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In banking, a merchant bank is a financial institution primarily engaged in offering financial services and advice to corporations and to wealthy individuals. The term can also be used to describe the private equity activities of banking.[1] The chief distinction between an investment bank and a merchant bank is that a merchant bank invests its own capital in a client company whereas an investment bank purely distributes (and trades) the securities of that company in its capital raising role. Both merchant banks and investment banks provide fee based corporate advisory services including in relation to mergers and acquisitions.

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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.

The Jewish trader performed both finance (credit) and an underwriting (insurance) functions. He would derive an income from lending the farmer money to develop and manufacture (through seeding, growing, weeding and harvesting) his annual crop (the crop loan at the beginning of the growing season). He would underwrite (insure) the delivery of the crop (through crop or commodity insurance) to the merchant wholesaler who was the ultimate purchaser of the farmer’s harvest. And he would make arrangements to supply this buyer through alternative sources (the merchant function) of supply (such as grain stores or alternate producer markets), should any particular farming district suffer a seasonal crop failure. He could also keep the farmer (or other commodity producer) in business during a drought or other crop failure, through the issuance of a crop (or commodity) insurance against the hazard of failure of his crop.

Thus in his underlying financial function the merchant banker (trader) would ensure the continuous smooth flowing of the commodity (crop, wool, salt; salt-cod, etc.) markets by providing both credit and insurance.

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, banca, as in a counter) in the great grain markets became centers 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.

Islam makes similar condemnations of 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. These and other great merchant banking families dealt in everything from underwriting bonds to originating foreign loans. Bullion trading and bond issuing were some of the specialties of the Rothschild family.

Modern practices

Known as “accepting and issuing houses” in the U.K. and “investment banks” in the U.S., modern merchant banks offer a wide range of activities, including portfolio management, credit syndication, acceptance credit, counsel on mergers and acquisitions, insurance, etc.

Of these two classes of merchant banks, the U.S. variant initiates loans and then sells them to investors.[2] Even though these companies call themselves "merchant banks," they have few, if any, of the characteristics of former merchant banks.

Goldman Sachs, Morgan Stanley, The Weston Group, maintain an active merchant banking presence.

Further reading

  • Ferris, Paul (1984). Gentlemen of Fortune: The World's Merchant and Investment Bankers. London: Weidenfeld and Nicolson. ISBN 0-297-78380-7.  
  • Wechsberg, Joseph (1966). The Merchant Bankers. Boston: Little, Brown.  
  • O'Sullivan, M.D. (1962). Italian Merchant Bankers in Ireland in the Thirteenth Century: A Study in the Social and Economic History of Medieval Ireland. Dublin: A. Figgis.  
  • Rosenbaum, Eduard (1962). M.M.Warburg & CO, Merchant Bankers of Hamburg; A Survey of the First 140 years, 1798 to 1938. London.  

See also

References

  1. ^ Merchant Banking: Past and Present
  2. ^ Fitch, Thomas P. [1990](2000)Dictionary of Banking Terms: Merchant Bank 4th Edition New York: Barron's Business Guides ISBN 0-7641-1260-0
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