3. Bankers in the Late Middle Ages

The fall of the Roman Empire meant the disappearance of most of its trade and the feudalization of economic and social relationships. The enormous reduction in trade and in the division of labor dealt a definitive blow to financial activities, especially banking. The effects of this reduction lasted several centuries. Only monasteries, secure centers of economic and social development, could serve as guardians of economic resources. It is important to mention the activity in this field of the Templars, whose order was founded in 1119 in Jerusalem to protect pilgrims. The Templars possessed significant financial resources obtained as plunder from their military campaigns and as bequests from feudal princes and lords. As they were active internationally (they had more than nine thousand centers and two headquarters) and were a military and religious order, the Templars were safe custodians for deposits and had great moral authority, earning them the trust of the people. Understandably, they began to receive both regular and irregular deposits from individuals, to whom they charged a fee for safekeeping. The Templars also carried out transfers of funds, charging a set amount for transportation and protection. Moreover, they made loans of their own resources and did not violate the safekeeping principle on demand deposits. The order acquired a growing prosperity which aroused the fear and envy of many people, until Philip the Fair, the King of France, decided to dissolve it. He condemned those in charge to be burned at the stake (including Jacques de Molay, the Grand Maître), with the prime objective of appropriating all of the order's riches.³⁷

The end of the eleventh century and beginning of the twelfth brought a moderate resurgence of business and trade, mainly among the Italian cities on the Adriatic (especially Venice), Pisa, and later, Florence. These cities specialized in trade with Constantinople and the Orient. Significant financial growth in these cities led to the revival of banking, and the pattern we observed in the classical world was reproduced. Indeed, bankers at first respected the juridical principles passed down from Rome and conducted their business lawfully, avoiding illicit use of demand deposits (i.e., irregular deposits of money). Only money received as loans (i.e., time “deposits”) was used or lent by bankers, and only during the agreed-upon term.³⁸ Nevertheless, bankers again became tempted to take advantage of money from demand deposits. This was a gradual process which led to abuses and the resumption of fractional-reserve banking. The authorities were generally unable to enforce legal principles and on many occasions even granted privileges and licenses to encourage bankers' improper activity and derive benefits from it, in the shape of loans and tax revenues. They even created government banks (such as Barcelona's Bank of Deposit, or Taula de Canvi, and others we will consider later).³⁹

THE REVIVAL OF DEPOSIT BANKING IN MEDITERRANEAN EUROPE

Abbott Payson Usher, in his monumental work, The Early History of Deposit Banking in Mediterranean Europe, ⁴⁰ studies the gradual emergence of fractional-reserve banking during the late Middle ages, a process founded on the violation of this general legal principle: full availability of the tantundem must be preserved in favor of the depositor. According to Usher, it is not until the thirteenth century that some private bankers begin to use the money of their depositors to their own advantage, giving rise to fractional-reserve banking and the opportunities for credit expansion it entails. Moreover, and contrary to a widely-held opinion, Usher believes this to be the most significant event in the history of banking, rather than the appearance of banks of issue (which in any case did not occur until much later, in the late seventeenth century). As we will see in chapter 4, although exactly the same economic effects result from the issuance of bank notes without financial backing and the loaning of funds from demand deposits, banking was historically shaped more by the latter of these practices than by the former. Usher states that: “the history of banks of issue has, until lately, obscured the importance of due deposit banking in all its forms, whether primitive or modern.” In an ironic reference to the undue importance given by economists to the problems of banks of issue versus the older but equally harmful activities of deposit banks, he concludes that:

the demand for currency, and the theoretical interests created by the problem, did much to foster misconceptions on the relative importance of notes and deposits. Just as French diplomats “discovered” the Pyrenees in the diplomatic crisis of the eighteenth century, so banking theorists “discovered” deposits in the mid-nineteenth century.⁴¹

Again and again, Usher shows that the modern banking system arose from fractional-reserve banking (itself the result of fraud and government complicity, as Usher illustrates in detail via the example of the late medieval Catalonian banking system), and not from banks of issue, which appeared much later.

Usher points out that the first banks in twelfth-century Genoa made a clear distinction in their books between demand deposits and “time” deposits, and recorded the latter as loans or mutuum contracts.⁴² However, bankers later began gradually to make self-interested use of demand deposits, giving rise to expansionary capabilities present in the banking system; more specifically, the power to create deposits and grant credits out of nowhere. Barcelona's Bank of Deposit is a case in point. Usher estimates that the bank's cash reserves amounted to 29 percent of total deposits. This meant their capacity for credit expansion was 3.3 times their cash reserves.⁴³

Usher also highlights the failure of public officials at different levels to enforce sound banking practices, particularly a 100-percent reserve requirement on demand deposits. Moreover, the authorities ended up granting banks a government license (a privilege—ius privilegium) to operate with a fractional reserve. Banks were nevertheless required to guarantee deposits.⁴⁴ At any rate, rulers were usually the first to take advantage of fraudulent banking, finding loans an easy source of public financing. It is as if bankers were granted the privilege of making gainful use of their depositors' money in return for their unspoken agreement that most of such use be in the shape of loans to public officials and funding for the government. On various occasions, rulers went so far as to create government banks, in order to directly reap the considerable profits available in banking. As we will see, Barcelona's Bank of Deposit, the Taula de Canvi, was created with this main objective.

THE CANONICAL BAN ON USURY AND THE “DEPOSITUM CONFESSATUM”

The ban on usury by the three major monotheistic religions (Judaism, Islam and Christianity) did much to complicate and obscure medieval financial practices. Marjorie Grice-Hutchinson has carefully studied the medieval prohibition of interest and its implications.⁴⁵ She points out that Jews were not forbidden to loan money at interest to Gentiles, which explains why, at least during the first half of the medieval period, most bankers and financiers in the Christian world were Jewish.⁴⁶

This canonical ban on interest added greatly to the intricacies of medieval banking, though not (as many theorists have insisted) because bankers, in their attempt to offer a useful, necessary service, were forced to constantly search for new ways to disguise the necessary payment of interest on loans. When bankers loaned money received from clients as a loan (or “time” deposit), they were acting as true financial intermediaries and were certainly doing a legitimate business and significantly contributing to the productive economy of their time. Still, the belated recognition by the Church of the legitimacy of interest should not be regarded as overall approval of the banking business, but only as authorization for banks to loan money lent to them by third parties. In other words, to act as mere financial intermediaries. The evolution of Church doctrine on interest in no way implies a sanction of fractional-reserve banking, i.e., bankers' self-interested use (which usually means granting loans) of demand deposits.⁴⁷

To a great extent, the conceptual confusion we are dealing with arose in the Middle Ages as a result of the canonical ban on interest. One of the main artifices⁴⁸ devised by economic agents to conceal actual interest-paying loans was to disguise them as demand deposits. Let us see how they did it. First, we must think back to our discussion of the monetary irregular-deposit contract in chapter 1. One of the most notable guidelines found for this contract in the Corpus Juris Civilis stipulated that, if the depositary were unable to return the deposit on demand, not only was he guilty of theft for misappropriation, but he was also obliged to pay interest to the depositor for his delay in repayment (Digest, 16, 3, 25, 1). Hence, it should come as no surprise that throughout the Middle Ages, in order to circumvent the canonical ban on interest, many bankers and depositors expressly declared that they had taken part in a monetary irregular-deposit contract, when they had actually formalized a true loan or mutuum contract. The method of concealment to which this declaration belonged was aptly named depositum confessatum. It was a simulated deposit which, despite the declarations of the two parties, was not a true deposit at all, but rather a mere loan or mutuum contract. At the end of the agreed-upon term, the supposed depositor claimed his money. When the professed depositary failed to return it, he was forced to pay a “penalty” in the shape of interest on his presumed “delay,” which had nothing to do with the actual reason for the “penalty” (the fact that the operation was a loan). Disguising loans as deposits became an effective way to get around the canonical ban on interest and escape severe sanctions, both secular and spiritual.

The depositum confessatum eventually perverted juridical doctrine on the monetary irregular deposit, robbing these tenets of the clarity and purity they received in classical Rome and adding confusion that has persisted almost to the present day. In fact, regardless of experts' doctrinal stand (either strictly against, or “in favor” within reasonable limits) on interest-bearing loans, the different approaches to the depositum confessatum led theorists to stop distinguishing clearly between the monetary irregular deposit and the mutuum contract. On one hand, over-zealous canonists, determined to expose all hidden loans and condemn the corresponding interest, tended to automatically equate deposit contracts with mutuum contracts. They believed that by exposing the loan they assumed was behind every deposit they would put an end to the pretense of the depositum confessatum. This is precisely where their error lay: they regarded all deposits, even actual ones (made with the essential purpose of safeguarding the tantundem and keeping it always available to the depositor) as deposita confessata. On the other hand, those experts who were relatively more supportive of loans and interest and searched for ways to make them acceptable to the Church, defended the depositum confessatum as a kind of precarious loan which, according to the principles embodied in the Digest, justified the payment of interest.

As a result of both doctrinal stances, scholars came to believe that the “irregularity” in the monetary irregular deposit referred not to the deposit of a certain quantity of a fungible good (the units of which were indistinguishable from others of the same type and the tantundem of which was to be kept continually available to the depositor), but rather to the irregularity of always disguising loans as deposits.⁴⁹ Furthermore, bankers, who had used the depositum confessatum to disguise loans as deposits and to justify the illegal payment of interest, eventually realized that the doctrine which held that deposits always concealed loans could also be extremely profitable to them, because they could employ it to defend even the misappropriation of money which had actually been placed into demand deposits and had not been loaned. Thus, the canonical ban on interest had the unexpected effect of obscuring Roman jurists' clear, legal definition of the monetary irregular-deposit contract. Many capitalized on the ensuing confusion in an attempt to legally justify fraudulent banking and the misappropriation of demand deposits. Experts failed to clear up the resulting legal chaos until the end of the nineteenth century.⁵⁰

Let us now examine three particular cases which together illustrate the development of medieval banking: Florentine banks in the fourteenth century; Barcelona's Bank of Deposit, the Taula de Canvi, in the fifteen century and later; and the Medici Bank. These banks, like all of the most important banks in the late Middle Ages, consistently displayed the pattern we saw in Greece and Rome: banks initially respected the traditional legal principles found in the Corpus Juris Civilis, i.e., they operated with a 100-percent reserve ratio which guaranteed the safekeeping of the tantundem and its constant availability to the depositor. Then, gradually, due to bankers' greed and rulers' complicity, these principles began to be violated, and bankers started to loan money from demand deposits, often, in fact, to rulers. This gave rise to fractional-reserve banking and artificial credit expansion, which in the first stage appeared to spur strong economic growth. The whole process ended in a general economic crisis and the failure of banks that could not return deposits on demand once the recession hit and they had lost the trust of the public. Whenever loans were systematically made from demand deposits, the historical constant in banking appears to have been eventual failure.⁵¹ Furthermore, bank failures were accompanied by a strong contraction in the money supply (specifically, a shortage of loans and deposits) and by the resulting inevitable economic recession. As we will see in the following chapters, it took economic scholars nearly five centuries to understand the theoretical causes of all of these processes.⁵²

BANKING IN FLORENCE IN THE FOURTEENTH CENTURY

Around the end of the twelfth and beginning of the thirteenth centuries, Florence was the site of an incipient banking industry which gained great importance in the fourteenth century. The following families owned many of the most important banks: The Acciaiuolis, the Bonaccorsis, the Cocchis, the Antellesis, the Corsinis, the Uzzanos, the Perendolis, the Peruzzis, and the Bardis. Evidence shows that from the beginning of the fourteenth century bankers gradually began to make fraudulent use of a portion of the money on demand deposit, creating out of nowhere a significant amount of expansionary credit.⁵³ Therefore, it is not surprising that an increase in the money supply (in the form of credit expansion) caused an artificial economic boom followed by a profound, inevitable recession. This recession was triggered not only by Neapolitan princes' massive withdrawal of funds, but also by England's inability to repay its loans and the drastic fall in the price of Florentine government bonds. In Florence, public debt had been financed by speculative new loans created out of nowhere by Florentine banks. A general crisis of confidence occurred, causing all of the above banks to fail between 1341 and 1346. As could be expected, these bank failures were detrimental to all deposit-holders, who, after a prolonged period, received half, a third, or even a fifth of their deposits at most.⁵⁴ Fortunately, Villani recorded the economic and financial events of this period in a chronicle that Carlo M. Cipolla has resurrected. According to Villani, the recession was accompanied by a tremendous tightening of credit (referred to descriptively as a mancamento della credenza, or “credit shortage”), which further worsened economic conditions and brought about a deluge of industry, workshop, and business failures. Cipolla has studied this economic recession in depth and graphically describes the transition from economic boom to crisis and recession in this way: “The age of ‘The Canticle of the Sun’ gave way to the age of the Danse macabre. ”⁵⁵ In fact, according to Cipolla, the recession lasted until, “thanks” to the devastating effects of the plague, which radically diminished the population, the supply of cash and credit money per capita approached its pre-crisis level and laid the foundation for a subsequent recovery.⁵⁶

THE MEDICI BANK

The history of the Medici Bank has come to light through the research and determination of Raymond de Roover, whose work was in turn advanced by the 1950 discovery of the Medici Bank's confidential ledgers (libri segreti) in Florence's Archivio di Stato. ⁵⁷ The secrecy of these ledgers again betrays the hidden, shameful nature of bankers' activities (see footnote 52), as well as the desire of many customers of Italian banks (nobles, princes, and even the Pope) to deposit their money in secret accounts. The discovery of these bank books was indeed fortunate, as they provide us with an in-depth understanding of how the Medici Bank operated in the fifteenth century.

We must stress that the Medici Bank did not initially accept demand deposits. At first it only took time deposits, which were actually true loans from the customer to the bank. These mutuum contracts were called depositi a discrezione. The words a discrezione indicated that, as these supposed “deposits” were really loans, the bank could make full use of them and invest them freely, at least for the length of the stipulated term.⁵⁸Discrezione also referred to the interest the bank paid clients who loaned it money in the form of time “deposits.”

In his book, Raymond de Roover performs a thorough, detailed study of the development and vicissitudes of the Medici Bank through the century of its existence. For our purposes, it is only necessary to emphasize that at some point the bank began to accept demand deposits and to use a portion of them inappropriately as loans. The libri segreti document this fact. The accounts for March 1442 accompany each demand deposit entry with a note in the margin indicating the likelihood that each depositor would claim his money.⁵⁹

A balance sheet from the London branch of the Medici Bank, dated November 12, 1477, shows that a significant number of the bank's debts corresponded to demand deposits. Raymond de Roover himself estimates that at one point, the bank's primary reserves were down to 50 percent of total demand liabilities.⁶⁰ If we apply the standard criterion used by A.P. Usher, this implies a credit expansion ratio of twice the demand deposits received by the bank. There is evidence, however, that this ratio gradually worsened over the bank's life-span, especially after 1464, a year that marked the beginning of growing difficulties for the bank. The roots of the general economic and bank crisis that ruined the Medici Bank resemble those Carlo M. Cipolla identifies in his study of fourteenth-century Florence. As a matter of fact, credit expansion resulting from bankers' misappropriation of demand deposits gave rise to an artificial boom fed by the increase in the money supply and its seemingly “beneficial” short-term effects. Nevertheless, since this process sprang from an increase in the money supply, namely credit unbacked by growth in real savings, the reversal of the process was inevitable, as chapters 4 and following will explain in detail. This is exactly what happened in Italy's large business centers in the second half of the fifteenth century. In terms of economic analysis, Raymond de Roover's grasp of the historical process is unfortunately even shallower than Cipolla's, and he even goes so far as to state, “what caused these general crises remains a mystery.”⁶¹ However, it is not surprising that the Medici Bank eventually failed, as did the other banks that depended on fractional-reserve banking for a large part of their business. Though Raymond de Roover claims he does not understand what caused the general crisis at the end of the fifteenth century, his blow-by-blow historical account of the final stage of the Medici Bank reflects all of the typical indications of an inescapable recession and credit squeeze following a process of great artificial credit expansion. De Roover explains that the Medicis were forced to adopt a policy of credit restriction. They demanded the repayment of loans and attempted to increase the bank's liquidity. Moreover, it has been demonstrated that in its final stage the Medici Bank was operating with a very low reserve ratio, which even dropped below 10 percent of total assets and was therefore inadequate to meet the bank's obligations during the recession period.⁶² The Medici Bank eventually failed and all of its assets fell into the hands of its creditors. The bank's competitors failed for the same reasons: the unavoidable effects of the artificial expansion and subsequent economic recession invariably generated by the violation of the traditional legal principles governing the monetary irregular deposit.

BANKING IN CATALONIA IN THE FOURTEENTH AND FIFTEENTH CENTURIES: THETAULA DE CANVI

The emergence of private banks in Barcelona coincided with the development of private banking in large Italian business centers. During the reign of Jaime I, the Conqueror, (1213–1276), the Gothic and Roman laws governing business were repealed and replaced by the Usos de Barcelona. In addition, a thorough, detailed set of regulations to control banking was established by the Cortes of 1300–1301. It set down the powers, rights, and responsibilities of bankers, and stipulated requirements with respect to guarantors. Some of the rules adopted are quite relevant to our topic.

For example, on February 13, 1300 it was established that any banker who went bankrupt would be vilified throughout Barcelona by a public spokesman and forced to live on a strict diet of bread and water until he returned to his creditors the full amount of their deposits.⁶³ Furthermore, on May 16, 1301, one year later, it was decided that bankers would be obliged to obtain collateral or guarantees from third parties in order to operate, and those who did not would not be allowed to spread a tablecloth over their work counter. The purpose was to make clear to everyone that these bankers were not as solvent as those using tablecloths, who were backed by collateral. Any banker who broke this rule (i.e., operated with a tablecloth but without collateral) would be found guilty of fraud.⁶⁴ In view of these regulations, Barcelona's banking system must initially have been quite solvent and banks must have largely respected the essential legal principles governing the monetary bank deposit.

Nevertheless, there are indications to show that, in spite of everything, private bankers soon began to deceive their clients, and on August 14, 1321 the regulations pertaining to bank failures were modified. It was established that those bankers who did not immediately fulfill their commitments would be declared bankrupt, and if they did not pay their debts within one year, they would fall into public disgrace, which would be proclaimed throughout Catalonia by a town crier. Immediately afterward, the banker would be beheaded directly in front of his counter, and his property sold locally to pay his creditors. In fact, this is one of the few historical instances in which public authorities have bothered to effectively defend the general principles of property rights with respect to the monetary bank-deposit contract. While it is likely that most Catalonian bankers who went bankrupt tried to escape or pay their debts within a year, documentary evidence shows that at least one banker, a certain Francesch Castello, was beheaded directly in front of his counter in 1360, in strict accordance with the law.⁶⁵

Despite these sanctions, banks' liquid funds did not match the amount received on demand deposit. As a result, they eventually failed en masse in the fourteenth century, during the same economic and credit recession that ravaged the Italian financial world and was studied by Carlo M. Cipolla. Though there are signs that Catalonian banks held out a bit longer than Italian ones (the terrible penalties for fraud undoubtedly raised reserve ratios), documents show that in the end, Catalonian banks also generally failed to meet their obligations. In March 1397, further regulations were introduced when the public began to complain that bankers were reluctant to return money deposited, offered their clients all sorts of excuses, told them to “come back later” and would pay them (in the end, if the clients were lucky) only in small coins of little value and never in the gold which had originally been deposited.⁶⁶

The bank crisis of the fourteenth century did not lead to increased monitoring and protection of the property rights of depositors. Instead, it resulted in the creation of a municipal government bank, the Taula de Canvi, Barcelona's Bank of Deposit. This bank was formed with the purpose of taking in deposits and using them to finance city expenditures and the issuance of government bond certificates for the city of Barcelona. Hence, the Taula de Canvi fits the traditional model of a bank created by public authorities to take direct advantage of the dishonest benefits of banking. A.P. Usher studied the life of this bank in detail. Predictably, it ended up suspending payments (in February 1468), because a large portion of its reserves had been channeled into loans to the city of Barcelona and the bank was unable to satisfy depositors' demands for cash withdrawals.⁶⁷ From that point on, the bank was reorganized and gradually given more and more privileges, such as a monopoly on all deposits deriving from judicial attachments and seizures. This was an almost guaranteed source of continuous income and acted as collateral for loans to finance the city's projects. The Taula was also granted a monopoly on resources from all administrative deposits, guardianships and testate proceedings. These funds were deposited and fixed in the bank.⁶⁸