Modern bankers are protected from personal bankruptcy by the concept of “too big to fail.” This hasn’t always been the case as in medieval times banking was a very risky business with failed bankers losing everything.
I have just finished reading Money, banking and credit in Medieval Bruges by Raymond de Roover who discusses a number of issues about money and banking most of which are still relevant.
His book covers the Italian merchant bankers who used bills of exchange to avoid shipping specie, the Lombards who operated as pawnbrokers to provide licensed usury and retail credit and the money changers who were the forerunners of today’s commercial banks. It is the latter that I found most interesting.
One of the first things to impress me was de Roover’s use of the term purchasing power to describe money. When so many people think of money as a commodity with a value in its own right, it is important to be reminded that the main function of money is as purchasing power. He points out the Italian merchant bankers used bills of exchange to transfer purchasing power from one place to another. Also the money changers transferred purchasing power when they assisted their customers to transfer funds from one person to another.
Medieval bankers knew that loans to princes and governments were perilous and should be avoided. Considering the amount of debt owed by governments today is so great it will never be repaid this is probably a good rule. Rolling over debt plus interest is a racket and a lot of people are going to lose a lot of purchasing power. Some will find their retirement plans disappearing.
De Roover is emphatic that the money changers were creating money through their fractional reserve policies. They were accepting deposits and making transfers of purchasing power by via entries from one account to another. As all the money changers were physically close they could do transfers between customers of different bankers. As most of their transfers were on paper and they kept about 30 per cent in reserve, much of the money in their strong boxes was available for other uses. Some was loaned to customers as overdrafts and the rest was invested in commercial ventures. In either case they were creating fractional reserve money and adding to the money supply. Modern banks follow a fractional reserve policy and are creating money when they make loans.
Because of usury laws no interest was paid on deposits or charged on overdrafts. They made their money on exchanging currency and from investments. This is interesting because I believe interest being charged on fractional reserve money/loans causes us a lot of problems.
By making investments in commercial ventures the money changers were living dangerously because this money was not on hand if requested by depositors. Financing long-term investments with short-term or demand deposits is a high risk business plan and many money-changers found themselves bankrupt. De Roover quotes a medieval source as saying that in Venice 96 out of 103 banks came to a bad end. He figures this may be an exaggeration but in any case banking was a high risk venture and many bankers lost everything.
When we had our banking crisis a few years ago some bankers were financing sub prime mortgages with overnight loans. This was more dangerous than the medieval money changers because it was on a much larger scale. This practice was highly profitable because of the high spreads between short- and long-term interest rates. When it became apparent these mortgages were problems the overnight financing was no longer available and the banks were in serious difficulty.
The difference between the money changers and Wall Street bankers was that the money changers were very small operations. The concept of too big to fail had not yet been invented. Even so the payment transfer function was so important that new money changers quickly appeared and eventually a number of medieval cities established civic banks to perform that function.
There are a number of issues discussed in this book many of them still problems even if on a much larger scale.
I have long believed that banking is a risky business and that there is a need to find a way of creating money other than the fractional reserves of banking. I still do.
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