History and future of financial centres..

Financial centres is perhaps the least studied but one of the most fascinating areas of finance. We ignore the locational aspects of finance/banking which combine so much of scholarship – history, economics, politics and finance..

There are two recent speeches – first by Clara Furse of Bank of England and another by Mr Tharman Shanmugaratnam, Chairman of MAS Singapore. Both obviously look at their own financial centres.

Clara Furse takes you to history of fin centres:

Given the importance of financial centres, we should consider the conditions for their success or failure. One approach is to look at economic models, which seek to explain the existence of global financial centres as the equilibrium outcome from the interplay of rational agents seeking to maximise their utility. The ‘agglomeration benefits’ model, which I have already mentioned, is one way of thinking about why finance might cluster in a particular place. A related idea is ‘comparative advantage’: if the UK has a lower opportunity cost for providing financial services, it may be economically efficient for these services to cluster here.¹³

Economic models like these can be very useful, but they only take us so far. The location of financial centres is the product of unique historical circumstances – in economists’ terms, they are ‘path dependent’. As policy makers, we need a detailed contextual understanding of the economies in which our policies operate – and that means considering their history in order to draw lessons for today. 

When the first European financial centres developed, finance was not an industry. Rather, it was an outgrowth of trade. As Kindleberger noted in his seminal comparative history of financial centres, ‘the bulk of bankers started as merchants’.¹⁴ Following the ‘commercial revolution’ of the thirteenth century, international trade and commercial activity gradually became more complex and large-scale, and merchants invented a set of systems to make their own lives easier: shipping insurance to pool the risk of long and dangerous voyages, equity finance to support major projects like mining or shipbuilding, and bills of exchange to make it easier to trade goods.¹⁵ It was over many centuries that finance, and professional services more generally, took on a life of their own as specialised activities. Their relative prominence as industries in developed countries is, in historical terms, a recent phenomenon. Even in the City of London, ‘physical trade in merchandise ranked top among… commercial activities’ until the 1870s.¹⁶

It should come as no surprise, then, that financial centres have tended to cluster around centres of economic power. We see this throughout history.¹⁷ Venice was Europe’s financial centre in the 15th century, as a result of its trade with Alexandria, its proximity to the industries of Lombardy, and its own manufacturing strength in silk, glass and sugar-refining.  As the centre of European commercial power shifted over the centuries, other cities – Bruges, Antwerp, Amsterdam, London – took advantage as hubs of global trade, backed by industrial prowess and supported by favourable politics, to position themselves as international financial centres. Thinking about the UK specifically, this historical prominence cannot be separated from Britain’s economic rise following the industrial revolution. In the nineteenth century the UK was the world’s greatest trading nation, accounting for as much as a quarter of world trade and producing around a tenth of global GDP.¹⁸

Modern history tells a similar story. New York‘s increasingly important financial role tracks the US’s emergence as an economic and political superpower; although New York’s financial business remains largely domestic, a function of the country’s very rapid and impressive growth.  And centres like Hong Kong and Singapore are gaining traction, reflecting the globalisation of trade and the economic rise of Asia.

Superb.

Despite changes centres remain sticky.  What were important earlier remain important today. Only a shock unsettles the status quo.

But while financial centres usually start life in countries or cities that provide particular economic value and relative political stability, a financial centre can prosper even after economic power has shifted elsewhere. In other words, financial centres have proved themselves pretty ‘sticky’ so far. The explanation for this probably lies in some of the agglomeration benefits discussed above – once a particular country has the infrastructure, people and institutions required, the costs of moving and losing these benefits may outweigh the gains from being closer to power. This will only be true, of course, if the old centre of finance is well-positioned to provide services to the new centres of commerce. Again, we can look to history for instruction. Antwerp remained an international financial centre for decades after regional power and trade had shifted, primarily to Amsterdam. And the UK has maintained its position right into this century, even though the days in which Britain was the dominant superpower are long gone.

But while financial centres tend to be sticky, international finance is increasingly mobile. While the balance of international power is the product of long-term demographic, economic and technological trends, the decline of a financial centre is often precipitated by a ‘shock’ – an adverse event that either makes the continued provision of financial services impossible, uneconomic or simply destroys confidence in it. In the past, many of these shocks were the result of what macroprudential policymakers might call ‘the crystallisation of heightened geopolitical risk’ – at the time, they were simply called ‘wars’.  Examples abound. The Netherlands’ financial and commercial ambitions were dealt a ‘fatal blow’ by a war with Great Britain in 1780-84.¹⁹ Paris was destined to play a secondary role to the UK following French defeat in the Franco-Prussian war of 1870-71. And the UK’s central position in the international financial system was seriously undermined in the decades after the First World War, only to be revived later in the 20th Century. Of course, the shock doesn’t need to be a war: Spufford (2006) attributes the collapse of the Antwerp money market to a sovereign default by Spain in 1596, which triggered ‘a wave of bankruptcies in Spain itself and in Antwerp’, setting in motion a longer-term decline.

One lesson I draw from history is that policy choices and institutions matter. When finance was a lucrative side-line for merchants, the main policy choices required for a successful financial centre were openness to trade and political stability. But as finance became more complex, so too did the policy framework required for a global financial centre. The Bank of England, originally founded to fund a war with France, grew into its role as lender of last resort in the 19th century, starting down the path that would lead it to macroprudential policy. Accounts of our rise as a financial centre highlight the UK’s regulatory approach as well as a US policy error as key factors in our dominance of the Eurodollar market in the second half of the last century. 

The one by MAS Chair is more about Singapore emergence as fin centre:

The MAS’ credibility was founded in its early years. I want to mention the leaders and staff who were involved in putting in placed these foundations of today’s credibility. Mr Hon Sui Sen in particular, our first Chairman (1971980), Mr Michael Wong Pak-Shong, who was the Managing Director, and the staff at that time, including Mr Ng Kok Song, Mrs Ong-Ang Ai Boon, Mrs Elizabeth Sam. Together they built an organisation, bringing together no fewer than nine different offices and functions in Government at the time, melding them together in one organisation.

They also set the foundations for an international financial centre. Singapore was not a serious financial centre until then. Mr Hon Sui Sen and his team built the foundation for a financial centre that went beyond Singapore. In Mr Hon’s words, said back in 1972: “In Asia, Singapore now offers the best prospects for developing into a financial centre, if not for the whole of Asia, at least beyond the Southeast Asian or ASEAN region.”

So it started then, and continued through the years when Dr Goh Keng Swee became Chairman (1980-85). But the most important development in this second phase, starting when Dr Goh led the MAS, was the re-orienting of our monetary policy to one centred on the S$ exchange rate. It was a novel policy at the time. We were one of the few central banks that managed monetary policy by focusing exclusively on the exchange rate. It was not conventional, but it has worked.

Through that second phase in MAS’ evolution, with Dr Goh as Chairman and subsequently under Dr Richard Hu’s chairmanship (1985997), we built credibility in our exchange rate-centred monetary policy. We also built credibility as a no-nonsense financial regulator. That was a very important second phase, in the 1980s and 1990s.

The third phase began when PM Lee Hsien Loong, then DPM, took over as Chairman of MAS (1997-2004), and continued through the years when ESM Goh was Chairman (2004-2011). It involved liberalising and opening up our financial sector to greater competition, and at the same time developing further resilience in the system.

This seemed a contradiction in terms to many countries – liberalising and opening up but at the same time developing resilience in the financial centre. But we have achieved both. We have managed the tension between liberalisation and developing resilience. I think we’ve managed it rather well. If you look at what happened during the Asian Financial Crisis and subsequently, the Global Financial Crisis, we hav e come out as one of the safest financial systems in the world. So that was an important third phase – liberalising and opening the financial centre but also developing further resilience.

Useful reads..

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