Merchant Bank

In banking, a merchant bank is a traditional term for an Investment Bank. It can also be used to describe the private equity activities of banking. This article is about the history of banking as developed by merchants, from the Middle Ages onwards.

History

Merchant banks, now so-called, are in fact the original “banks”. These were invented in the Middle Ages by Italian grain merchants. As the Lombardy merchants and bankers grew in stature based on the strength of the Lombard plains cereal crops, many displaced Jews fleeing Spanish persecution were attracted to the trade. They brought with them ancient practices from the middle and far east silk routes. Originally intended for the finance of long trading journeys, these methods were now utilized to finance the production of grain.

The Jews could not hold land in Italy, so they entered the great trading piazzas and halls of Lombardy, alongside the local traders, and set up their benches to trade in crops. They had one great advantage over the locals. Christians were strictly forbidden the sin of usury. The Jewish newcomers, on the other hand, could lend to farmers against crops in the field, a high-risk loan at what would have been considered usurious rates by the Church, but did not bind the Jews. In this way they could secure the grain sale rights against the eventual harvest. They then began to advance against the delivery of grain shipped to distant ports. In both cases, they made their profit from the present discount against the future price. This two-handed trade was time-consuming and soon there arose a class of merchants, who were trading grain debt instead of grain.

It was a short step from financing trade on their own behalf to settling trades for others, and then to holding deposits for settlement of “billete” or notes written by the people who were still brokering the actual grain. And so the merchant’s “benches” (bank is a corruption of the Italian for bench, as in a counter) in the great grain markets became centres for holding money against a bill (billette, a note, a letter of formal exchange, later a bill of exchange, later still, a cheque).

These deposited funds were intended to be held for the settlement of grain trades, but often were used for the bench’s own trades in the meantime. The term bankrupt is a corruption of the Italian banca rotta, or broken bench, which is what happened when someone lost his traders’ deposits. Being “broke” has the same connotation.

A sensible manner of discounting interest to the depositors against what could be earned by employing their money in the trade of the bench soon developed; in short, selling an “interest” to them in a specific trade, thus overcoming the usury objection. Once again this merely developed what was an ancient method of financing long-distance transport of goods.

Islamic banking has the same constraints against usury as Christianity.

The medieval Italian markets were disrupted by wars and in any case, were limited by the fractured nature of the Italian states. And so the next generation of bankers arose from migrant Jewish merchants in the great wheat-growing areas of Germany and Poland. Many of these merchants were from the same families who had been part of the development of the banking process in Italy. They also had links with family members who had, centuries before, fled Spain for both Italy and England.

This course of events set the stage for the rise of banking names which still resonate today: Schroders, Warburgs, Rothschilds, even the ill-fated Barings, were all the product of the continental grain trade, and indirectly, the early Iberian persecution of Jews. It may be defined as, “ an institution which covers a wide range of activities such as management of customer services, portfolio management, credit syndication, acceptance credit, counselling and insurance etc., The merchant banks are also known as “ accepting and Issuing houses” in the UK and as “Investment Banks” in the US. They offer a package of financial services for fee mostly in new issues market.

Modern Practices

The definition of merchant banking has changed greatly since the days of the Rothschilds. The great merchant banking families dealt in everything from underwriting bonds to originating foreign loans. Bullion trading and bond issuing were some of the specialities of the Rothschild family. The modern merchant banks, however, tend to advise corporations and wealthy individuals on how to use their money. The advice varies from counsel on Mergers and acquisitions to recommendation on the type of credit needed. The job of generating loans and initiating other complex financial transactions has been taken over by investment banks and private equity firms.

Today there are many different classes of merchant banks. One of the most common forms is primarily utilized in America. This type initiates loans and then sells them to investors. Even though these companies call themselves “Merchant banks,” they have few, if any, of the characteristics of former Merchant banks.

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