I wrote this historical essay for my own personal amusement while doing an MSc in Economic History at the LSE last year.  It formed no part of my final grade, which is probably just as well.

We need to talk about lending.

Before we talk about banking, first off, let’s cover some basics. If I told you that I would either give you a thousand pounds now or a thousand pounds in a year’s time, which would you choose? You can take your time, there is no right answer. Actually, that’s nonsense, there is a right answer – you’d want the money now.

For one thing, in a year I might not have the money, possibly because I may have experienced negative returns on some investments made at Chepstow racecourse. I might simply refuse to give you the money even if I had it. I might claim not to recognise you. Maybe you’ve put on weight or grown facial hair or, tragically, both. One way or the other, by waiting for the cash, you are at risk; a bird in the hand and all that. Let’s put it another way: if you were tempted to go for the option of the thousand pounds in year’s time you could alternatively simply take the money now, throw it in a drawer and wait a year. If you changed your mind in the meantime and wanted to use the cash (maybe you yourself may discover an exciting investment opportunity at Sandown Park or may be presented with a mysteriously large bar bill) you could just open the drawer early. In short, money in the future is not worth as much as money now.   This is why if, instead of giving you the money, I were to lend you a thousand pounds for a year, I’d want you to give me more than a thousand back; the difference is called interest. What determines the amount of interest on loans?   It may surprise you to know that economists have argued about the finer points of this for centuries. Or maybe it wouldn’t surprise you, since everyone knows that economists are capable of arguing at length about whether eels are slippery. Either way, the basics are clear if you are prepared to simplify shamelessly which, of course, I am.

The fundamental fact is that money acquired now allows you to do things now rather than in the future. If you are a hardworking swotty kind of person you might wish to buy machinery to make yourself more productive in your job or to plant some fruit-bearing trees or something worthy like that. Even if you are not, which I think would be more sensible, you could just consume stuff now, an activity which is obviously more fun than waiting to consume stuff later. There is convenience and potential enjoyment to be had from having money in the present. Gaining that convenience from money now means borrowers will pay up for it; losing the convenience means that lenders will want to get paid. Everyone will have different views about the value of convenience depending on their circumstances but when a borrower’s and lender’s views match: voila! A loan is born.   Seen over a large number of borrowers and lenders – in other words, a market – an interest rate will emerge for each different maturity of loan. But this so-called ‘time preference’ explanation is only one part of the story.

The second part is whether the lender will actually get his money back. Sometimes the loan is not repaid because the borrower just doesn’t fancy it. And in a way you can see the logic of this because it is clearly much more fun to keep the money than to hand it back. This is a failure of ‘willingness to pay’. Much more common is a failure of ‘ability to pay’ whereby the borrower puts on a sad, poor-looking face and turns out his empty pockets on the repayment date. In a society governed by law, problems over ‘willingness to pay’ can be addressed via the courts. If you are outside the law (maybe if you are a part of good old fashioned crime syndicate) a few heartfelt swings of a baseball bat may make the borrower come around to the lender’s point of view.

Problems over ‘ability to pay’ are trickier because the money isn’t there. One way for a lender to avoid this problem is not to lend to people who look like they might have some difficulty with repayment. It’s far safer to lend to people who don’t need the money. Another way around the problem is to demand some kind of security (or collateral) for the cash. The loan is made and the lender points to something valuable that the borrower owns. In the event of non-payment the valuable property is transferred to the lender who can then use it as he sees fit. In the old days, valuable property could be livestock or women or your own personal liberty. In modern times, fewer people own livestock, slavery is outlawed and women get surprisingly pissy about being used as collateral.

These days, the most common everyday source of security for loans is housing. If you have a mortgage you will be part of this trend. The degree to which the loan is made less risky for the lender depends on the value of the collateral compared to the loan and the ease with which that value can be realised. But unsecured or secured, the risk of a loan is always there, so any interest rate on any loan can be thought of in two pieces: the first is the ‘risk free’ rate arising simply from time preference. This is the rate of interest that would be charged if there was no risk of non-payment[1]. The second is an add-on, or spread, to try to recompense the lender for the chance that the money is not forthcoming when required: the riskier the loan, the higher the spread should be. That, in short, explains the basis of the vast majority of banking deals through most of recorded time. Now, with these basics in place, we can move on to look at lending and banking through the ages to see how we got to where we are in banking right now.

That’s ancient history.

On my bookshelf at home is a volume entitled, ‘A history of interest rates’ by Homer and Sylla. It is over 700 pages long and packed from cover to cover with tables of interest rates recorded over thousands of years. If you are not into that type of thing I can imagine it would strike you as a book that would need to get quite a lot racier before it could even manage to be classed as exceedingly tedious.   Even if, like me, you are a bit of finance nerd, I doubt you would be holding out much hope of seeing ‘A history of interest rates’ turned into a thriller starring Johnny Depp. It is a masterpiece of scholarship but, let’s be blunt, it’s a dry old read. What surprised me when I first bought a copy was not its dryness (I had steeled myself for that) but rather where and when, historically speaking, it starts. Not, as I imagined, in Florence with the Medicis, but in Mesopotamia thousands of years before Christ.

Actually, there is even a chapter before the one on Mesopotamia which speculates that lending was already taking place in pre-history. A man would lend his brother some seed grain and get it back at harvest time, that sort of thing. The reason we know for a fact that lending was taking place in Mesopotamia is that we have written records of commercial loans and deals. In fact, archaeologists believe that writing was invented by the Sumerians around 3200 BC in order to keep track of the trading and banking of grain. As an ex- banker this makes me curiously proud, not least because I think it is the last time in human history that a communications technology was invented without its primary purpose being the dissemination of pornography.

The types of deals that were recorded have an archaic feel to them although their resemblance to modern practices is obvious. Grain (barley) was deposited in temples and could be withdrawn; so too was silver. Sales of land were documented. Following the conquests of Sargon I of Akkad around 2300 BC, trade between city states became more common. (Sargon is regarded as the first king in history to have won an empire by having a standing army. This gave him a strong competitive edge over other kings whose armies merely sat or slouched.)  In 1800 BC, the Babylonian ‘Code of Hammurabi’ was created to regulate all this commercial activity. It codified the rules for the ownership and rental of land. It set out rules for commercial partnerships and for the extension of credit. It regulated loans of grain and silver both secured and unsecured and set a maximum interest rate. All in all, it was a remarkable document and its rules stood for over a thousand years until the time of the Persians.

At first, banks as we know them did not exist. Temples were the equivalent of banks, making loans of grain and silver at commercial rates. According to Homer and Sylla, in the temple at Sippon the chief banker was, technically speaking, the Sun God acting though his priests and priestesses. Whether or not the Sun God was ever inspired to set down on clay tablets any lessons about his stellar leadership skills is not made clear. By 600 BC, privately run banking had emerged doing a lot of things that would look familiar today: lending money to governments and individuals, taking deposits, even entering into business ventures as partners. However, the long period of Mesopotamian stability (at least in financial terms) came to an end with the Persian conquest of Babylonia in 539 BC, after which time the commercial centre of gravity of the ancient world shifted to Greece.

Now, if you are like me, when you think of the ancient Greeks you probably think of their advances in philosophy, mathematics, pottery, sculpture, the techniques of warfare and of course some specialist work in the art of lovin’. What you probably don’t think of is ancient Greek finance. But finance there was and, across Greece, but especially in the city state of Athens, the development of banking continued. In the seventh century BC, the first standardised and state-regulated coins were struck in Lydia and in the sixth century the first gold coins were created by King Croesus (as in, ’rich as Croesus’). Previously, precious metal used in payment was simply weighed. As in Mesopotamia, temples provided a store for wealth and loans secured on shipping and properties were common, enabled by a legal system of growing sophistication. And it is in ancient Greece that we first see evidence of a phenomenon which has appeared and re-appeared regularly over the course of human history like a nasty, recurring rash – the debt crisis. In the sixth century BC, debt had mushroomed and speculation had grown in its wake. Slavery of whole families had become commonplace as a result of debt default. Antagonism between classes was, understandably I suppose, growing. Eventually in 594 BC, Solon, an Athenian statesman and poet, was chosen as Archon (or chief magistrate) to try to sort out the turmoil. He went about this with commendable vigour. Debts were cancelled. The enslaved were freed. Personal slavery for debts was outlawed. Coinage was devalued. Along with the financial measures, there were a slew of economic and constitutional reforms. All told, I think it’s fair to say that Solon did not mess about. His reforms stuck (in part because he slipped out of Athens for ten years so that his laws couldn’t be repealed – a move that strikes me as a cunning one, if a teeny tiny bit extreme) and the crisis was over.

In the centuries that followed, despite an attempted, and failed, Persian invasion and despite devastating wars between city states, banking gradually developed to the point that in the fourth century BC, bankers, ‘The Trapezitei’, took deposits, made loans both to individuals and to states, issued letters of credit and engaged in an early form of foreign exchange trading (changing money between the various coinages issued by different cities) all while keeping complete records of their deals. A slave, Pasion, who had joined the Antisthenes and Archestratus Banking and Loan Company as a clerk, rose to own the company, gain citizenship and become one of the richest men in Athens.   This is one of the earliest recorded examples of the upward mobility of bankers. I’m sure he too was unpopular at dinner parties.

Over time, banking grew as trade became more widespread throughout the ancient world. It expanded further with the conquests of Alexander the Great in the 320s BC which, in addition to opening up trade routes that were previously closed, also massively increased the stock of precious metals in circulation by releasing vast quantities of captured Persian gold and silver. In consequence, prices increased steeply and interest rates fell – the world’s first ever recorded bout of inflation (though by no means its last).  After the short-lived Alexandrine empire fissured and descended into civil war upon Alexander’s death in 323 BC, the centre of power in the Mediterranean gradually but inexorably shifted westwards once again: this time to Republican Rome which ultimately put an end to Hellenistic dominance by conquering Greece in 146 BC.

In truth, Republican Romans and, in turn, their descendents in the Empire didn’t have a great deal of time for finance and bankers. They were chiefly interested in farming and fighting, which, in my experience, makes them very much like the population of modern day Yeovil. Even commerce was infra dig (or as they said back then, ‘infra dignitatem’) for wealthy Romans. Cato the Elder, in his book ‘On Agriculture’, written in around 160 BC, notes approvingly that, “Our forefathers thought…a moneylender was worse than a thief”.[2]   Given this antipathy to finance, banking activities similar to those we saw in Mesopotamia and Greece were almost exclusively carried out by foreigners.

This is the way it remained through the centuries encompassing the life of the Republic. It also continued this way throughout the creation, rise and zenith of the Empire and then through the long, terrible years of decline leading to the Empire’s ultimate fall. No record of any banker of importance comes from these hundreds of years of Roman hegemony although it is well documented that the business went on and was regulated and supported by a robust legal system (for example, a legal limit of 12% interest set by Sulla in 88 BC remained in force until the collapse of the Western Empire). The Roman Empire’s extensive and partly privatised tax collection system (taxes were collected by the ‘publicani’ in the provinces) allowed for the efficient transfer of funds without shipping money physically: if I owed you a million sesterces I could pay the tax collectors in Rome and you could withdraw money from the tax collectors in, say, Gaul. Papers called ‘nomina’ which represented money were also common and could be transferred from person to person.

To conclude: what is clear is that from the earliest records of settled society in Mesopotamia, right through to the catastrophe of the fall of Rome three and a half thousand years later, banking, in one form or the other (some forms being surprisingly sophisticated), was an essential adjunct to the daily life and commerce of some of the greatest civilisations the world has ever known.   Then came the Dark Ages.

The fun years: Dark Ages, Usury and Plague.

There is a tendency for all received opinion on all subjects to be constantly questioned and challenged – and thank goodness for that! Scientists call this ‘the Scientific Method’. In historical circles it is known as Revisionism. The received opinion on the Dark Ages (by which I mean the fifth to tenth Centuries AD) has traditionally been that they were uniformly nasty, chaotic, violent, brutish and unpleasant.   In recent years this view has been challenged by some historians and the new, slightly less doom-laden name of ‘Early Middle Ages’ has been proposed for the period. But nothing, in my view, can alter the simple fact that Roman civilisation with all its complexity and orderliness (widespread trade, legal system, commerce, literacy, learning, cities) was replaced by a patchwork of more primitive societies which were less specialised, less wealthy and far less comfortable. Put it this way: if I offered you the chance to go back in time and live for a while in any period of history, would you go for the Dark Ages in preference to Rome? No? I thought not.

It would probably not surprise you to learn that there is no record of organised banking in Western Europe in the Dark Ages (presumably because it was a little difficult to concentrate on keeping your books up to date while being hacked into dog-food-sized chunks by marauding Vikings or Arabs) although it is true that the Eastern Roman Empire based in Byzantium retained some of the old forms. However, by the time an economic and cultural revival started getting underway in the tenth and eleventh centuries, the complicating factor preventing the rapid re-emergence of banking was a novel one: the opposition of the Church through its ban on usury.

Throughout ancient times, there were always loan sharks who would take advantage of the needy and desperate in order to charge interest rates way above normal. To prevent this, regulations on maximum interest rates were often in place to prevent such abuses (think ‘Code of Hammurabi’). But levels of interest at or below these maxima were widespread and routine as we have seen. Although lenders were never exactly popular, they were not seen to be doing anything wrong. The charging of interest and the pledging of collateral was accepted as natural from the earliest recorded times, as well it should have been given the obvious reality (obvious at least to both the ancient and the modern mind) that money now is worth more than money later. But all this changed with the application of the doctrines of the ever-more-powerful Christian Church and, in areas under Muslim control, by those of Islam.

The inspiration for the Christian prohibition was the interpretation of verses from Deuteronomy (23:19-20) that prohibited usury ‘to thy brother’ but permitted it ‘unto a stranger’. This somewhat vague ruling was gradually more and more strictly defined by the Church. First, all usury by Clerics was banned at the Council of Nicea in 325 AD (the same council that decided the Nicene Creed that still forms part of Christian worship today). Then, over the centuries, scholars continued to try to clarify the rules with the eventual result that by the twelfth century usury was prohibited regardless of who was lending, who was borrowing and what the rate was. Taking any interest at all on loans was considered a form of theft. Manifest usurers were excommunicated – a punishment which had terrifying force in those times.   All told, at least it could be said that the Church took a clear position even if it was one that was utterly nuts. And where the Church led, civil authorities followed; every state prohibited usury although exact rules varied. The same was true of regions under Muslim control since Islam considered the taking of interest (‘riba’) as one of its seven heinous sins. The ban on taking interest continues to this day[3].

Jewish people were less constrained.   Ambiguities in the biblical rulings on usury were not, in the Jewish faith, unlike in Christian law, resolved by a sweeping ban – in large part because there was no overarching Jewish authority in place to do so. So although the ban on lending at interest to fellow Jews was generally observed (while gradually being clarified, expanded and explained by various rabbinical texts) lending at interest to non-Jews was allowed.   What’s more, for obvious reasons, Jewish people felt no fear of excommunication. Their fear of the civil authorities depended on the degree to which bans were enforced – this varied widely state by state and even city by city. The divergence in religious attitudes to interest and the variation in civil rules and their enforcement had important consequences for the development of banking into the late Middle Ages. In particular, the fragmentation of Italy into city-states, many with peculiarly anti-monarchical worldviews led to a greater flexibility in interpreting usury rules which, in turn, was a factor in making Italy a centre for banking. Equally important, the very fact that the Church’s ban on usury meant that perfectly reasonable commercial transactions had become conflated with the predatory; that lending and borrowing had been forced into the margin; and that interest had been defined as synonymous with sin made an activity which, in ancient times, had been normal, accepted and bounded by law, now seem suspect and illicit, even when widely practised. This attitude lived on in folk memory as a vague distaste for banking even after the religious and legal impediments had gradually disappeared after the Reformation. Arguably, as a distant echo, it lives on still.

The history of banking restarted in earnest in the twelfth century at which time the economy of Europe had begun to expand and trade had started to boom; the Crusades were good for business in the Mediterranean and the wealth spread inland. Wine, silk, cloth and other goods were now freely traded. Increased flow of precious metals from mining led to increasing prices just as the flow of Alexander’s captured gold had done in Greece. At first, money lending was dominated by the Jews – primarily because they were not barred from doing so and partly because they were often barred from doing anything else, for example, holding land.

The types of deals that were done would have been familiar to Pasion of Athens: deposits and loans (often secured by land or property), loans on shipping cargos, lending against future harvests and the like. The business of banking was, at this stage, small-scale and performed by wealthy individuals. But this started to change in the thirteenth and fourteenth centuries. These were times of great material progress during which Europe’s population rose to its highest point since Roman times despite a widespread famine in 1315-17.

The world of finance saw innovations like double-entry book keeping, the issuance of transferable, tradable debt (‘prestiti’) by the city-state of Venice, and the invention of the ‘bill of exchange’. These bills were issued to a trader when he deposited money with a banker; the bill promised repayment in a different currency at a later date (the date was usually determined by reference to the journey time between trading centres). The trader could then use it to purchase goods in another town whereupon the goods’ seller would redeem the bill with a local banker for cash. The profit, or interest, for the banker was embedded in the favourable (to the banker) conversion rate between the amount of money deposited in one currency and the repayment in another. The creation of bills of exchange had a number of advantages. First, it allowed traders to travel without having to carry around a lot of money – a dangerous business at a time when the sport of free-style violent robbery had a solid and enthusiastic participation base. Second, because the repayment was in the future and in another currency and since exchange rates could fluctuate, the banker was seen to be taking risk and so his profit was considered less problematic by the Church[4].

As a result of growing trade and innovations such as these, banking flourished and organised families of bankers emerged in Genoa, Venice and, particularly, Florence. The Florentine Peruzzi clan, for example, made their fortunes in textiles but then accumulated more capital from 1300 onwards by engaging in banking: their clients included towns, abbeys, Popes and Kings. They and their competitor banking families often demanded hard terms from their debtors – including slices of national revenue from entire industries in return for providing the loans to allow a monarch to wage war; a crushingly costly undertaking, then as now.

The fact that these families, as Christians, were able to evade the usury laws was in part due to blind-eye turning by the authorities and in part due to dazzling legal legerdemain. The Peruzzi’s banking empire (with offices in 15 countries and capital of 100,000 gold florins – an enormous sum) collapsed in 1343, primarily because of a default on a loan to Edward III of England which he was using to start the military campaign that became the Hundred Years War. In this the Peruzzis were joined by their rival clan the Bardis who had teamed up with them for this deal. ‘Willingness to pay’ was the problem here and, given that Edward had a pretty bad-ass army at his disposal, it was a tricky problem for the Peruzzi clan to baseball bat their way out of. Such are the risks of banking, especially banking with Sovereigns who are effectively outside, or above, the law.  The collapse caused hardship in Florence (particularly for the Peruzzis and Bardis I suspect); but then, only a few years later in 1347, Europe faced a new and much bigger problem – the Black Death.

Unlike the Dark Ages, no amount of historical revisionism or rebranding has ever been attempted and certainly none has ever succeeded in making the Black Death seem cuddly. The obvious key problem word here is ‘death’ (which is difficult to find the fun side of) and attempts to append a more upbeat colour than ‘black’ have failed. Although there is still debate about exactly what the plague was and how it was transmitted – the stuff I learned at school about bubonic plague and rats is apparently under constant attack – its effect is not disputed. Millions upon millions of people died in the throes of a disease as gruesome and agonising as it was deadly.

Estimates vary, but between 30-60% of Europe’s population perished. In effect, it was as devastating as a nuclear war. At first the result was that, to a large extent, the population of Europe took leave of its senses. Panic stricken, fearful and ignorant of the real cause of their suffering, people blamed a variety of likely, but innocents, culprits. Jews were massacred because people believed they had poisoned wells. Friars were killed because they hadn’t prayed effectively enough. Foreigners were killed because they were foreign. And lepers were killed because…I’m not entirely sure why lepers were killed, but killed they were (as if they didn’t have problems enough already).

Longer term, the consequences of the mass de-population were profound. For one thing, the Church’s impotence in the face of the plague weakened its previously unchallenged authority, a first step down the road which eventually led to the Reformation. For another, the economic effects were dramatic. After the plague there was just as much land and gold as before but only about half as many people. Agricultural workers were in short supply and so their wage bargaining power increased hugely. Despite panicked governments imposing price controls on wages, (e.g.’ The Ordinance of Labourers’ in England in 1349) ultimately wages and prices both rose and, little by little, the strong link between a labourer and his feudal master began to break. With it, in time, broke the entire feudal system. Thus began the period described by Marx as ‘the pre-history of capitalism’. Another, more popular term is, ‘The Renaissance’.

The Magnificent Medicis.

Much as I’d love for us to dally a while contemplating the glories of Renaissance architecture and art, we can’t because this post is about banking. Pity, really. The story of banking in the fifteenth century was dominated by the Medicis. The rise and fall of their bank is instructive even after the passage of hundreds of years. The Medici bank was set up in 1397 by Giovanni di Bicci de’Medici. Like the Peruzzis, the Medicis had made their money by other means before becoming bankers. In the Medici’s case, they did this by owning land in northern Tuscany. The bank expanded rapidly on the back of deposits from the Vatican. Despite the usury laws the Church was always keen to deposit money and was a hugely important client whose massive wealth was another reason that Italy became the home for banking powerhouses. Within a couple of decades, branches of the Medici bank were opened in Venice, Rome, Naples and Gaeta; each was a partnership under the control of the central office in Florence. This centralised organisational structure appears to have been a Medici innovation.

Giovanni died in 1429 and the control of the bank passed to Giovanni’s son Cosimo. Contemporary portraits of Cosimo show a fleshy but handsome man solidly in middle-age. His image in posterity is that of a true representative of the Renaissance – both for good and ill. On the good side of the ledger he used his enormous riches to sponsor artists and philosophers; to create a comprehensive library second to none; to finance the completion of Brunelleschi’s magnificent dome of the Duomo in Florence; and to create the astoundingly beautiful Palazzo Medici. On the flip side, he was a political fixer of legendary power, single-handedly using his money and influence to twist Florentine politics in his favour for decades. This made him some bitter enemies and in 1433 he was blamed for Florence’s failure in the attempted conquest of Lucca and was sentenced to imprisonment, later softened to exile in Venice (which doesn’t strike me as a punishment so unbearably terrible – “Oh no! Not Venice!”). But within a year he was back in Florence and running the bank which continued to flourish and expand to Bruges, London, Geneva, Avignon and Milan. When, eventually, Cosimo died in 1464 at the – for the time – very creditable old age of 74, the bank was taken over by his son, ‘Piero the Gouty’.

I once suffered from an agonising pain in the joint of my big toe that was diagnosed as a touch of gout. Happily it never returned. My brief brush with this extremely unpleasant complaint makes me profoundly grateful that I never suffered so often and so violently that I became known as ‘Kevin the Gouty’. Sadly for Piero, he did. Being almost permanently bed-ridden and in agony can’t be helpful when you are running a bank and to me it seems unsurprising that the fortunes of the Medici bank started to slip from this point. To be fair to Piero he did try. He had a review of the bank’s finances carried out and then started to reduce the bank’s risk by calling in long term loans (a move which made the Medicis yet more enemies). But he was only in charge for five years, dying of lung disease in 1469.

He was succeeded by his son Lorenzo the Magnificent[5] and that’s when the real trouble started. Lorenzo was magnificent in terms of his lifestyle and political power. As a banker he was somewhat less than magnificent. The first crack in the facade came, as it did for the Peruzzis, in London. England was an important trading centre because of the Europe-wide demand for wool. English wool was regarded as the finest available and loans were made freely. Unfortunately for the Medicis, they loaned money to both sides of the increasingly vicious dynastic power struggle which we know today as the War of The Roses. The rival factions were united in only one respect: they preferred not to repay their loans to a bunch of damned Florentines.   The London branch duly collapsed and its debts were folded into those of the Bruges branch. Sadly for the Medicis, Bruges had been mismanaged by a certain Tommaso Portinari for decades and a combination of bad loans to the Burgundian court and the strain of the addition of the London books meant that Bruges too had to be liquidated at enormous loss.

The year 1478 marked a low point for the Medici clan. London and Bruges were finally closed down and their rival bankers the Pazzis attempted to take over power in Florence by using the admirably direct plan of killing Lorenzo (in which they failed) as well as his brother Guiliano (in which they succeeded)[6]. In the aftermath Lorenzo tightened his grip on power in Florence but the bank went from bad to worse. Things weren’t helped by what might seem like a technicality: the price of silver declined steadily relative to that of gold. The reason was that newly invented extraction techniques allowed greater production of Bohemian silver and the resulting supply depressed the price. The problem for the Medicis and other banks was that they had accepted deposits in gold in Italy and made loans in silver in those countries with silver coinage: e.g., France, Flanders, England. There was a shortage of gold and a reluctance to devalue the gold florin so the Medici’s liabilities (gold) rose steadily in value relative to their assets (silver). This pain of this squeeze was compounded by the fact that, to fund their extravagant lifestyle, the Medicis had taken a lot of capital out of the bank. Even sneakily raiding the Florence state treasury couldn’t help.  By 1494 it was all over. The Medicis were deposed in Florence and the bank, which by then had closed most of its branches save Florence, was wound up. The Medici clan came back strongly in the centuries to come: they provided the world a steady succession of Popes in addition to two queens of France but the family’s day as a banking power was over.

What are the lessons of the Medici bank collapse? The first is that lending can be a very risky business, especially to Sovereigns. Second, that it is a good idea to have competent people running your branches: sorry Tommaso. Third, that you should pay close attention to matching your liabilities and your assets (gold versus silver in this case). Fourth, that a healthy amount of capital is needed and taking most of it out to build palazzos might not be the smartest move. And last, in what I think could be said to be a lesson of universal relevance for all of us, that it is probably not a great idea to infuriate people so much that they try to kill you.

Now with added history! The Sixteenth Century.

There are some centuries which seem to have a lot more history in them than others. The sixteenth century is packed solid with history like passengers on one of those buses you see in India: history squeezed inside on the seats; history hanging onto the doors; and history perched precariously on the roof.   Where to start?   First, the sixteenth century saw the rise to power of Spain. Ferdinand of Aragon and Isobel of Castile had been married in 1469. Later, when they ascended to their respective thrones in the 1470s, it created a sort of friendly merger of the royal families of the two big pieces of the Spanish peninsula. In 1492, they made a couple of decisions of immense importance: they financed Columbus’s voyage of discovery to the Americas and they expelled the Jewish population of Spain. The ultimate consequences of Columbus’s voyage are well known. Over the decades, Spain (and Portugal) acquired huge new imperial possessions and wealth. By way of polite thanks to the natives, the Conquistadors more or less exterminated them, partly through the exciting and traditional technique of manly swordplay but mainly though infecting them with diseases they had no ability to withstand: flu, smallpox, plague and the like. The consequence of the expulsion of the Jews (a simple phrase that masks the utter brutality of its effect on 200,000 unfortunate people) was that Spain lost the core of its population of bankers – this caused some problems many years later. In 1516, the joint crown of Aragon and Castile was inherited by Charles I[7]. Charles was a Hapsburg born in Flanders and on his accession Spain, once it was joined to Hapsburg possessions in Flanders, Central Europe and Southern Italy, acquired a continent-wide presence at one stroke. Spain was now the greatest power in Europe.

In the other major historical story of the century, the following year (1517) saw one of those symbolic events so beloved by the illustrators of children’s history books: Martin Luther nailing his Ninety-five Theses on the church door at Wittenberg thus marking the start of the Protestant Reformation[8]. Among other things, he was complaining about the Church’s habit of selling indulgences which, for a fee, were meant to absolve buyers from divine punishment as if God was a heavenly version of a corrupt traffic cop (“There you go pal, that’s something for you, your son and that spirit fella. You don’t need to write out that ticket do you?”). From this, Luther’s criticism widened to extend to large tracts of the Church’s teachings and practices. He also argued that the Papacy represented the anti-Christ which I imagine could not have been a view greeted with laughter and smiles chez Pope.

Indeed so unsmilingly did Leo X greet Luther’s writings that, when Luther refused to retract his opinions in front of Leo and the Holy Roman Emperor Charles V (a.k.a. Charles I of Spain) at the splendidly named Diet of Worms in 1521, the Pope promptly pulled hard on the excommunication lever. Not that Luther cared. In time, others added weight to his protests. Zwingli and Calvin in Switzerland (although their views differed from Luther’s in some important details) agreed on the central thrust: salvation was to be gained by means of a direct relationship between a Christian and God, not intermediated through a corrupt and compromised Catholic Church. In effect, to use ghastly management speak, it was gigantic attempt to decentralise Christianity – and it succeeded, at least in part.   Aided by the (sometimes self-interested) actions of monarchs and by widespread pamphleteering enabled by the now ubiquitous printing-press, gradually, by stages, Europe split into two camps: the Protestant north and Catholic south, a situation that remains to this day.

How did all this affect banking? The first thing to point out is that, by reducing the reach of the Catholic Church, the Reformation also starved it of a chunk of its income and wealth. In England for example, the serially monogamous Henry VIII, having made himself head of the break-away (if not yet technically Protestant) Church of England, then plundered the enormous wealth of the Church’s Monasteries between 1536 and 1541. Even if other Protestant princes didn’t actually steal the cash as blatantly as Henry did, part of the Catholic Church’s income stream from tithes, relic donations, indulgence sales and other suchlike lucrative mumbo-jumbo suddenly dried up. This and the fall of the Medici bank meant that the centre of gravity of wealth in Europe started to drift northwards away from Rome and Tuscany.

The main banking beneficiaries were the Fugger family of Augsburg (now in Germany) who first made their fortune in textiles. Like the Peruzzis before them they used this money to start up in banking and were able to take over much of the Medici bank’s business on its collapse. Their rise was cemented when they found a new set of demanding but profitable clients in the Hapsburgs. One of their biggest loans was to Charles I to finance his attempt to become Holy Roman Emperor in 1519.

The Holy Roman Empire was a hodgepodge of small and medium-sized principalities covering modern day Germany, Switzerland, Austria, Northern Italy, The Netherlands, Belgium and slivers of each of their neighbours[9]. Being Emperor was a matter of great if largely symbolic prestige to which a candidate was elected by a panel of seven princely ’Electors’ – a bit like a Renaissance version of ‘The X Factor’. Unhappily for Charles, Frances I of France also wanted the position and rather than having some kind of talent show ‘sing off’, the contest was decided by the much more linear and objective process of a ‘bribe off’. Charles borrowed a gigantic sum from the Fuggers at eye watering rates of interest and then sprayed the cash in the direction of the Electors. Imagine the scene on the night of the final! Charles and Frances on stage, looking nervous and fidgety; lights suddenly dimmed; a deep male voiceover, “…and the winner of the 1519 title of Holy Roman Emperor is…… (a long, long, dramatic pause)….CHARLES!”. Sudden explosion of fireworks; whoops from the audience; Charles looking tearful; Frances applauding politely, his face contorted into a rictus grin. The decision was nearly unanimous: bribery had worked. Unfortunately, Frances didn’t really take the loss with a great deal of grace. In 1521 he declared war on Charles.

Charles versus Frances was an epic grudge match of bewildering complexity that lasted for decades. In a series of intermittent conflicts (collectively termed the ‘Italian Wars’) France fought Spain and the Hapsburg Monarchy for control of various parts of Italy. Other nations were dragged in on both sides, most notably the Ottoman Empire which, controversially, given that they were Muslims, teamed up with Christian France at one point. Seen from the point of view of an article on banking the details of the various phases of the war are not really that important – what is important is that the crippling expense of warfare meant that both sides, but especially Charles, needed to borrow continuously as their expenses outstripped their ability to raise money.

Charles was reliant on foreign bankers since his own native Spanish (Jewish) bankers had been expelled. The price was high – bankers received leases on sources of royal income as collateral (the revenues from Knightly orders or from silver and copper mines, for example) and so bit by bit, the country was mortgaged to foreigners like the Fuggers or the bankers in Genoa. The process continued after Charles’ abdication in 1556 when his son Phillip II became King of Spain. Faced with a huge debt from his father’s reign he taxed more (a move which generated widespread and bitter resentment) but also borrowed more. Then, in 1557, he defaulted. He defaulted again in 1560; then again in 1575; and again in 1596. This was the first serial sovereign default in recorded history and is an event analysed by economic historians to this day. Wars against the Ottomans, an intervention in a religious conflict in France and the expense of putting down a religiously-inspired revolt of his possessions in the Netherlands all contributed.

But the final killer blow to his finances was the failure and total destruction of the colossally costly Spanish Armada launched against England in 1588. If Phillip kept defaulting, why did the bankers keep lending?   The commonly held view used to be that they were simply irrational. A more nuanced modern view is that the contractual arrangements they had with the King were sophisticated enough to protect them from ruin and that it made sense to keep lending at least until the disaster (from Phillip’s viewpoint) of the Armada. Certainly the Fuggers were still in good shape well into the seventeenth century and did not meet the fate of the Perruzis, Bardis or Medicis after their sovereign defaults. Ditto the Genoese. Either way, the century of warfare and overspending meant that Spain’s golden era was over and ensured that the country’s future held only gradual stagnation and relative decline.

The sixteenth century’s influence on the history of banking also had a more subtle and far reaching set of effects than the familiar story we’ve just seen of loans for endless warfare leading to sovereign default (albeit with the novel twist of bankers smart enough to avoid utter catastrophe as a result). Crucially, the Reformation led directly to the end of the ban on usury. But there was more; in the early twentieth century the hugely influential, if controversial, sociologist Max Weber went further by arguing that Protestantism (and specifically Calvinism) itself was the force that inspired the ‘Spirit of Capitalism’ and thus led to the epochal changes that Capitalism brought. Both the end of the religious injunction on interest (at least in Protestant lands) and the development of capitalism began the transformation of banking into its modern form.

Calvin, credit and capitalism

At the start of the sixteenth century the Church’s ban on usury was still in place but there were sufficient numbers of officially sanctioned special cases, loopholes and exceptions that lending at interest was widespread as we have seen. By the end of the century, in the Protestant world, lending at interest was legal (although with certain restrictions). Why the change? In part, the exceptions paved the way for legal acceptance – it’s difficult to maintain a hard-line stance in the face of ‘ifs’ and ‘buts’. The sharp reduction in interest rates during the century caused by the influx of New World gold and silver via Spain also helped since lending at 10% looks quite a lot less sinful that 30%, if not by exactly a factor of three. Last, and crucial, was the influence of John Calvin.

Calvin, along with Luther, was the great theological figure of the Reformation. By the 1540s, the City of Geneva was being run along the lines of his teachings. His solution to the thorny issue of usury was not the traditional one of a ban weakened by loopholes but, instead, permission hedged with restrictions. Interest was lawful provided it did not exceed a legal maximum; loans should be free to the poor; the borrower should gain as much as the lender; etc.   In a practical sense, this was not such a big change. Psychologically, it was radical. One of my favourite cartoons by American cartoonist Gary Larson is called, ‘What we say to dogs and what they hear’. The first panel shows an irate man scolding his dog, “Okay, Ginger! I’ve had it! You stay out of the garbage! Understand Ginger? Stay out of the garbage, or else!”.   The second panel shows the same scene but reveals what the dog hears: “blah blah GINGER blah blah blah blah blah blah GINGER blah blah blah”.   I suspect that while the bankers and money lenders of sixteenth century Europe were being told, “Listen here! You can lend at interest but make sure you don’t screw the poor! And make sure the borrower is happy!”, they actually heard something like this: ”blah blah blah YOU CAN LEND MONEY AT INTEREST blah blah blah”. Certainly, Calvin’s views on interest were seized upon with somewhat indecent eagerness by commercial men all over Protestant Europe. The Rubicon had been crossed.

Naturally, Calvin’s teachings covered a wider variety of topics than lending at interest; the one that Weber saw as critically important in an economic sense was that of predestination.   When I was at school and learned about Calvin, it was the idea of predestination that I simply couldn’t get happy with, no matter how many questions I asked. I’ll be honest and say that forty years later I feel the same way. The idea grew from a theological problem: how can God be all powerful and all knowing at the same time that you, a sinner, can decide whether or not to accept salvation and go to heaven? If it is your decision, God can’t know everything. If he knows, it is not your decision. Calvin solved the problem decisively– the winner was God’s omniscience. He knows and you don’t decide; you are ‘predestined’. In fact, Calvin’s system is a double predestination because God has decided both those who will go to heaven and those who will go to hell. Clearly, if you are a devout Calvinist in sixteenth century Geneva, the million Thaler question you ask yourself is this: which way am I going to go, up or down? There’s nothing you can actually do to make a blind bit of difference, remember – you are predestined – but rather like the bank robber apprehended by Clint Eastwood’s Dirty Harry wondering whether Harry has only fired five bullets or all six, the question nags at you and you feel, “I gots to know!”.

Weber’s idea was that, to reassure yourself of the fact you had been chosen, you would accumulate wealth as a sign of God’s favour. You would develop a ‘calling’ for your profession or trade. You would develop a work ethic, specifically a ‘Protestant Work Ethic’. In this way the urgency with which you and your fellow Calvinists need to reassure yourselves that your predestined path is a happy one leads to a ‘Spirit of Capitalism’ and then to full-blown Capitalism itself. Because Calvinist teaching begins to influence churches all over northern Europe, gradually the spirit (and with it Capitalism) spreads. The theory is a powerful and densely argued one. Needless to say, since sociologists and historians make economists look like an almost consensual bunch, they’ve been fighting about Weber’s theory for a century like tweed-clad academic cowboys in a barroom brawl. Marxists point to sixteenth century laws outlawing vagabondage and idleness which forced the poor into waged labour as being more important than religion in capitalism’s rise. Other historians point to the development of earlier capitalist forms in Catholic Italy as undermining Weber’s theory. Yet others (e.g. Tawney) claim that the connection between religion and capitalism went the other way. Whatever the truth, what is clear is that some combination of the huge commercial forces unleashed by the New World discoveries and the passionate drives of the Protestant reformation led to a new spirit which transformed the economy of Europe and with it, banking. The stage was set for the development of banking into the industry that we know and love today.



[1] Technically, every borrower has some risk of not paying but some large Sovereigns (e.g. the USA) are considered practically risk free

[2] Although in this regard Cato is in tune with current opinion, his punchy and no-nonsense views on slaves (in short: work them continuously; starve the sick ones; sell the old and infirm) probably aren’t, or at least aren’t with most folk.

[3] It should be noted however that there are loopholes which are exploited by the modern-day exponents of ‘Shariah-compliant banking’. It’s odd that anyone thinks that an all-powerful God can be fooled by small print but, in fairness, Christians have been trying this ruse for centuries regarding the (possibly even clearer) ruling, ‘Thou shalt not kill’.

[4] The fact that ordinary loans are risky in their own right because the borrower might simply fail to pay was an argument that the Church’s boffins had not quite got their heads around. It’s a blind spot for risk that is still widespread.

[5] ‘Kevin the Gouty’ doesn’t appeal, but I could live with ‘Kevin the Magnificent’

[6] If you think this sounds a bit operatic, you’re absolutely right. The so-called ‘Pazzi conspiracy’ is the main plot component of the obscure opera ‘I Medici’ by Ruggiero Leoncavallo whom you may know better as the composer of the verismo tear-jerker ‘Pagliacci’.

[7] Son of ‘Phillip the Handsome’ and ‘Joanna the Mad’. Yes and no to those nicknames in that order in my view.

[8] Historian friends of mine tell me that this event probably never actually happened. Curse their inhumanly pedantic hides, the spoilsports!

[9] However, to paraphrase the irrepressibly wonderful Voltaire’s jibe – it was neither Holy, nor Roman, nor an Empire.