HISTORY OF MERCHANT BANKING

Merchant banks were actually the first modern banks. A

merchant bank was historically one which dealt in commercial
loans and investment, its primary purpose being to facilitate
and/or finance the production and trade of commodities, hence
the adoption of the Old French “merchant” which in turn
derives from the Latin word “mercari” meaning “to trade”.
They originally emerged in the Middle Ages, evolving from
Italian commodity merchants who traded mostly in cloth and
grain in the piazza or mercato (market placeo) in the north-west
Lombardy region of Italy. They then developed further in the
11th century at the large European fair of St. Giles, England,
and the Champagne fairs in France.
As the Lombardy merchants and bankers grew in stature, many
displaced Jews fleeing Spanish persecution were attracted to the
trade and set up alongside the locals. The Jewish and Florentine
merchants perfected ancient practices that had been originally
used to finance the long Middle East trade routes and Far East
silk routes, and in propagating these new financial practices all
over Europe, they were instrumental in driving forward the
medieval “commercial revolution”.
The Jewish traders had the advantage of being able to lend
money to farmers (high-risk loans secured against the crops in
the field), a practice which was seen as usury and therefore
forbidden to both Christian and Muslim traders. Soon some
merchants began to trade in grain debt and future grain crops
instead of actual grain. This is analogous to the future contract
market in modern finance. Jewish bankers, known as “Court
Jews”, also performed both financing (credit) and underwriting
(insurance) functions, which allowed farmers to stay in business
in the event of a drought or other crop failure.
Merchant banking progressed to holding deposits for
settlement of “billette” or notes written by those who were still
brokering the actual grain. This is how the merchant’s trading
benches (“bank” is derived from the Italian for bench, banco, as
in a “counter”), set up in the great grain markets, became places
for holding money against a billette (note) which evolved into a
“bill of exchange” and then a cheque. These deposited funds
were initially intended to be held for the settlement of grain
trades, but often were used for the bench’s own trades in the
meantime, and discounted interest rates were offered to
depositors against what could be earned by employing their
money in the bench’s trade.
The medieval Italian markets were disrupted by wars and
limited by the fractured nature of the Italian states, so the next
generation of bankers arose from migrant Jewish merchants in
the vast, wheat-growing areas of Germany and Poland. Many
were descendants of the original merchant bankers in Italy, and
also often had links with family who had fled Spain for both
Italy and England centuries before. As non-agricultural wealth
expanded, many families of goldsmiths (another business
prohibited to Christians but not Jews) also moved into banking.
This set the stage for the rise of prominent Jewish family
banking firms, some of whose names still resonate today, such
as the Rothschilds and the Warburgs. In France during the 17th
and 18th century, a merchant banker or marchand-
banquier was not just considered a trader but also had the status
of entrepreneur par excellence.
Later, the rise of Protestantism freed many European
Christians from Rome’s dictates against usury, and by the late
18th century some Protestant merchant families began to move
into banking. This increased in the early 19th century,
especially in the largest trading countries such as the UK
(Barings, Britain’s first merchant bank which was established in
1762 by brothers Francis and John Baring), Germany
(Schroders, Berenbergs) and the Netherlands (Hope & Co.,
Gülcher & Mulder).
At the same time, new types of financial activities broadened
the scope of merchant banking, taking it far beyond its narrow
origins. The merchant-banking families dealt in everything
from underwriting bonds to originating foreign loads. Bullion
trading and bond issuance, for example, were just two of the
specialities of the Rothschilds. They also began to form cross-
country strategic alliances – for instance, in 1803 Barings
Bank teamed up with Hope & Co. to facilitate the Louisiana
Purchase.
In the 19th century, the rise of trade and industry in the United
States led to the establishment of powerful new private
merchant banks, including perhaps the most famous of them
all, J.P. Morgan & Co.
However, during the 20th century, the financial world began to
outgrow the resources of family-owned and other forms of
private equity banking. Corporations came to dominate the
banking business and merchant banking activities became just
one area of interest for these massive modern banks.
Meanwhile, some of the long-established, emblematic
merchant banks were acquired by, and merged into, larger
investment banks, while others, including Barings, moved into
non-core activities with increased complexity which ultimately
led to their collapse. In Barings’ case, the bank’s catastrophic
collapse in 1995 was largely blamed on one rogue Singapore-
based employee, Nick Leeson, whose fraudulent and reckless
investments in futures contracts had apparently led to massive
and unsustainable losses of at least £827 million (£1.6 billion in
today’s money).
Today, a modern version of the merchant bank has begun to
emerge, with the traditional model reimagined for the 21st
century and getting a contemporary twist. Modern merchant
banks like Umbra can offer a much wider array of activities than
our medieval counterparts, while appealing to discerning
investors, funds and companies with our differentiated model
and fintech approach.