27
See also: Public companies 38 ■ Financial engineering 262–65 ■ Market uncertainty 274–75 ■ Financial crises 296–301 ■
Bank runs 316–21
of Europe. Wealth began to
accumulate, especially in Venice
and Florence. Venice relied on sea
power: institutions were created
there to finance and insure voyages.
Florence focused on manufacturing
and trade with northern Europe, and
here merchants and financiers came
together at the Medici Bank.
Florence was already home to
other banking families, such as
the Peruzzi and the Bardi, and to
different types of financial bodies—
from pawnbrokers, who lent money
secured by personal belongings, to
local banks that dealt in foreign
currencies, accepted deposits, and
lent to local businesses. The bank
founded by Giovanni di Bicci de’
Medici in 1397 was different.
The Medici Bank financed long-
distance trade in commodities such
as wool. It differed from existing
banks in three ways. First, it grew
to a great size. In its heyday under
the founder’s son, Cosimo, it ran
branches in 11 cities, including
London, Bruges, and Geneva. Second,
its network was decentralized.
Branches were managed not by
an employee but by a local junior
partner, who shared in the profits.
The Medici family in Florence were
the senior partners, watching over
the network, earning most of the
profit, and retaining the family
trademark, which symbolized the
bank’s sound reputation. Third,
branches took in large deposits from
wealthy savers, multiplying the
lending that could be given out for a
modest amount of initial capital, and
so multiplying the bank’s profits.
Economics of banking
These elements of the Medici
success story correspond to three
economic concepts highly relevant
to banking today. The first is
“economies of scale.” It is expensive
for an individual to draw up a single
legal loan contract, but a bank can
draw up 1,000 such contracts at
a fraction of the “per-contract”
cost. Dealings in money (cash
investments) are suitable for
economies of scale. The second
is “diversification of risk.” The
Medicis lowered the risk of bad
lending by spreading their lending
geographically. Moreover, because
the junior partners shared in profits
and losses, they needed to lend
wisely—in effect they took on some
of the Medici risks. The third
concept is “asset transformation.”
Merchants might want to deposit
earnings or borrow money. One ❯❯LET TRADING BEGIN
Lend wisely, and
monitor your loans.Gather deposits and
keep enough cash to
cover withdrawals.As the bank grows,
average costs fall
and profits multiply.Spread your risks across
different investments.Make money
from money.Use your wealth to
found a bank.Merchant bankers of the late 14th
century arranged deposits and loans
but also converted foreign currencies
and watched over the circulation for
signs of forged or forbidden coins.