Merchant Banking in the Medieval and Early Modern Economy
By Meir Kohn
Dartmouth College Department of Economics Working Paper (1999)
Abstract: This paper describes the evolution of merchant banks – merchants who specialized in remittance and credit. It examines the sources of their funds and the use to which they put them in exchange trading, commercial credit, and sovereign lending. It discusses the methods the banks used to manage liquidity and risk and the crises that resulted from sovereign defaults.
Introduction: All merchants were involved in finance – as givers of credit, as receivers of credit, or usually as both. Credit, mainly sales credit, was an intrinsic part of commerce. Indeed, managing his finances was commonly a merchant’s primary concern – where to borrow, to whom to extend credit, how to ensure that obligations could be met. However, for most merchants, finance – important as it was – remained but an adjunct to their commercial business. For a few, finance developed into a business in its own right: these were the merchant bankers.
Merchant bankers entered finance through remittance – transferring funds from place to place for others – using bills of exchange. Their trading in bills of exchange created a well-integrated international exchange market. The exchange business drew them into lending, and they became the principal financiers of international commerce. Merchant bankers also played a pivotal role in bringing sovereign borrowers into the international money market. For many, however, their involvement with sovereign borrowers proved to be their downfall.
Why did some merchants become merchant bankers? Often, it was a case of one thing leading to another. Large trading companies with permanent branches or correspondents in many places found it easy to transfer funds for other merchants, so becoming merchant bankers. Because of the delay between the time a merchant bank accepted funds in one place and the time it paid them in another, it necessarily became the recipient of a loan. In this way, remittance provided a merchant bank with funds that it could in turn lend and so drew it into finance.
There was another reason why some merchants came to specialize in finance. Commerce, when successful, could generate enormous profits. As a successful merchant’s wealth grew, he found it necessary to increasingly devote his time to managing his wealth. Opportunities for further investment in his own business were limited, and considerations of diversification made it anyhow undesirable. Good financial assets were hard to find. In many cases, the wealthy merchant’s best alternative was to lend his capital – to become a financier. The move was an easy one – he would already, as a merchant, have been well versed in finance. While he would start by lending his own capital, he might soon find that good opportunities for lending exceeded his capacity to fund them. It was then a natural step to increase the funds at his disposal by borrowing. The career of Francesco Datini of Prato, born in 1335, is typical of this progression from commerce to finance. Following a year of apprenticeship to a merchant in Florence, he set up business in Avignon, the home of the papal court. There, for over thirty years, he traded in armor, cloth, religious articles, paintings, jewelry, and other goods. Having made his fortune, he returned to Florence to become a merchant banker, opening additional offices in Pisa, Genoa, Barcelona, Valencia, and Majorca and engaging correspondents in Bruges and London.