Banking and Credit

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BANKING AND CREDIT

BANKING AND CREDIT. Early modern European banking had its origins in Italy. The profession grew out of the trade boom of the so-called commercial revolution of the High Middle Ages (1000–1350). The first bankers engaged in manual exchange of coins and did not extend credit. By the early modern period, however, banking spread throughout Europe and became complex and increasingly involved in credit transactions.

By the late thirteenth and fourteenth centuries there were three basic types of banks: international merchant banks, local deposit banks, and pawnbroking establishments. The categories were not exclusive: the same businessmen sometimes engaged in two or all three types simultaneously.

INTERNATIONAL MERCHANT BANKS AND BILLS OF EXCHANGE

The international merchant banks were the largest and most sophisticated. They began as a Tuscan phenomenon, established by merchants to facilitate their long-distance trade and the transfer of funds across national boundaries. Several extremely large firms—what modern scholars have called "super companies"—developed in Florence. The second largest of them, the Peruzzi bank, had fifteen branches located throughout Europe and in North Africa. The bank collapsed suddenly in 1345, bringing down with it much of the Florentine banking industry. This demise resulted from a combination of unwise fiscal practices and bad market conditions. The companies organized themselves so that all branches were jointly owned by large extended families. There was no limited liability, and thus investors lost more than what they put into their companies. Whole family fortunes were lost.

The collapse was followed by a new generation of banks. The most famous was the great Medici firm, which lasted from 1397 to 1494. To avoid the calamity of its predecessors, the Medici bank configured itself in the manner of a modern holding company. Members of the family held controlling interest in the branches, but each branch was a separate partnership and thus a distinct legal entity with its own books. When one branch faltered, as the Geneva branch did in 1465, the whole structure did not fall. Investors lost only the amount of money they put into the particular branch.

A major obstacle to making money in the banking business was the church's ban on usury. The basic position was taken from the Gospel of Luke and held that any interest beyond the principal constituted usury. It was therefore illegal for a bank to extend credit to its customers with the expectation of gain. Merchants found ways around the prohibition, the most ingenious of which was the bill of exchange. The bill evolved from letters of payment used at medieval trading fairs. It entailed a merchant lending money in one currency and receiving repayment in another, with the profit disguised in the exchange rate. Repayment could be effected only after the passage of a fixed amount of time, known as usance. This differed from town to town and depended on the amount of time it commonly took to travel between the places. For example, usance between London and Venice was ninety days. Since exchange rates could fluctuate, the precise return on the bill was uncertain. This element of risk helped make the bills more palatable to some Scholastic thinkers, who argued that the uncertainty constituted a justification for profit. The bill often involved two banks. The taker would send it to an affiliate or branch to be repaid, while the drawer would instruct his correspondent to redeem the bill. The bill itself was a small rectangular piece of paper, which usually began with the words "in the name of God."

Apart from its role as a credit instrument, the bill of exchange helped banks remit funds from one place to another and spared merchants the risk of transporting specie. This long remained an Italian phenomenon. Hanseatic merchants on the Baltic, for example, were at first suspicious of the bills and did not use them. But the bills progressively gained wide acceptance, particularly at trade fairs in the fifteenth and sixteenth centuries, and at Antwerp, where the practice of endorsement widely expanded the use of the bills.

The Medici dealt a great deal in bills of exchange, speculating in the international money market. They diversified their business into other areas, notably tax farming and sale of commodities. They used their connections to help market wool cloths and silks produced by their industrial firms. But the Medici bank—and Florentine banking in general—owed its primacy to its connection with the papacy. From early on, the Medici banks served pontiffs in the post of "depositary general," the highest level of the pope's financial hierarchy. Depositary generals performed a wide array of services, including collection of tithes and other sources of revenue. They made money through lucrative tax farms. Papal bankers could also use their access to the pope to gain excommunications against recalcitrant borrowers. The chief drawback to serving the papacy, however, was that it often entailed lending large amounts of money to the popes themselves, who were notoriously bad at repaying loans. One of the counterparts of the Medici, the Spinelli bank, ran into serious fiscal difficulty in 1456 when Pope Calixtus III failed to pay back the principal on a loan for a proposed crusade against the Turks. But loans to popes were, like loans to secular rulers, the price of operating in the market.

The Florentine banking system fell into crisis in the sixteenth century, but Italians remained active in international banking into the seventeenth century. In the meantime, banking on the Italian model grew in southern Germany. The most notable of the firms was the great Fugger company of Augsburg. It derived from the trading activities of a fourteenth-century weaver, Hans Fugger. His son Jacob and grandson Jacob II (d. 1525) parlayed their inheritance into a banking and mercantile empire. Like the Medici, the Fugger banks engaged in a range of activities, including speculation in the money market and trade in commodities. More so than the Medici, however, the Fugger extended enormous amounts of credit to secular rulers. They virtually bankrolled the wars of the German Habsburgs. They lent large sums to Maximilian I (ruled 1493–1519) to sustain his armies and floated immense loans to Charles V (ruled 1519–1556) to help him secure his election as Holy Roman emperor. In return, the Fugger received lucrative tax farms as well as interests in and administration of royal monopolies. They dominated the trade in silver, copper, and mercury. Their operating capital at one point exceeded 2 million gulden, a figure that dwarfed the capital of the Medici in its heyday.

The Fugger bank maintained branches in other cities and also did business with the pope. It oversaw the sale of indulgences in Germany and Scandinavia, including that done by Johann Tetzel in Wittenberg, which moved Martin Luther to issue his famous Ninety-Five Theses (1517) against the practice. The Fugger took from Italian banks the use of double-entry bookkeeping and added the practice of sending auditors out to individual branches to check inventories and accounts. They engaged more forcefully than their predecessors in monopolistic practices. In addition to his control of mines in Tyrol and Hungary, Jacob II Fugger owned the plants that processed the ore. He set up his own merchant fleets and even built housing, the socalled Fuggerei, for his workers. Structurally, the Fugger bank remained a family business. Whereas the Medici brought in outside investors, the Fugger brought in few. The bank survived until the seventeenth century, when its practice of extending large loans finally brought it down.

DEPOSIT BANKS AND FRACTIONAL RESERVE

In addition to international merchant banks, local deposit banks existed in Europe. The first deposit banks arose in Genoa and Venice, where they were known as giro firms (from the Italian verb "to rotate"). They serviced merchants, taking in deposits and making transfers from one account to another (hence "rotate"). The transfers were strictly controlled and done in person by verbal order. In Venice and elsewhere, bankers began to invest some of their savings, thus creating "bank money." The fourteenth-century Bruges moneychanger Guillaume Ruyelle kept only 30 percent in cash reserves; the Pisani bank of Venice in the sixteenth century invested savings in galley voyages and lent money for war.

The practice of fractional reserve proved very risky in the volatile business climate of the times. Deposit banks frequently failed. At the turn of the fifteenth century, three out of four such Venetian banks had gone out of business; their counterparts in the Low Countries had also disappeared by then. Similar difficulties were experienced by merchant banks, which were only slightly more stable. By the sixteenth century, only a handful of firms survived in Florence.

To stave off collapse, governments tried to restrict the practice of fractional reserve and transfer of funds. They became directly involved, initiating a species of publicly controlled deposit banks. The first, the so-called Taula de Canvi of Barcelona, appeared in 1401. It acted as fiscal agent for the city of Barcelona and for the kingdom of Catalonia. It accepted deposits from citizens, but could not lend to private individuals. It had to keep sufficient reserves to meet the demands of depositors. The Taula proved remarkably durable, and though it experienced numerous crises, it lasted until the nineteenth century, when it was absorbed by the Bank of Spain. A similar initiative undertaken in Genoa in 1408 was less successful. But public deposit banks gained momentum, particularly in the second half of the sixteenth century. The Spanish introduced several successful ones in southern Italy. The Genoese opened up the Cartulario d'oro in the sixteenth century to handle specie taken by Spain from the New World. This also did well. The most famous of the public banks, however, was the great Wisselbank founded in Amsterdam in 1609. It had a monopoly of transactions involving gold and silver, received deposits in specie, made transfers, but could not lend money to private individuals. It did, however, lend to the government, including to the Dutch East India Company. Similar banks emerged in Middelberg in 1616 and Hamburg in 1619. The Hamburg bank had greater latitude in lending to private individuals.

In England, banking took a different route. It grew from goldsmiths, makers and sellers of plate and jewelry. The profession flourished after King Henry VIII (ruled 1509–1547) dissolved the monasteries in the 1530s, thereby increasing the amount of available gold. By 1640 goldsmiths were taking royal valuables on deposit for safekeeping. The English Civil War (1642–1648) and subsequent troubles broadened business, as members of the gentry placed deposits with the smiths. By 1677 there were forty-four goldsmith banks in London, which functioned essentially as deposit banks. They were known by contemporaries as "keepers of running cashes," because they accepted money for safe custody and gave a receipt in return. They were the precursors of the Bank of England, a public institution that began in 1694.

BANKING, COMMERCIAL FAIRS, AND CREDIT INSTRUMENTS

Despite the restrictions on banks and the precarious nature of their business, the access to credit generally increased for European merchants during the sixteenth and seventeenth centuries. Demographic expansion and the opening of the Atlantic helped quicken the pace of trade. International banking was always closely linked to trade, particularly to commercial fairs. The period saw the growth and development of major fairs in the cities of Lyon, Medina del Campo, Besançon, Frankfurt, and Piacenza. In 1531, the Antwerp bourse emerged as a permanent market that, unlike the seasonal fairs, met all year round. It became a critical exchange point, particularly among English merchants trading in cloth, with German merchants trading in copper and silver and Portuguese merchants trading in spices and sugar. Wars destroyed Antwerp's preeminence in the late sixteenth century, and the mantle was passed to the city of Amsterdam.

Innovations occurred in the context of the fairs and the bourse. The bill of exchange, heretofore used more as a means of transferring capital than as a credit instrument, was transformed by northern merchants into a versatile fiscal device. Endorsement of bills became common, especially at Antwerp, and diffused to other parts of Europe. There are scattered examples of endorsed bills as early as the fourteenth century, but the practice did not become widespread until the seventeenth century. At first, the original drawee remained responsible for the debt, thus limiting the utility of the device. But eventually the beneficiary became responsible for the bill. In the sixteenth century, merchants began discounting bills, that is, selling them to a third party before maturity for a smaller sum. This also became common in the Low Countries after the middle of the century. The Dutch expanded the access to credit even further when authorities passed a decree in 1540 making lending at interest legal. In Catholic France, laws against usury remained in place.

In London, goldsmiths, by the mid-1600s, began issuing convertible cash notes or promissory notes payable to the bearer as receipts for deposits. These receipts were initially used to reclaim the whole deposit, but soon came to be presentable for part payment and, eventually, assignable to others—thus these were the antecedents of the modern banknote. Clients could withdraw money by writing a note requesting a sum to be paid to a third party. In 1661 the Bank of Stockholm issued "letters of credit," which were convertible into copper, an expedient undertaken when the government was at war and needed money. But the bank closed in 1664 when a panic broke out. In France in 1718, the Scottish immigrant John Law founded a bank that issued similar notes. The venture ended in disaster two years later and left in that country a lingering distrust of the banking business. A French central bank was not established until 1800.

PAWNBROKERS AND CONSUMER CREDIT

The system of banking and credit described thus far did not involve the ordinary consumer. When the common man sought credit, he did so not from merchant or deposit banks but from pawnbrokers. They offered short-term loans on pledges of personal property at high interest. The profession developed at the same time as the original money-changers, or earlier, and was, like that profession, an Italian phenomenon. The term "Lombard" came to signify a pawnbroker. Jews, who were denied the right to own land in much of Europe, were also involved in the profession, but their numbers were always small in comparison to the number of Christians. Pawnbrokers represented the lower end of the banking profession. They constituted in the minds of the authorities a necessary evil, not unlike gambling and prostitution. Biblical law prevented Jews from charging each other interest, but there was no restriction on Christians. Christians, on the other hand, needed special sanction from local authorities to do the business.

Pawnbrokers could charge high interest, and in Italy there were purportedly rates of 70 percent. Concerns about gouging led Italian authorities to establish public pawnbroking firms, so-called monti di pieta (literally 'mountains of piety'). They usually operated under the auspices of a religious house. This movement began in Italy in the fourteenth century and gained momentum throughout Europe in the later sixteenth century. Important public pawnbroking firms opened in the Netherlands and Sweden in the seventeenth century.

See also Capitalism ; Fugger Family ; Medici Family ; Money and Coinage .

BIBLIOGRAPHY

Center for Medieval and Renaissance Studies. The Dawn of Modern Banking. New Haven, 1979. A still useful collection of essays.

De Roover, Raymond. "New Interpretations of the History of Banking." The Journal of World History 2 (1954): 38–76. The most learned brief review of banking prior to the eighteenth century.

——. The Rise and Decline of the Medici Bank. Cambridge, Mass., 1963.