lord. Good. This may be very well as an ebullition of spleen
or vanity; but is there much common sense or regard to her own
satisfaction in it? Were there any likelihood of her succeeding in her
resolution, she would not make it: for it is the very distinction to be
attained that piques her ambition, and leads her to gratify her
conceit of herself by affecting to look down on any lower matches.
Let her suffer ever so much mortification or chagrin in the
prosecution of her scheme, it only confirms her the more in it: the
spirit of contradiction, and the shame of owning herself defeated,
increase with every new disappointment and year of painful
probation. At least this is the case while there is any chance left. But
what, after all, is this haughty and ridiculous pretension founded on?
Is it owing to a more commanding view and a firmer grasp of
consequences, or of her own interest? No such thing: she is as much
captivated by the fancied sound of ‘my lady,’ and dazzled by the
image of a coronet-coach, as the girl who marries a footman is smit
with his broad shoulders, laced coat, and rosy cheeks. ‘But why must
I be always in extremes? Few misses make vows of celibacy or marry
their footmen.’ Take then the broad question:—Do they generally
marry from the convictions of the understanding, or make the choice
that is most likely to ensure their future happiness, or that they
themselves approve afterwards? I think the answer must be in the
negative; and yet love and marriage are among the weightiest and
most serious concerns of life. Mutual regard, good temper, good
sense, good character, or a conformity of tastes and dispositions,
have notoriously and lamentably little to say in it. On the contrary, it
is most frequently those things that pique and provoke opposition,
instead of those which promise concord and sympathy, that decide
the choice and inflame the will by the love of conquest or of
overcoming difficulty. Or it is a complexion, or a fine set of teeth, or
air, or dress, or a fine person, or false calves, or affected
consequence, or a reputation for gallantry, or a flow of spirits, or a
flow of words, or forward coquetry, or assumed indifference,
something that appeals to the senses, the fancy, or to our pride, and
determines us to throw away our happiness for life. Neither in this
case, on which so much depends, are the main-chance and our real
interest by any means the same thing.
‘Now, all ye ladies of fair Scotland,
And ladies of England that happy would prove,
Marry never for houses, nor marry for land,
Nor marry for nothing but only love.’[18]—Old Ballad.
Or take the passion of love where it has other objects and

consequences in view. Is reason any match for the poison of this
passion, where it has been once imbibed? I might just as well be told
that reason is a cure for madness or the bite of a venomous serpent.
Are not health, fortune, friends, character, peace of mind, every thing
sacrificed to its idlest impulse? Are the instances rare, or are they not
common and tragical? The main-chance does not serve the turn
here. Does the prospect of certain ruin break the fascination to its
frail victim, or does it not rather enhance and precipitate the result?
Or does it not render the conquest more easy and secure that the
seducer has already triumphed over and deserted a hundred other
victims? A man à bonnes fortunes is the most irresistible personage
in the lists of gallantry. Take drunkenness again, that vice which till
within these few years (and even still) was fatal to the health, the
constitution, the fortunes of so many individuals, and the peace of so
many families in Great Britain. I would ask what remonstrance of
friends, what lessons of experience, what resolutions of amendment,
what certainty of remorse and suffering, however exquisite, would
deter the confirmed sot (where the passion for this kind of
excitement had once become habitual and the immediate want of it
was felt) from indulging his propensity and taking his full swing,
notwithstanding the severe and imminent punishment to follow
upon his incorrigible excess? The consequence of not abstaining
from his favourite beverage is not doubtful and distant (a thing in the
clouds) but close at his side, staring him in the face, and felt perhaps
in all its aggravations the very morning, yet the recollection of this
and of the next day’s dawn is of no avail against the momentary
craving and headlong impulse given by the first application of the
glass to his lips. The present temptation is indeed heightened by the
threatened alternative. I know this as a rule, that the stronger the
repentance, the surer the relapse and the more hopeless the cure!
The being engrossed by the present moment, by the present feeling,
whatever it be, whether of pleasure or pain, is the evident cause of
both. Few instances have been heard of, of a final reformation on this
head. Yet it is a clear case; and reason, if it were that Giant that it is
represented in any thing but ledgers and books of accounts, would
put down the abuse in an instant. It is true, this infirmity is more
particularly chargeable to the English and to other Northern nations,
and there has been a considerable improvement among us of late
years; but I suspect it is owing to a change of manners, and to the
opening of new sources of amusement (without the aid of ardent
spirits flung in to relieve the depression of our animal spirits,) more
than to the excellent treatises which have been written against the
‘Use of Fermented Liquors,’ or to an increasing, tender regard to our
own comfort, health, and happiness in the breast of individuals. We
still find plenty of ways of tormenting ourselves and sporting with
the feelings of others! I will say nothing of a passion for gaming here,
as too obvious an illustration of what I mean. It is more rare, and
hardly to be looked on as epidemic with us. But few that have
dabbled in this vice have not become deeply involved, and few (or
none) that have done so have ever retraced their steps or returned to
sober calculations of the main-chance. The majority, it is true, are
not gamesters; but where the passion does exist, it completely
tyrannizes over and stifles the voice of common sense, reason, and
humanity. How many victims has the point of honour! I will not
pretend that, as matters stand, it may not be necessary to fight a
duel, under certain circumstances and on certain provocations, even
in a prudential point of view, (though this again proves how little the
maxims and practices of the world are regulated by a mere
consideration of personal safety and welfare)—but I do say that the
rashness with which this responsibility is often incurred, and the
even seeking for trifling causes of quarrel, shows any thing but a
consistent regard to self-interest as a general principle of action, or
rather betrays a total recklessness of consequences, when opposed to
pique, petulance, or passion.
Before I proceed to answer a principal objection (and indeed a
staggering one at first sight) I will mention here that I think it
strongly confirms my view of human nature, that men form their
opinions much more from prejudice than reason. The proof that they
do so is that they form such opposite ones, when the abstract
premises and independent evidence are the same. How few
Calvinists become Lutherans! How few Papists Protestants! How few
Tories Whigs![19] Each shuts his eyes equally to facts or arguments,
and persists in the view of the subject that custom, pride, and
obstinacy dictate. Interest is no more regarded than reason; for it is
often at the risk both of life and fortune that these opinions have
been maintained, and it is uniformly when parties have run highest
and the strife has been deadliest that people have been most forward
to stake their existence and every thing belonging to them, on some
unintelligible dogma or article of an old-fashioned creed. Half the
wars and fightings, martyrdoms, persecutions, feuds, antipathies,
heart-burnings in the world have been about some distinction, ‘some
trick not worth an egg’—so ready are mankind to sacrifice their all to
a mere name! It may be urged, that the good of our souls or our
welfare in a future state of being is a rational and well-grounded
motive for these religious extravagances. And this is true, so far as
religious zeal falls in with men’s passions or the spirit of the times. A
bigot was formerly ready to cut his neighbour’s throat to go to
Heaven, but not so ready to reform his own life, or give up a single
vice or gratification for all the pains and penalties denounced upon
it, and of which his faith in Holy Church did not suffer him to doubt a
moment!
But it is contended here, that in matters not of doctrinal
speculation but of private life and domestic policy, every one consults
and understands his own interest; that whatever other hobbies he
may have, he minds this as the main object, and contrives to make
both ends meet, in spite of seeming inattention and real difficulties.
‘If we look around us’ (says a shrewd, hard-headed Scotchman) ‘and
take examples from the neighbourhood in which we live, we shall
find that allowing for occasional exceptions, diversities and
singularities, the main-chance is still stuck to with rigid and
unabated pertinacity—the accounts are wound up and every thing is
right at the year’s end, whatever freaks or fancies may have
intervened in the course of it. The business of life goes on (which is
the principal thing) and every man’s house stands on its own bottom.
This is the case in Nicholson-street, in the next street to it, and in the
next street to that, and in the whole of Edinburgh, Scotland, and
England to boot.’ This, I allow, is a home-thrust, and I must parry it,
how I can. It is a kind of heavy, broad-wheeled waggon of an
objection that makes a formidable, awkward appearance, and takes
up so much of the road, that I shall have a lucky escape if I can dash
by it in my light travelling gig without being upset or crushed to
atoms. The persons who in the present instance have the charge of it,
in its progress through the streets of Edinburgh, are a constitutional
lawyer, a political economist, an opposition editor, and an ex-officio
surveyor of the Customs—fearful odds against one poor
metaphysician! Their machine of human life, I confess, puts me a
little in mind of those square-looking caravans one sometimes meets
on the road in which they transport wild beasts from place to place;
and dull, heavy, safe, and flat as they look, the inmates continue their
old habits, the monkeys play their tricks, and the panthers lick their
jaws for human blood, though cramped and confined in their
excursions. So the vices and follies, when they cannot break loose, do
their worst inside this formal conveyance, the main-chance. As this
ovation is to pass up High-street, for the honour of the Scottish
capital, I should wish it to stop at the shop-door of Mr. Bartholine
Saddletree, to see if he is at home or in the courts. Also, to inquire
whether the suit of Peter Peebles is yet ended; and to take the
opinion of counsel, how many of the Highland lairds or Scottish
noblemen and gentlemen that were out in the fifteen and the forty-
five, perilled their lives and fortunes in the good cause from an eye to
the main-chance? The Baron of Bradwardine would have scorned
such a suggestion; nay, it would have been below Balmawhapple or
even Killancureit. But ‘the age of chivalry is gone, and that of
sophists, economists, and calculators has succeeded.’ I should say
that the risk, the secrecy, the possibility of the leaders having their
heads stuck on Temple-Bar, and their estates confiscated, were
among the foremost causes that inflamed their zeal and stirred their
blood to the enterprise. Hardship, danger, exile, death,—these words
‘smack of honour,’ more than the main-chance. The modern Scotch
may be loyal on this thriving principle: their ancestors found their
loyalty a very losing concern. Yet they persevered in it till and long
after it became a desperate cause. But patriotism and loyalty (true or
false) are important and powerful principles in human affairs,
though not always selfish and calculating. Honour is one great
standard-bearer and puissant leader in the struggle of human life;
and less than honour (a nickname or a bugbear) is enough to set the
multitude together by the ears, whether in civil, religious, or private
brawls. [But to return to our Edinburgh shop-keepers, those
practical models of wisdom, and authentic epitomes of human
nature. Say that by their ‘canny ways and pawky looks’ they keep
their names out of the ‘Gazette,’ yet still care (not the less perhaps)
mounts behind their counters, and sits in their back-shops. A
tradesman is not a bankrupt at the year’s end. But what does it
signify, if he is hen-pecked in the mean time, or quarrels with his
wife, or beats his apprentices, or has married a woman twice as old
as himself for her money, or has been jilted by his maid, or fuddles
himself every night, or is laying in an apoplexy by overeating himself,
or is believed by nobody, or is a furious Whig or Tory, or a knave, or
a fool, or one envious of the success of his neighbours, or dissatisfied
with his own, or surly, or eaten up with indolence and
procrastination, never easy but bashful and awkward in company
(though with a vast desire to shine) or has some personal defect or
weak side on which the Devil is sure to assail him, and the venting
his spleen and irritability on which, through some loop-hole or other,
makes the real business and torment of his life—that of his shop may
go on as it pleases. Such is the perfection of reason and the triumph
of the sovereign good, where there are no strong passions to disturb,
or no great vices to sully it! The humours collect, the will will have
head, the petty passions ferment, and we start some grievance or
other, and hunt it down every hour in the day, or the machine of still-
life could not go on even in North Britain. But were I to grant the full
force and extent of the objection, I should still say that it does not
bear upon my view of the subject or general assertion, that reason is
an unequal match for passion. Business is a kind of gaoler or task-
master, that keeps its vassals in good order while they are under its
eye, as the slave or culprit performs his task with the whip hanging
over him, and punishment immediately to follow neglect; but the
question is, what he would do with his recovered freedom, or what
course the mind will for the most part pursue, when in the range of
its general conduct it has its choice to make between a distant,
doubtful, sober, rational good (or average state of being), and some
one object of comparatively little value, that strikes the senses,
flatters our pride, gives scope to the imagination, and has all the
strength of passion and inclination on its side. The main-chance
then is a considerable exception, but not a fair one or a case in point,
since it falls under a different head and line of argument.] The fault
of reason in general, (which takes in the whole instead of parts,) is
that objects, though of the utmost extent and importance, are not
defined and tangible. This fault cannot be found with the pursuit of
trade and commerce. It is not a mere dry, abstract, undefined,
speculative, however steady and well-founded conviction of the
understanding. It has other levers and pulleys to enforce it, besides
those of reason and reflection. As follows:—
1. The value of money is positive or specific. The interest in it is a
sort of mathematical interest, reducible to number and quantity. Ten
is always more than one; a part is never greater than the whole; the

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ISBN: 978-1-292-24033-6 (print)

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To Marc, Matteo and Leonardo. To my parents Nieves and Sandro (CG)

To Delyth, Alun, Catrin, Gareth, Gethin, Lois and Rhiannnon (PM)

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List of figures xiv

Part 1 Introduction to banking

1 What is special about banks? 3

2 Bank activities and services 20

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3.7 Investment banking 67

5 Islamic banking 119

Part 2 Central banking and bank regulation

6 Central banking 141

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7 Bank regulation and supervision 175

8 Bank failures and banking crises 216

Part 3 Issues in bank management

9 Banks’ balance sheet and income structure 249

10 Bank financial management 289

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10.5 Off-balance-sheet (OBS) business in banking 297

11 Banking risks 324

12 Bank risk management 354

Part 4 Comparative banking markets

13 Banking in the UK 403

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13.3 Regulatory reforms and the changing face of UK banking 413

14 Banking in Europe 445

15 Banking in the US 496

16 Banking in Japan 533

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17 Banking in emerging markets 563

Part 5 Advanced topics in banking

18 Banks and markets 597

19 Mergers and acquisitions 626

20 Bank competition and financial stability 654

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20.5 Competition and risk in banking 673

Appendix A1 Interest rates, bonds and yields 681

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1.1 The intermediation function 4

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6.5 Reserve requirements 156

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11.2 Reinvestment risk 331

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15.6 Performance of US commercial banks – return on assets (ROA), 1984–2020 519

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2.1 A simplified bank balance sheet 21

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9.1 Simplified commercial bank balance sheet 250