Banks form the core of a modern financial system: mobilizing capital, facilitating payments, and allocating resources to productive activity. How banks are designed may affect how they perform these key functions and may also relate to the organization of the banking industry as a whole. These structural characteristics may also tie into the cost of banking services as well as into banks’ ability to mobilize resources and to influence the economy overall. This chapter examines the industrial organization of banking, the development of banks’ services, and the performance of the banking industry during the late nineteenth and early twentieth centuries. The comparison across all five countries sheds new light on the influence of the banking scope on bank scale, competition, and performance. The results often run contrary to assumptions born out of more recent experience, particularly that of the United States.

Industrial Organization of Banking

In the realm of commercial and investment banking, it is often assumed that universal banks – those that combine services – are large compared to specialized commercial banks. These sorts of assumptions hinge on the idea that minimum efficient scale ought to be larger for a universal bank, or the notion that universality offers greater opportunities for a bank to grow. Although we cannot say for sure what the minimum efficient scale is for specialized versus universal banks, particularly in the historical context, we can investigate the empirical relationship between bank size and scope of services. The average size of individual banks depends heavily on the use or avoidance of branching networks, and branching in turn influences the number of separate banking firms. Growth of branching networks suggests expansion of the banking industry and improvements in capital mobilization. Deposits to the banking system may grow without branching, of course, because it is possible for institutions in other areas to collect funds regionally and make deposits with larger banks in their base cities. But branching by a single institution may facilitate the flow of information and enable more efficient interregional transfers while diversifying short-term liabilities and possibly safeguarding against systemic instability. Geographical diversification therefore permits lower reserve ratios, which in turn pushes more capital into productive uses.