Financial systems and development

Box 3.2 Trade financing in Renaissance Italy
The businessmen and bankers of northern Italy's Re- ies. For a fee, the bank could pay the exporter as soon
naissance city-states-particularly Genoa, Florence, as the shipment embarked. The importer would then
and Venice-developed many of the fundamental prac- pay the bank's agent-adding a fee-when the ship- '
tices of modern finance. Their innovations included ment arrived. For an additional fee the same bank
double-entry bookkeeping and the provision of credit might even insure the shipment.
through discounted promissory notes. One of their Over time, the Italian banks developed this vital
most important innovations, however, was trade trade-financing function. The leading Florentine bankcredit.
ing family, the Medici, acquired agents or correspon-
Suppose that a Florentine textile manufacturer re- dents in Europe's trading cities and made itself indisceived
a potentially profitable order from Barcelona pensable in the continent's commerce. Probably in the
and had the means to fill it. Two things might keep him thirteenth or fourteenth century, the bankers invented
from accepting the business. First, the importer might a variation that limited the degree to which their own
not pay until he received the goods-perhaps not even capital was tied up over the course of the transaction.
until he had sold them. Meanwhile, the exporter This was the "acceptance," or "four-name paper."
would have to pay for materials, labor, storage, and The Barcelona agent (name 1) would sign a document
shipment. Second, having produced and shipped his "accepting" the liability of the importer (name 2) to the
goods, the exporter would have to bear the risk that the exporter (name 3), and the document would be conimporter
might simply fail to pay. And there was no veyed to the banker in Florence (name 4). The banker
court to which the exporter could take the Barcelona would disburse (after subtracting a discount) to the exmerchant.
porter against this acceptance. The banker could then
Commercial banks-that is, banks which specialize in sell the acceptance at a discount in the Florentine finanfinancing
commerce-came into being to solve such cial market and thus replace most or all of the cash the
problems. By providing short-term finance (working bank had disbursed. After some weeks the importer K
capital), commercial banks enabled such merchants to would pay the agent, the agent would pay the bank, :.
pay for materials and labor in advance. They solved the and the bank would repurchase the acceptance, consecond
problem by having trusted agents in major cit- cluding the operation.
insurance contract, which was repayable upon the Italy, for instance, made significant advances in
safe completion of the voyage). Otherwise, bor- trade finance (see Box 3.2).
rowing and lending were mostly on a small scale Apart from granting charters to trading compaand
were limited to trade credit, short-term loans nies and note-issuing banks, governments proto
farmers, and loans for nonbusiness purposes. moted financial development indirectly, through
The financial system comprised money changers the preservation of peace or the waging of wars
and moneylenders and a few private bankers who and through their success or failure in maintaining
dealt mostly with wealthy individuals, accepting macroeconomic stability. War finance was the spur
deposits for safekeeping and providing loans. In for many of the innovations of this period-the
addition, tax farmers helped to administer the tax creation of the Bank of England and other charsystem
by collecting and transferring taxes, and tered banks, for example, and the issue of governvarious
religious establishments offered their ser- ment bonds.
vices as safekeepers.
Urbanization and the capital requirements of in-
The expansion of commerce was driven by the frastructure projects toward the end of the eighspread
of trade fairs from medieval times and by teenth century created a need to mobilize new fiadvances
in maritime technology in the fifteenth nancial resources. But the onset of the Industrial
century. It led to the accumulation of large per- Revolution had relatively little impact on finance:
sonal fortunes in Europe. Deposit banking and the capital requirements of early industrial entergeneral
and maritime insurance evolved to meet prises were small. Many owners came from prosthe
growing needs of merchants and wealthy indi- perous trading or artisan families that were diverviduals.
The creation of trading companies with sifying into manufacturing; such owners provided
special charters and limited liability gave rise to the most of the capital from their own resources. Famiissue
and informal trading of company securities. lies, friends, and wealthy private investors pro-
The pace of financial development differed from vided the balance. Banks supplied mainly shortcountry
to country; the city-states of northern term working capital, which was routinely rolled
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