A commercial bank (or business bank) is a type of financial institution and

intermediary. It is a bank that provides transactional, savings, and money market

accounts and that accepts time deposits.[1]

After the implementation of the Glass–Steagall Act, the U.S. Congress required that
banks engage only in banking activities, whereas investment banks were limited to
capital market activities. As the two no longer have to be under separate ownership
under U.S. law, some use the term "commercial bank" to refer to a bank or a
division of a bank primarily dealing with deposits and loans from corporations or
large businesses. In some other jurisdictions, the strict separation of investment and
commercial banking never applied. Commercial banking may also be seen as
distinct from retail banking, which involves the provision of financial services direct
to consumers. Many banks offer both commercial and retail banking services.

remunerative. Foreign currency deposits became less attractive due to the rise in
forward cover charged by the SBP. Banks reduced return on deposits to maintain
their spread. However, they were not able to contain the decline in ROA due to
declining stock and remuneration of their earning assets.

Liquidity

Movement in liquidity indicators since 1997 indicates the painful process of

adjustments. Ratio of liquid assets to total assets has been on a constant decline.
This was consciously brought about by the monetary policy changes by the SBP to
manage the crisis-like situation created after 1998. Both the cash reserve
requirement ((CRR) and the statutory liquidity requirement (SLR) were reduced in
1999. These steps were reinforced by declines in SBP's discount rate and T-Bill
yields to help banks manage rupee withdrawals and still meet the credit
requirement of the private sector.

Foreign banks have gone through this adjustment much more quickly than other
banks. Their decline in liquid assets to total assets ratio, as well as the rise in loan
to deposit ratio, are much steeper than other groups. Trend in growth of deposits
shows that most painful part of the adjustment is over. This is reflected in the
reversal of decelerating deposit growth into accelerating one in year 2000.

Sensitivity to market risk

Rate sensitive assets have diverged from rate sensitive liabilities in absolute terms
since 1997. The negative gap has widen. Negative value indicates comparatively
higher risk sensitivity towards liability side, while decline in interest rates may prove
beneficial.

Deposit Mobilization

Deposit mobilization has dwindled considerably after 1997. Deposits as a proportion

of GDP have been going down. Growth rate of overall deposits of banks has gone
down. However, the slow down seems to have been arrested and reversed in year
2000.

Group-wise performance of deposit mobilization is the reflection of the varying

degree with which each group has been affected since 1998. Foreign banks were
affected the most due to their heavy reliance of foreign currency deposits. They
experience 14 per cent erosion in 1999. However, they were able to achieve over 2
per cent growth in year 2000. Similar recovery was shown by private banks.

Deposit mobilization by NCBs seems to be waning after discontinuation of their

rupee deposit schemes linked with lottery prizes. Growth in their deposits were on
the decline. Despite the decline NCBs control a large share in total deposits.
Aggressive posture of private banks in mobilizing more deposits in year 2000 is
clearly reflected in their deposit growth, from 1.9 per cent in year 1999 to 21.7 per
cent in year 2000. This has also helped them in increasing their share in total
deposits to over 14 per cent in year 2000.

Due to the shift in policy, now banks are neither required nor have the option to
place their foreign currency deposits with the SBP. Although, the growth in foreign
currency deposits increase the deposit base, it does not add to their rupee liquidity.
The increasing share of foreign currency deposits in total base is a worrying
development. In order to check this trend, SBP made it compulsory for the banks
not to allow foreign currency deposits to exceed 20 per cent of their rupee deposits
effective from January 1, 2002.

Credit extension
Bulk of the advances extended by banks is for working capital which is self-
liquidating in nature. However, due to an easing in SBP's policy, credit extension
has exceeded deposit mobilization. This is reflected in advances growing at 12.3 per
cent in year 1999 and 14 per cent in year 2000.

Group-wise performance of banks in credit extension reveals three distinct

features.1) Foreign banks curtailed their lending,2) continued dominance by NCBs
and3) aggressive approach being followed by private banks. Private banks were the
only group that not only maintained their growth in double-digit but also pushed it
to over 31 per cent in year 2000. With this high growth, they have surpassed
foreign banks, in terms of their share in total advances in year 2000.

Banking spreads

Over the years there has been a declining trend both in lending and deposit rates.
Downward trend in lending rates was due to SBP policy. The realized trend in
lending rates was in line with monetary objectives of SBP, though achieved with
lags following the sharp reduction in T-Bill yields in year 1999, needed to induce
required change in investment portfolio of banks.

Downward trend in deposit rates was almost inevitable. One can argue that banks
should have maintained, if not increased, their deposit rates to arrest declining
growth in total deposits. However, this was not possible at times of eroding balance
sheet, steady earnings were of prime importance. Consequently banks tried to find
creative ways of mobilizing deposits at low rates. However, due to inefficiencies of
the large banks, the spread has remained high.

Asset composition

Assets of banking sector, as per cent of GDP, have been on the decline. Slowdown
in asset growth was also accompanied by changing share of different groups.
Negative growth in the assets of foreign banks during 1998 and 1999 was the prime
reason behind declining growth in overall assets of the banking sector. Share of
NCBs have been decreasing since private banks were allowed to operate in 1992. In
terms of asset share, private banks are now as large as foreign banks.

Problem bank management

COMMERCIAL BANKS
The central bank is the sole authority to supervise, monitor and regulate financial
institutions. It is also responsible to safeguard the interest of depositors and
shareholders of these institutions. Lately, SBP took actions against two private
banks which became a threat to viability of the financial system in the country.
These were Indus Bank and Prudential Commercial Bank. On the basis of detailed
investigations, the license of Indus Bank was cancelled on September 11, 2000.
After successful negotiations, management and control of Prudential Bank handed
over to Saudi-Pak group.

Outlook

Commercial banks have been going through the process of restructuring. There are
efforts to reduce lending rates. The SBP has been successful in implementing its
policies. Most of the banks have been able to adjust to new working environment.
The proposed increase in capital base will provide further impetus to financial
system in the country.

In the post September 11 era, the GoP borrowing from SBP and commercial banks is
expected to come down substantially and private sector borrowing to increase.
However, a temporary decline in repayment ability of borrowers may increase
provisioning for the year 2001. The situation is expected to improve in year 2002.

Unless efforts are made by banks to shrink spread, depositors will not be able to get

return which corresponds with the rate of inflation in the country.

Privatization of NCBs is expected to be delayed due to external factors. However, it

is an

opportunity for the banks to further clean their slat

banks for operating in Pakistan? Or, the higher profit made in the past was only
because

of the inefficiency of local banks?

To explore this one has to look at the shift in paradigm in Pakistan's commercial
banking
sector. The process was initiated in early nineties with the privatization of Muslim

Commercial Bank (MCB) and Allied Bank of Pakistan (ABL) and establishment of a

dozen banks in the private sector. This was followed by the first phase of financial
sector

reforms. Now the consultations with banks is going on to initiate the second phase .
The

local banks have been asked to: raise their paid-up capital to one billion rupee,
follow

maximum disclosure requirement and make full provisions against non-performing

loans

(NPLs). Efforts are also being made to restructure NCBs for their ultimate
privatization.

All these measures have changed the working environment. The local banks have

emerged strong competitor of foreign banks. Have the foreign banks lost the zeal to

compete or do they find themselves inadequate to compete with the local banks?

Foreign banks operating in Pakistan have thrived in the past mainly due to selective

clientele, better standard of services and virtually no burden of NPLs. Their biggest

strength was the ability to mobilize foreign currency deposits and to swap these
deposits.

As they were mobilizing dollar deposits, they were also considered blue-eyed kids of
the

Government of Pakistan (GoP). Then came freezing of foreign currency accounts

(FCAs)

in May 1998. Though, there was restriction on withdrawal of money in foreign

exchange,

foreign banks experienced, initially, large erosion in deposits. They also found
mobilizing

local currency deposit difficult due to limited branch network.

Foreign banks were, and still, competing mainly with the five big banks. The private

banks have intruded, to a large extent, into their niche market. They also realized
the fact

that they could not put up effective resistance against the local banks due to their
limited

number of branches. Opening more branches was not only an expensive proposal
but also

not enough to compete with the five big banks and to face the ambitious branch

expansion plan of the private banks. To overcome this limitation, foreign banks are

making huge investment in technology, i.e. on-line banking, ATMs, credit cards, etc.

However, these services could only be used in urban areas, mostly. With the
gradual

increase in the paid-up capital of private banks and depositors' confidence in them,

branch rationalization programme followed by the NCBs and privatized banks, the

feeling of inadequacy among the foreign banks further intensified.

Some of the foreign banks have either already sold their Pakistan operations to local

banks or are actively involved in the negotiations. The two banks which have
already

taken an exit are Bank of America and Societe Generale of France (SG). Earlier, a
very

important feature was conversion of Pakistan branch network of foreign banks into

locally incorporated banks followed by acquiring of large equity stakes by foreign

groups, particularly from the Middle East, in the local banks. Faysal Bank of Bahrain
was

the first to convert its Pakistan operations into a locally incorporated bank— Faysal

Bank. A foreign investors' group acquired Habib Credit & Exchange Banks
(previously

branch network of BCCI) and renamed it, Bank Alfalah. Schon Bank was bought by
some foreign investors from the Middle East and given the name, Gulf Commercial

Bank. This was subsequently takenover by Pakistan Industrial Credit and Investment

Corporation (PICIC) and became PICIC Commercial Bank.

As a result of merger ANZ Grindlays Bank of Australia and Standard Chartered Bank
of

UK, now the two banks are operating under Standard Chartered banner. The
majority

shares of Union Bank were acquired by another group from the Middle East. Union
Bank

has also acquired Pakistan operations of Bank of America and some business of

American Express in Pakistan. It has also acquired Pakistan operations of Emirates

Bank

International of UAE.

It is very important to explore the motives behind the above mentioned

transactions, but

first the SG deal. Al-Meezan Investment Bank, established by Pakistan Kuwait

Investment Company, recently acquired commercial banking licence and the name
was

changed to Meezan Bank. The new bank also acquired Pakistan operations of SG. An

interesting point is that SG sold its Pakistan's operations to Meezan Bank but also

acquired substantial stake in the bank. The point which makes it further interesting
is the

declaration of Meezan Bank to undertake commercial banking activities on the basis

of

Riba free transactions only. It is rather unusual that a European bank has become a

partner in a bank which promises Riba free banking.

There has been no official announcement about the takeover of Emirates Bank's
Pakistan

operations by Union Bank. However, the sources in banking sector say that the deal
has

been concluded at a substantial cost and formal approval from the shareholders of
Union

Bank was acquired at a recently held extraordinary general meeting. It may look a
bit

strange that Emirates Bank, which has been going strong in Pakistan, makes such a

decision. However, banking sector experts say that Emirates Bank's decision is due
to the

shift in its policy which envisages making the bank a strong domestic bank. It has
already

sold its operations in the UK and India and it was expected they would also pull out
of

Pakistan.

It is also important to look at the recently held bidding for the sale of 51 per cent
shares

alongwith transfer of management of United Bank Limited (UBL). Muslim

Commercial

Bank (MCB) submitted the highest bid, almost double the amount offered by other

participants. Though, State Bank of Pakistan (SBP) has suggested to the

Privatization

Commission to ask the bidders to raise the bids further, it seems that MCB will
ultimately

takeover UBL. A question was raised, why did MCB offered such a high price? The

sector experts say, "MCB has most probably submitted such a bid to make it
difficult for

others to match the price."

Why should MCB be so keen in taking over UBL? The sector experts say, "The
biggest

attraction for MCB, in UBL, is its overseas operations. MCB has already attained the

status of the largest private sector bank in Pakistan and now intends to make its
presence

felt in the global market. Whereas Union Bank should be keen in consolidating its

operations after the takeover of Pakistan operations of Bank of America, American

Express and Emirates Bank." It must be kept in mind that UBL's ultimate handing
over to

any bidder is largely dependent on the formal clearance of the buyer by the Bank of

England. Therefore, the transfer of ownership and management of UBL to MCB

seems

most likely.

It may be of some interest to compare MCB with Union Bank in slightly more detail.

MCB has a long history of operations and successful restructuring after its
privatization.

It also enjoys extensive and intensive branch network. Lately it has invested heavily
in

technology to improve quality and range of its services which include on-line
banking,

ATMs and MNET. Under the new management efforts were made to recover NPLs
and

full provisioning against such loans.

Compared to MCB, Union Bank has a rather bumpy track record. The initial
sponsors,

Saigol Group, relinquished their stake in the bank under a distressed sale. The new

management, mostly comprising of zealous and ambitious bankers, have yet to

make a
mark. It is true that the bank is making a lot of investment to become the preferred
bank

but has little control on expenditures. According to the annual report for year 2001,
bulk

or almost total income was eaten up by operating expenses and the bank posted a
meager

profit of around Rs 10 million for the year.

It is often said that most of the banks listed in Pakistan follow orthodox or
conservative

approach and they must come out of this syndrome. However, the critics are often
not

able to differentiate between orthodox and prudent approach in banking. It is still

the

better to be a little conservative and make stable profit rather than being
adventurous and

posting marginal profit or incurring loss. Ensuring decent return to depositors and

shareholders should always be the key objective of the management of any bank.

ELIMINATION OFRIBA

According to an order by the Supreme Court of Pakistan local financial institutions

were

required to eliminateRiba from the system by June 30, 2001. However, taking into

consideration the quantum of work, the deadline was extended for one more year,
to June

30, 2002. While the intellectual deliberations continued, the battle in the court of
law

became more focused. Now, the court has ordered for determination afresh in the
light of

contentions of the parties and the observations. The financial institutions may no
longer
face the pressure to re-engineer the system, at least for the time being. However,
one may

raise a question, Is the court order more important or the Islamic injunctions
demanding

elimination ofRiba ?

The future deliberations must address key issues like: 1) what is the real definition
of

Riba ? 2) Does the prevailing system provides assurance against exploitation of

borrowers by the lenders? 3) Are the borrowers paying market-based rates? 4) Are
the

fixed lending and borrowing rates only notional? There are host of other issues
which

have to be dealt with. However, both the sides, religious scholars and economists,
must

not enter into due diligence with rigid stands. This is an academic discussion of the

highest importance — it deals with the basic teaching of Islam,Rizzaq-e- Halal.

PRIVATIZATION

The present government is making efforts to ensure swift and smooth privatization
of

NCBs. This includes two tier strategy, sale of remaining shares of GoP in already

privatized banks and sale of majority shares alongwith transfer of management of

remaining NCBs. There was plan to list the NCBs on stock exchanges first and then
off-

load part of GoP holding, according to the market appetite. Following this policy,

National Bank of Pakistan was listed on local stock exchanges and 5 per cent shares
were
offered to general public. As the issue was heavily over-subscribed, the GoP decided
to

exercise 'green-shoe option' and off-loaded its 10 per cent shares.

As regards UBL, the GoP decided to sell 51 per cent shares alongwith transfer of

management. The bidding was held and MCB submitted the highest bid of Rs 8.5
billion.

The next major transaction on agenda is sale of majority shares of Habib Bank
Limited

(HBL) alongwith transfer of management. Initially the GoP had the plan to first enlist

HBL on local stock exchanges and sell part of its holding to general public. However,
the

plan has been changed. Now the GoP wishes to make outright sale of the bank. The
GoP

has also offered to sell its holding in Bank Alfalah.

KEY PLAYERS

Askari Commercial Bank posted over one billion rupee profit before tax and
improved

its payout for the year 2001 compared to dividend paid for the previous year. The
Board

of Directors approved payment of 20 per cent dividend and issue of 5 per cent
bonus

shares.

Bank Alfalah may rightly term year 2001, 'another year of remarkable performance
and

another year of consistent growth'. This is evident from a 47 per cent growth in
deposits, 24 per cent increase in advances, 31 per cent growth in profit before tax
and 44 per cent hike in profit after tax as compared to the previous year. At the end
of the year equity of the bank also stood at Rs 1.361 billion, a growth of 51 per cent
over the previous year.

Faysal Bank was able to wipe out its accumulated losses. Over the last couple of
years

the bank not only managed to clean its slate but to also pay 10 per cent dividend.
There

was improvement in mark-up as well as non-mark up income. The management was

able

to control expenses, though there was slight increase in administrative expenses.

There

was also improvement in basic earning per share — from Rs 1.53 to Rs 1.82.

Habib Bank posted Rs 2.2 billion profit before tax for the year, almost double the

amount posted for the previous year. This was despite the fact that the bank made

provisions amounting to Rs 2.6 billion as compared to Rs 1.2 for the year 2000.
Profit

after tax of Rs 1.1 billion was more than double the amount posted for the previous
year.

The bank managed to curtail administrative expenses. There was a reduction in

non-

performing loans. The bank has increased lending to SMEs. There was improvement
in

overseas operations which contributed towards higher profit. Another improvement

was

the increase in number of ATMS — 61 of its own and over 100 machines through
sharing

with other banks.

Metropolitan Bank posted Rs 742.7 million profit before tax as compared to Rs

567.9
million profit for the year 2000. Out of Rs 338 million profit after tax, Rs 200 million

were appropriated for issue of bonus shares. Rs 175 million bonus shares were also

issued in year 2000.

Muslim Commercial Bank is the largest private sector bank and the third largest
bank of

Pakistan. The year 2001 was yet another year of achievements. The bank posted
over Rs

2.1 billion profit before tax and total dividend payout for the year 2001 was 25 per
cent.

PICIC Commercial Bank (formally Gulf Commercial Bank) completed the first

successful year of operations since the acquisition of the bank by Pakistan Industrial

Credit and Investment Corporation (PICIC). The various structural and financial
changes

introduced, yielded positive results. Some of the indicators of improvement were, a

hefty

153 per cent growth in profit before tax and 79 per cent increase in deposits. The
Board

of Directors approved issue of 25 per cent bonus shares and 40 per cent right
shares to

further improve the balance sheet footing.

Prime Commercial Bank was able to improve its earnings per share due to higher

income, though there was also increase in expenses. The bank posted Rs 241
million

profit before tax as compared to a profit of Rs 158.6 million for the previous year.
Out of

Rs 152.6 million profit after tax Rs 122 million were transferred to revenue reserve
and

the Board of Directors preferred to skip dividend payment.

The Bank of Khyber posted Rs 231 million profit after tax for the year 2001 as

compared to a loss of Rs 157 million for the previous year. One of the reasons for

+++

on against NPLs. By making such a provision the bank has cleaned its slate and the
step

would augur well in the future performance.

Union Bank posted a meager Rs 9.95 million profit before tax for the year 2001. A
closer

look at the financial results reveals that out of an interest income of Rs 597.5
million,

provision against non-performing loans and advances amounted to Rs 197.6 million.

While interest income amounted to Rs 597.5 million, non-interest income amounted

to

over one billion rupee. An interesting observation was that as against a total income
of Rs

1,064.6 million for the year, administrative expenses were as high as Rs 1,040
million.

The financial results of commercial banks for the year 2001 seem good despite
economic

slow down, barring a few. However, analysts say that the earnings for the year 2002
may

ommercial Bank

Bank Alfalah

30,207

20,482

Bank Al Habib
24,697

17,823

Metropolitan Bank

17,902

13,136

Platinum Commercial Bank

3,991

6,416

Prime Commercial Bank

10,367

8,264

PICIC Commercial Bank

9,619

5,371

Soneri Bank

16,054

14,030

Union Bank

20,721

17,171

ADVANCES

(Rs in million)

Name

2001

2000

Askari Commercial Bank

23,291

17,893

Bank Alfalah

19,131

15,242

Bank Al Habib

15,902

14,722

Metropolitan Bank

12,988

11,367

Platinum Commercial Bank

2,147

6,355

Prime Commercial Bank

6,853

6,794

PICIC Commercial Bank

6,330

4,746

Soneri Bank

10,199

10,931

Union Bank

13,869

13,346
OUTLOOK

Most of the banks have been able to make full provisions against NPLs. The impact
of

September 11 incident did not appear in first quarter reports. The real impact can
only be

quantified after half-year results are announced.

The demand for funds by the private sector has not increased despite reduction in
lending rates. State Bank of Pakistan has been consistently reducing T-Bill yields
and discounting rates which have reduced the spread. Therefore, profits of banks
are expected to remain under pressure despite reduction in corporate tax rate.

While further reduction in lending rates seems improbable. The analysts forecast for
slow and gradual increase in interest rates during October-December quarter this
year. That is the time when fun+

s are needed the most by textile and sugar industries.

Analysts hint towards more foreign banks leaving Pakistan. These include Doha
Bank,

Mashriq Bank, IFIC and Rupali Bank. Operations of some of these banks may be
taken

over by local financial institutions and closure of a couple of banks seems certain, if
local

buyers do not come forward. The three foreign banks, namely Standard Chartered,

Citibank and ABN AMRO are expected to get further strength mainly because of the

diversified range of their products and services.

ADB's Support to the Government of Pakistan's Efforts

for Creating an Enabling Environment for MSMEs1

Introduction
The Government of Pakistan, under its I-PRSP, emphasizes the importance of the

private sector and enhanced investment as core elements of the strategy for high

growth and employment generation. Because of its under-utilized potential for

generating employment, increasing incomes, and reducing poverty, the

Government

accords high priority to the development of micro, small, and medium enterprises

(SMEs). ADB has been assisting the Government in the development of the SME

Sector through facilitating SME access to Trade Finance under the SME Trade

Enhancement Finance Program, or SMETEF, approved in 2000 for $150 million.

SMETEF has four components including:

A $150 million revolving facility, the so-called Foreign Currency Export

Finance Facility (FCEF);

A Partial Risk Guarantee facility up to a maximum exposure of $150 million

for import/letter of credit confirmation2;

An equity investment of up to $2 million in the Pakistan Export Finance

Guarantee Agency (PEFG) to provide an alternative to traditional collateral

instruments3;

An $800,000 technical assistance to support the reform of the Export

Promotion Bureau as a facilitator for exports.

At the request of the Government, ADB is currently preparing a second major

operation, the SME Sector Development Program (SDP), which intends to
specifically

address the policy environment, which is the topic of today's workshop. In addition,

the SDP will also support market based financial and business services, and

development of service institutions for SMEs. The SDP is part of ADB's 2003 lending

assistance package to Pakistan.

To assist the Government to prepare the SDP, the ADB approved a grant technical

assistance of $800,000 in February 2002, the implementation of which is currently

in

progress. The diagnostic phase of the TA has been completed, on the basis of which

the following opportunities and issues in Pakistan's SME sector have been identified:

Large, untapped growth potential. Pakistan's SMEs contribute more than

30% to GDP and absorb more than 80% of nonfarm employment. Because of

an unfavorable business environment, coupled with low investments and rent

seeking behavior, the SMEs' growth potential for employment, income

generation, and poverty reduction remains largely untapped.

The lack of SME-friendly tax regulations imposes high barriers for entry

into the documented economy. Most SMEs prefer to remain in the informal

economy, which in turn precludes them from improving their competitiveness

by accessing business support and financial services.

•
Labor, tax, and industry legislation, and implementation procedures are complex
and written in language, which is not understood by a large part of the population.
This constitutes a common source for the

reported abuse of power by officials, e.g. labor, industry, and tax inspectors

and adds to the costs of doing business. As a result, enterprises have a

negative attitude toward such legislation.

Industry associations and chambers of commerce and industry often

fail to act collectively, which undermines their lobbying power and potential

to assist the SMEs at improving their competitiveness.

SME lack of access to finance is a major impediment to investment,

business growth and innovation. The existing prudential regulations of the

State Bank of Pakistan (SPB) require financial information and physical

collateral for lending. This results in lending policies and processes of banks,

which effectively preclude the SMEs' access to finance.

Banks have yet to realize the full potential of SME market from a

commercial perspective, and lack the skills to develop profitable financial

services for the SMEs.

In the absence of effective market-based support to the SMEs, the

Government has established and maintains institutions to support the

SMEs access to finance, provide business support services and represent SME
interests within the Government. However, the Government recognizes that

direct government intervention is not an effective approach and that a

market-based mechanism and private ownership will ultimately need to

replace these institutions.

Against the background of these issues and opportunities in the SME sector, five
key

areas have been identified for support and assistance under ADB's SDP. These

include:

Key policy reforms to enhance competitiveness

Access to finance

Access to Business Support Services

Restructuring and capacity building of key institutions supporting the SMEs

Investments supporting the reform process

Given the focus of this workshop, I will elaborate further on key policy, regulatory,

and institutional reforms ADB is considering to support under the SDP. On the legal

side, under the ongoing technical assistance, we have reviewed a number of laws

affecting the operations of enterprises and have identified several areas for

improvement and proposed modifications of legislation and regulations, which will

be

finalized in consultation with the Government. The Government has already taken
the following initiatives on the legal side:

Establishment of a deregulation commission under the chairmanship of the Minister

for Commerce top review existing labor, industry, and taxation laws and
regulations;

Major effort being undertaken, with World Bank support, to revise the

Factories Act of 1934, which is the main reference for enterprise legislation;

The Government issued in September 2002 a new Industrial Relations

Ordinance, which is the first of a set of six laws amalgamating more than 50

labor related laws.

While continued law reforms and simplification of procedures are essential, a focus

on law reforms alone will not be effective to improve the business environment in a

tangible way. To this end, ADB proposes support to address a number of key

crosscutting concerns, which undermine the purpose of laws in practice, for a higher

impact of reforms on the SMEs. These include the following:

Establishing simple business registration and financial incentives to

facilitate SMEs entry into the formal economy

Complicated and poorly drafted laws and regulations pose a severe barrier for

SMEs to enter the formal sector. Also taxation at entry, and registration fees

are perceived to be high for enterprises. Registration processes are

cumbersome. As a result, the benefits of formalization such as the access to

services are poorly understood, and even if they are understood,

entrepreneurs are reluctant to enter the formal sector. Against this

background, ADB proposes to assist the Government in undertaking measures

of awareness building and support the development of simple, cheap, and

easy registration processes and business friendly one-stop-shop

arrangements to improve the coverage of registration. Also, effective SME

friendly arrangements for entry under the formal tax net will be identified and

considered.

Improving quality standards for industry and labor and reduce the

abuse of power by inspectors

To reduce the widespread abuse of power by inspectors, ADB would

encourage the Government to limit inspection visits to a single inspector and

by adopting a selective risk-based inspection approach. The risk-based

approach adopts measures through three tiers of intervention. First,

individual, selective inspection of enterprises, which are prone to particular

risks at the work place or those known for non-compliance. Second, self-

inspection by the private sector trade bodies or alternatively inspection by the

private companies assigned by the Government, which would cover a majority

of SMEs. Third, awareness building for very small SMEs. ADB also proposes to

focus on the improvement of the labor and industry inspection function

through the preparation of an appropriate inspection policy and

implementation process, and pilot testing in a number of locations. Meeting

international product quality standards will be a gradual but significant benefit

to the SMEs, and the image of Pakistan.

Enhancing export readiness of SMEs

It has been recognized that enterprises need to meet minimum quality

standards and practices to be ready for competitive export markets. To this

end, effective collaboration of institutions such as SMEDA, the EPB, and the

Pakistan Standard and Quality Control Authority (PSQCA) is required. ADB

proposes the development of a policy and action plan to enhance export

readiness of SMEs. The current operations of SMEDA, EPB, and PSQCA need

to be reviewed and modified to foster export readiness and export

performance. Business plans for SMEDA and EPB need to accommodate this.

Supporting SME-Neutral prudential regulations

Prudential regulations based on lending processes to corporate customers

pose an unnecessary barrier to effective, prudent approaches that would

enhance SME access to finance. Especially collateral and documentation

requirements limit access severely. In the design phase of the ongoing

technical assistance, ADB will support the State Bank of Pakistan's initiative in

preparing prudential regulations. ADB would like to propose the preparation of

the Final draft regulations by mid-March 2003.

Restructuring the SME Bank

The SME Bank has the mandate to serve the SMEs through providing access
to finance and related services. However, fulfilling its mandate has been

severely constrained, due to its creation through the amalgamation of two

insolvent and inappropriately staffed financial institutions. Against this

backdrop, ADB is proposing assistance for the restructuring and ultimate

privatization of the SME Bank for it to play an important and effective role in

serving SMEs. To this end, the SME Bank needs to focus on commercial

banking services to the SMEs. While recovery operations over the last three

years proved very successful, the Bank should now concentrate on new

business and transfer recovery operations, including portfolio, staff and

related liabilities outside the Bank, for example to a dedicated company with a

limited lifetime.

Supporting SMEDA

SMEDA was established in October 1998 and obtained legal status in August

2002 through an Ordinance. So far it has undertaken significant advocacy

work, awareness-building activities, and prepared a number of important

sector strategies, publications and feasibility studies for SMEs. To assist

SMEDA in achieving a significant outreach to the SMEs and fulfill its mandate

more effectively, ADB is proposing support in the preparation of SMEDA's new

strategy and business plan. This plan will entail the focus of SME facilitator

function and well-defined performance benchmarks.

Organizational Review of Export Promotion Bureau

Although the Export Promotion Bureau (EPB) is neutral to firm size in

principle, larger firms in the traditional sectors have historically been the main

beneficiaries of EPB's trade promotion. To support a global and commercially

driven approach EPB's functions, staffing, and organizational set up will need

to be adjusted taking into account the needs of the SMEs as well as larger

enterprises. Under the ongoing ADB supported SME Trade Enhancement

Facility, an organizational review of EPB is currently being carried out to

enhance the effectiveness of trade promotion. This will be of immediate

relevance to the SME SDP.

In conclusion, let me reiterate that ADB considers the creation of a conducive

policy environment through following the broad policy and institutional reform

agenda I have just highlighted as indispensable to promote SME development in

Pakistan. In this regard, we would be happy to provide the necessary support and

assistance requested of us by the Government to further the reform agenda. ADB

will

be processing a $100 million nationwide SME Sector Development Program in 2003

which will be a hybrid of program and project activities, and require reform at the

policy, regulatory and institutional level beyond the 'project' aspects that would

directly benefit SMEs. We look forward to working together with all stakeholders to
promote a dynamic and vibrant SME sector in the country that lives up to its full

potential.

Origins of Commercial Banking in the United

States, 1781-1830
Posted Mon, 2010-02-01 18:21 by Anonymous
Robert E. Wright, University of Virginia
Early U.S. commercial banks were for-profit business firms, usually structured as joint-stock
companies. Many, but by no means all, obtained corporate charters from their respective state
legislatures. Although politically controversial, commercial banks, the number and assets of
which grew quickly after 1800, played a key role in early U.S. economic growth.1 Commercial
banks, savings banks, insurance companies and other financial intermediaries helped to fuel
growth by channeling wealth from savers to entrepreneurs. Those entrepreneurs used the loans to
increase the profitability of their businesses and hence the efficiency of the overall economy.

Description of the Early Commercial Banking Business

As financial intermediaries, commercial banks pooled the wealth of a large number of savers and
lent fractions of that pool to a diverse group of enterprising business firms. The best way to
understand how early commercial banks functioned is to examine a typical bank balance sheet.2
Banks essentially borrowed wealth from their liability holders and re-lent that wealth to the
issuers of their assets. Banks profited from the difference between the cost of their liabilities and
the net return from their assets.

Assets of a Typical Commercial Bank

A typical U.S. commercial bank in the late eighteenth and early nineteenth centuries owned
assets such as specie, the notes and deposits of other banks, commercial paper, public securities,
mortgages, and real estate. Investment in real estate was minimal, usually simply to provide the
bank with an office in which to conduct business. Commercial banks used specie, i.e. gold and
silver (usually minted into coins but sometimes in the form of bars or bullion), and their claims
on other banks (notes and/or deposits) to pay their creditors (liability holders). They also owned
public securities like government bonds and corporate equities. Sometimes they owned a small
sum of mortgages, long-term loans collateralized by real property. Most bank assets, however,
were discount loans collateralized by commercial paper, i.e. bills of exchange and promissory
notes "discounted" at the bank by borrowers.

Discount Loans Described

Most bank loans were "discount" loans, not "simple" loans. Unlike a simple loan, where the
interest and principal fall due when the loan matures, a discount requires only the repayment of
the principal on the due date. That is because the borrower receives only the discounted present
value of the principal at the time of the loan, not the full principal sum.

For example, with a simple loan of $100 at 6 percent interest, of exactly one year's duration, the
borrower receives $100 today and must repay the lender $106 in one year. With a discount loan,
the borrower repays $100 at the end of the year but receives only $94.34 today.3

Commercial Bank Liabilities

Commercial banks acquired wealth to purchase assets by issuing several types of liabilities. Most
early banks were joint-stock companies, so they issued equities ("stock") in an initial public
offering (IPO). Those common shares were not redeemable. In other words, stockholders could
not demand that the bank exchange their shares for cash. Stockholders who wished to recoup
their investments could do so only by selling their shares to other investors in the secondary
"stock" market. Because its common shares were irredeemable, a bank's "capital stock" was its
most certain source of funds.

Holders of other types of bank liabilities, including banknotes and checking deposits, could
redeem their claims during the issuing bank's open hours of operation, which were typically four
to six hours a day, Monday through Saturday. A holder of a deposit liability could "cash out" by
physically withdrawing funds (in banknotes or specie) or by writing a check to a third party
against his or her deposit balance. A holder of a banknote, an engraved promissory note payable
to the bearer very similar to today's Federal Reserve notes,4 could physically visit the issuing
bank to redeem the sum printed on the note in specie or other current funds, at the holder's
option. Or, a banknote holder could simply use the notes as currency, to make retail purchases,
repay debts, make loans, etc.

After selling its shares to investors, and perhaps attracting some deposits, early banks would
begin to accept discount loan applications. Successful applicants would receive the loan as a
credit in their checking accounts, in banknotes, in specie, or in some combination thereof. Those
banknotes, deposits, and specie traveled from person to person to make purchases and
remittances. Eventually, the notes and deposits returned to the bank of issue for payment.

Balance Sheet Management

Early banks had to manage their balance sheets carefully. They "failed" or "broke," i.e. became
legally insolvent, if they could not meet the demands of liability holders with prompt specie
payment. Bankers, therefore, had to keep ample amounts of gold and silver in their banks' vaults
in order to remain in business. Because specie paid no interest, however, bankers had to be
careful not to accumulate too much of the precious metals lest they sacrifice the bank's
profitability to its safety. Interest-bearing public securities, like U.S. Six Percent bonds, often
served as "secondary reserves" that generated income but that bankers could quickly sell to raise
cash, if necessary.

When bankers found that their reserves were declining too precipitously they slowed or stopped
discounting until reserve levels returned to safe levels. Discount loans were not callable.5
Bankers therefore made discounts for short terms only, usually from a few days to six months. If
the bank's condition allowed, borrowers could negotiate a new discount to repay one coming
due, effectively extending the term of the loan. If the bank's condition precluded further
extension of the loan, however, borrowers had to pay up or face a lawsuit. Bankers quickly
learned to stagger loan due dates so that a steady stream of discounts was constantly coming up
for renewal. In that way, bankers could, if necessary, quickly reduce the outstanding volume of
discounts by denying renewals.

Reduction of Information Asymmetry

Early bankers maintained profitability by keeping losses from defaults less than the gains from
interest revenues.6 They kept defaults at an acceptably low level by reducing what financial
theorists call "information asymmetry." The two major types of information asymmetry are
adverse selection, which occurs before a contract is made, and moral hazard, which occurs after
contract completion. The information is asymmetrical or unequal because loan applicants and
borrowers naturally know more about their creditworthiness than lenders do. (More generally,
sellers know more about their goods and services than buyers do.) Bankers, in other words, must
create information about loan applicants and borrowers so that they can assess the risk of default
and make a rational decision about whether to make or to continue a loan.

Adverse Selection

Adverse selection arises from the fact that risky borrowers are more eager for loans, especially at
high interest rates, than safe borrowers. As Adam Smith put it, interest rates "so high as eight or
ten per cent" attract only "prodigals and projectors, who alone would be willing to give this high
interest." "Sober people," he continued, "who will give for the use of money no more than a part
of what they are likely to make by the use of it, would not venture into the competition."

Adverse selection is also known as the "lemons problem" because a classic example of it occurs
in the unintermediated market for used cars. Potential buyers have difficulty discerning good
cars, the "peaches," from breakdown-prone cars, the "lemons." Sellers naturally know whether
their cars are peaches or lemons. So information about the car is asymmetrical -- the seller knows
the true value but the buyer does not. Potential buyers quite rationally offer the average market
price for cars of a particular make, model, and mileage. An owner of a peach naturally scoffs at
the average offer. A lemon owner, on the other hand, will jump at the opportunity to unload his
heap for more than its real value. If we recall that borrowers are essentially sellers of securities
called loans, the adverse selection problem in financial markets should be clear. Lenders that do
not reduce information asymmetry will purchase only lemon-like loans because their offer of a
loan at average interest will appear too dear to good borrowers but will look quite appealing to
risky "prodigals and projectors."

Moral Hazard

Moral hazard arises from the fact that people are basically self-interested. If given the
opportunity, they will renege on contracts by engaging in risky activities with, or even outright
stealing, lenders' wealth. For instance, a borrower might decide to use a loan to try his luck at the
blackjack table in Atlantic City rather than to purchase a computer or other efficiency-increasing
tool for his business. Another borrower might have the means to repay the loan but default on it
anyway so that she can use the resources to take a vacation to Aruba.

In order to reduce the risk of default due to information asymmetry, lenders must create
information about borrowers. Early banks created information by screening discount applicants
to reduce adverse selection and by monitoring loan recipients and requiring collateral to reduce
moral hazard. Screening procedures included probing the applicant's credit history and current
financial condition. Monitoring procedures included the evaluation of the flow of funds through
the borrower's checking account and the negotiation of restrictive covenants specifying the uses
to which a particular loan would be put. Banks could also require borrowers to post collateral,
i.e. property they could seize in case of default. Real estate, slaves, co-signers, and financial
securities were common forms of collateral.

A Short History of Early American Commercial Banks

Colonial Experiments

Colonial America witnessed the formation of several dozen "banks," only a few of which were
commercial banks. Most of the colonial banks were "land banks" that made mortgage loans.
Additionally, many of them were government agencies and not businesses. All of the handful of
colonial banks that could rightly be called commercial banks, i.e. that discounted short-term
commercial paper, were small and short-lived. Some, like that of Alexander Cummings, were
fraudulent. Others, like that of Philadelphia merchants Robert Morris and Thomas Willing, ran
afoul of English laws and had to be abandoned.

The First U.S. Commercial Banks

The development of America's commercial banking sector, therefore, had to await the
Revolution. No longer blocked by English law, Morris, Willing, and other prominent
Philadelphia merchants moved to establish a joint-stock commercial bank. The young republic's
shaky war finances added urgency to the bankers' request to charter a bank, a request that
Congress and several state legislatures soon accepted. By 1782, that new bank, the Bank of
North America, had granted a significant volume of loans to both the public and private sectors.
New Yorkers, led by Alexander Hamilton, and Bostonians, led by William Phillips, were not to
be outdone and by early 1784 had created their own commercial banks. By the end of the
eighteenth century, mercantile leaders in over a dozen other cities had also formed commercial
banks. (See Table 1.)

Table 1:
Names, Locations, Charter or Establishment Dates, and Authorized Capitals of the First
U.S. Commercial Banks, 1781-1799

Name Location Year of Charter (Year Authorized Capital (in

of Establishment) U.S. dollars)
Bank of North Philadelphia, 1781*/1782/1786** $400,000 (increased to
America Pennsylvania $2,000,000 in 1787)
The Bank of New York Manhattan, New York (1784) 1791 $1,000,000
The Massachusetts Boston, Massachusetts 1784 $300,000
Bank
The Bank of Maryland Baltimore, Maryland 1790 $300,000
The Bank of the United Philadelphia, 1791* $10,000,000
States Pennsylvania
The Bank of Providence, Rhode 1791 $500,000
Providence Island
New Hampshire Bank Portsmouth, New 1792 $200,000
Hampshire
The Bank of Albany Albany, New York 1792 $260,000
Hartford Bank Hartford, Connecticut 1792 $100,000
Union Bank New London, 1792 $50,000-100,000
Connecticut
Union Bank Boston, Massachusetts 1792 $400,000-800,000
New Haven Bank New Haven, 1792 $100,000 (increased to
Connecticut $400,000 in 1795)
Bank of Alexandria Alexandria, Virginia 1792 $150,000 (increased to
$500,000 in 1795)
Essex Bank Salem, Massachusetts (1792) 1799 $100,000-400,000
Bank of Richmond Richmond, Virginia (1792) n/a
Bank of South Charleston, South (1792) 1801 $200,000
Carolina Carolina
Bank of Columbia Hudson, New York 1793 $160,000
Bank of Pennsylvania Philadelphia, 1793 $3,000,000
Pennsylvania
Bank of Columbia Washington, D.C. 1793 $1,000,000
Nantucket Bank Nantucket, 1795 $40,000-100,000
Massachusetts
Merrimack Bank Newburyport, 1795 $70,000-150,000
Massachusetts
Middletown Bank Middletown, 1795 $100,000-400,000
Connecticut
Bank of Baltimore Baltimore, Maryland 1795 $1,200,000
Bank of Rhode Island Newport, Rhode Island 1795 $500,000
Bank of Delaware Wilmington, Delaware 1796 $500,000
Norwich Bank Norwich, Connecticut 1796 $75,000-200,000
Portland Bank Portland, Maine 1799 $300,000
Manhattan Company New York, New York 1799# $2,000,000

Source: Fenstermaker (1964); Davis (1917)

* = National charter.
** = The Bank of North America gained a second charter in 1786 after its original Pennsylvania
state charter was revoked. Pennsylvania, Massachusetts, and New York chartered the bank in
1782.
# = This firm was chartered as a water utility company but began banking operations almost
immediately.

Banking and Politics

The first U.S. commercial banks helped early national businessmen to overcome a "crisis of
liquidity," a classic postwar liquidity crisis caused by a shortage of cash, and an increased
emphasis on the notion that "time is money." Many colonists had been content to allow debts to
remain unsettled for years and even decades. After experiencing the devastating inflation of the
Revolution, however, many Americans came to see prompt payment of debts and strict
performance of contracts as virtues. Banks helped to condition individuals and firms to the new,
stricter business procedures.

Early U.S. commercial banks had political roots as well. Many Revolutionary elites saw banks,
and other modern financial institutions, as a means of social control. The power vacuum left after
the withdrawal of British troops and leading Loyalist families had to be filled, and many
members of the commercial elite wished to fill it and to justify their control with an ideology of
meritocracy. By providing loans to entrepreneurs based on the merits of their businesses, and not
their genealogies, banks and other financial intermediaries helped to spread the notion that
wealth and power should be allocated to the most able members of post-Revolutionary society,
not to the oldest or best groomed families.

Growth of the Commercial Banking Sector

After 1800, the number, authorized capital, and assets of commercial banks grew rapidly. (See
Table 2.) As early as 1820, the assets of U.S. commercial banks equaled about 50 percent of U.S.
aggregate output, a figure that the commercial banking sectors of most of the world's nations had
not achieved by 1990.

Table 2:
Numbers, Authorized Capitals, and Estimated Assets of Incorporated U.S. Commercial
Banks, 1800-1830

Year No. Banks Authorized Estimated

Capital (in Assets (in
millions $U.S.) millions $U.S.)
1800 29 27.42 49.74
1801 33 29.17 52.66
1802 36 30.03 50.00
1803 54 34.90 58.69
1804 65 41.17 67.07
1805 72 48.87 82.39
1806 79 51.34 94.11
1807 84 53.43 90.47
1808 87 51.49 92.04
1809 93 55.19 100.23
1810 103 66.19 108.87
1811 118 76.29 142.65
1812 143 84.49 161.89
1813 147 87.00 187.23
1814 202 110.02 233.53
1815 212 115.23 197.16
1816 233 158.98 270.30
1817 263 172.84 316.47
1818 339 195.31 331.41
1819 342 195.98 349.66
1820 328 194.60 341.42
1821 274 181.23 345.93
1822 268 177.53 307.86
1823 275 173.67 283.10
1824 301 185.75 328.16
1825 331 191.08 347.65
1826 332 190.98 349.60
1827 334 192.51 379.03
1828 356 197.41 344.56
1829 370 201.06 349.72
1830 382 205.40 403.45

Sources: For total banks and authorized bank capital, see Fenstermaker (1965). I added the Bank
of the United States and the Second Bank of the United States to his figures. I estimated assets
by multiplying the total authorized capital by the average ratio of actual capital to assets from a
large sample of balance sheet data.

Commercial banks caused considerable political controversy in the U.S. As the first large,
usually corporate, for-profit business firms, banks took the brunt of reactionary "agrarian"
rhetoric designed to thwart, or at least slow down, the post-Revolution modernization of the U.S.
economy. Early bank critics, however, failed to see that their own reactionary policies caused or
exacerbated the supposed evils of the banking system.

For instance, critics argued that the lending decisions of early banks were politically-motivated
and skewed in favor of rich merchants. Such was indeed the case. Overly stringent laws, usually
championed by the agrarian critics themselves, forced bankers into that lending pattern. Many
early bank charters forbade banks to raise additional equity capital or to increase interest rates
above a low ceiling or usury cap, usually 6 percent per year. When market interest rates were
above the usury cap, as they almost always were, banks were naturally swamped with discount
applications. Forbidden by law to increase interest rates or to raise additional equity capital,
banks were forced to ration credit. They naturally lent to the safest borrowers, those most known
to the bank and those with the highest wealth levels.

Early banks were extremely profitable and therefore aroused considerable envy. Critics claimed
that bank dividends greater than six percent were prima facie evidence that banks routinely made
discounts at illegally high rates. In fact, banks earned more than they charged on discounts
because they lent out more, often substantially more, than their capital base. It was not unusual,
for example, for a bank with $1,000,000 equity capital to have an average of $2,000,000 on loan.
The six percent interest on that sum would generate $120,000 of gross revenue, minus say
$20,000 for operating expenses, leaving $100,000 to be divided among stockholders, a dividend
of ten percent. More highly leveraged banks, i.e. banks with higher asset to capital ratios, could
earn even more.

Early banks also caused considerable political controversy when they attempted to gain a charter,
a special act of legislation that granted corporate privileges such as limited stockholder liability,
the ability to sue in courts of law in the name of the bank, etc. Because early banks were
lucrative, politicians and opposing interest groups fought each other bitterly over charters. Rival
commercial factions sought to establish the first bank in emerging commercial centers while
rival political parties struggled to gain credit for establishing new banking facilities. Politicians
soon discovered that they could extract overt bonuses, taxes, and even illegal bribes from bank
charter applicants. Again, critics unfairly blamed banks for problems over which bankers had
little control.

The Economic Importance of Early U.S. Commercial Banks

Despite the efforts of a few critics, most Americans rejected anti-bank rhetoric and supported the
controlled growth of the commercial banking sector. They did so because they understood what
some modern economists do not, namely, that commercial banks helped to increase per capita
aggregate output. Unfortunately, the discussion of banks' role in economic growth has been
much muddied by monetary issues. Banknotes circulated as cash, just as today's Federal Reserve
notes do. Most scholars, therefore, have concentrated on early banks' role in the monetary
system. In general, early banks caused the money supply to be procyclical. In other words, they
made the money supply expand rapidly during business cycle "booms," thereby causing
inflation, and they made the money supply contract sharply during recessions, thereby causing
ruinous price deflation.

The economic importance of early banks, therefore, lies not in their monetary role but in their
capacity as financial intermediaries. At first glance, intermediation may seem a rather innocuous
process -- lenders are matched to borrowers. Upon further inspection, however, it is clear that
intermediation is a crucial economic process. Economies devoid of financial intermediation, like
those of colonial America, grow slowly because firms with profitable ideas find it difficult to
locate financial backers. Without intermediaries, search costs, i.e. the costs of finding a
counterparty, and information creation costs, i.e. the costs of reducing information asymmetry
(adverse selection and moral hazard), are so high that few loans are made. Profitable ideas
cannot be implemented and the economy stagnates.

Intermediaries reduce both search and information costs. Rather than hunt blindly for
counterparties, for instance, both savers and entrepreneurs needed only to find the local bank, a
major reduction in search costs. Additionally, banks, as large, specialized lenders, were able to
reduce information asymmetry more efficiently than smaller, less-specialized lenders, like
private individuals.

By lowering the total cost of borrowing, commercial banks increased the volume of loans made
and hence the number of profitable ideas that entrepreneurs brought to fruition. Commercial
banks, for instance, allowed firms to implement new technologies, to increase labor
specialization, and to take advantage of economies of scale and scope. As those firms grew more
profitable, they created new wealth, driving economic growth.

Additional Reading
Important recent books about early U.S. commercial banking include:

Bodenhorn, Howard. A History of Banking in Antebellum America: Financial Markets and

Economic Development in an Era of Nation-Building. New York: Cambridge University Press.
2000.

Cowen, David J. The Origins and Economic Impact of the First Bank of the United States, 1791-
1797. New York: Garland Publishing, 2000.

Lamoreaux, Naomi. Insider Lending: Banks, Personal Connection, and Economic Development
in Industrial New England. New York: Cambridge University Press, 1994.

Wright, Robert E. Origins of Commercial Banking in America, 1750-1800. Lanham, MD:

Rowman & Littlefield. 2001.

Important recent overviews of the wider early U.S. financial sector are:

Perkins, Edwin J. American Public Finance and Financial Services, 1700-1815. Columbus: Ohio
State University Press, 1994.

Sylla, Richard. "U.S. Securities Markets and the Banking System, 1790-1840." Federal Reserve
Bank of St. Louis Review 80 (1998): 83-104.

Wright, Robert. The Wealth of Nations Rediscovered: Integration and Expansion in American
Financial Markets, 1780-1850. New York: Cambridge University Press. 2002.
Classic histories of early U.S. banks and banking include:

Cleveland, Harold van B., Thomas Huertas, et al. Citibank, 1812-1970. Cambridge: Harvard
University Press, 1985.

Davis, Joseph S. Essays in the Earlier History of American Corporations. New York: Russell &
Russell, 1917.

Eliason, Adolph O. "The Rise of Commercial Banking Institutions in the United States." Ph.D.,
diss. University of Minnesota, 1901.

Fenstermaker, J. Van. The Development of American Commercial Banking: 1782-1837.

Kent,Ohio: Kent State University, 1965.

Fenstermaker, J. Van and John E. Filer. "Impact of the First and Second Banks of the United
States and the Suffolk System on New England Bank Money: 1791-1837." Journal of Money,
Credit and Banking 18 (1986): 28-40.

Gras, N. S. B. The Massachusetts First National Bank of Boston, 1784-1934. Cambridge:

Harvard University Press, 1937.

Green, George. Finance and Economic Development in the Old South: Louisiana Banking,
1804-1861. Stanford: Stanford University Press, 1972.

Hammond, Bray. Banks and Politics in America, from the Revolution until the Civil War.
Princeton: Princeton University Press, 1957.

Hedges, Joseph Edward. Commercial Banking and the Stock Market Before 1863. Baltimore:
Johns Hopkins Press, 1938.

Hunter, Gregory. The Manhattan Company: Managing a Multi-Unit Corporation in New York,
1799-1842. New York: Garland Publishing, 1989.

Redlich, Fritz. The Molding of American Banking: Men and Ideas. New York. Johnson Reprint
Corporation, 1968.

Schweikart, Larry. Banking in the American South from the Age of Jackson to Reconstruction.
Baton Rouge: Louisiana State University Press, 1987.

Smith, Walter Buckingham. Economic Aspects of the Second Bank of the United States.
Cambridge: Harvard University Press, 1953.

Wainwright, Nicholas B. History of the Philadelphia National Bank: A Century and a Half of
Philadelphia Banking, 1803-1953. Philadelphia: Philadelphia National Bank, 1953.
1
Which is to say that they increased real per capita aggregate output. Aggregate output is the
total dollar value of goods and services produced in a year. It can be measured in different ways,
the two most widely used of which are Gross National Product (GNP) and Gross Domestic
Product (GDP). The term per capita refers to the total population. Aggregate output may increase
simply because of additional people, so economists must take population growth into
consideration. Similarly, nominal aggregate output might increase simply because of price
inflation. Real aggregate output means output adjusted to account for price changes (inflation or
deflation). Real per capita aggregate output, therefore, measures the economy's "size," adjusting
for changes in population and prices.
2
A balance sheet is simply a summary financial statement that lists what a firm owns (its assets)
as well as what it owes (its liabilities).
3
Early bankers used the formula for present value familiar to us today: PV = FV/(1+i)n where
PV = present value (sum received today), FV = future value (principal sum), i = annual interest
rate, and n = the number of compounding periods, which in this example is one. So, PV =
100/1.06 = 94.3396 or $94.34.

5
In other words, banks could not demand early repayment from borrowers.
6
In order to maintain bank revenues, bankers are willing, under competitive conditions, to take
some risks and therefore to suffer some defaults. For example, making a simple year-long loan
for $100 at 10 percent per annum, if the banker determines that the borrower represents, say,
only a 5 percent chance of default, is clearly superior to not lending at all and foregoing the $10
interest revenue. Early U.S. banks, however, rarely faced such risk-return tradeoffs. Because the
supply of bank loans was inadequate to meet the huge demand for bank loans, and because banks
were constrained by usury law from raising their interest rates higher than certain low levels,
usually around 6 to 7 percent, bankers could afford to lend to only the safest risks. Early bankers,
in other words, usually faced the problem of too many good borrowers, not too few.
Citation: Wright, Robert. "Origins of Commercial Banking in the United States, 1781-1830".
EH.Net Encyclopedia, edited by Robert Whaples. March 26, 2008. URL
http://eh.net/encyclopedia/article/wright.banking.commercial.origins