Insights from Henley Business School

Lessons from the past? A 'credit crunch' in 1294. [1]

Dr Adrian Bell, Professor Chris Brooks, Dr Tony Moore

This short essay will highlight an episode from medieval Europe that has many parallels with today's financial situation.The financial crisis of 1294 featured sub-prime borrowers, liquidity disappearing, recriminations, the seizure of foreign owned assets and runs on the bank. While the study of history cannot provide us with a toolkit to fix the current seizure in bank lending, by identifying some common elements in both crises, we can place current events in a wider perspective.

A European Credit Network

Our study centres on the English king, Edward I, and his bankers, the Ricciardi of Lucca in northern Italy. In the twenty years before 1294, the Ricciardi had advanced large sums to Edward and, in return, had collected the customs tax on wool exports from England. This was possible because the 1280s in particular was a decade of abundant liquidity. Just as Western banks benefitted from the 'Asian savings glut', at least until recently, in the 1280s and early 1290s, the Ricciardi and other Italian merchant societies managed large sums of papal taxation, collected in England and across Europe in support of a proposed crusade. Like modern banks, the merchant societies would have used this opportunity to make profits by loaning this money at interest or investing in trade. The figure below shows the position of the merchant at the centre of a pan-European network of trade and credit:                                                                                                      

  Figure 1 – The merchant as money manager

Although this meant that much of their own capital was committed in various ventures, the Ricciardi could look to other merchant societies for short-term injections of liquidity, a forerunner of today's interbank lending. The current 'credit crunch' arguably started with the 'sub-prime crisis' in the US, as a result of which banks were unwilling to lend to each other, thus removing liquidity from the market. In the early 1290s, first the pope called in much of his funds deposited with the merchant societies, and then the French king levied a heavy tax on the Italians in France. This had a similar effect of sucking liquidity out of the system, leaving the Ricciardi vulnerable should Edward need to make a large withdrawal at short notice. Unfortunately, this was precisely the situation that arose in 1294 when war broke out between England and France. Although the Ricciardi should have been well-capitalised at that time thanks to the money they had received on Edward's behalf, it seems that much of this was tied up. The Ricciardi thus needed to raise a very large sum of money quickly to meet Edward's demands for money to fund his armies.

Previously, the Ricciardi would have looked to their fellow merchant societies for short-term loans until they could realise some of their assets. However, the other merchant societies were also affected by the lack of liquidity and seem to have been unable or unwilling to advance the necessary sums. These difficulties were compounded by the war, which cut communications between Italy and England. Unable to update the account books of their various branches across Europe, the Ricciardi and their fellow merchants could not manage their money. The following quotes from the Ricciardi's internal letters may sound familiar:

• 'Everyone to whom we owed money ran to us and wanted to be paid, and because of this we were held very tight everywhere'
• 'It seems that money has disappeared'
• 'We do not find anyone willing to give us credit of even £10 of Lucca'. [2]
• At the Champagne fairs: 'Where we used to have credit and could borrow 100,000 and 200,000 livres tournois (£25,000-50,000 sterling) and even more, we are now reduced to such a point that if we wanted 100 livres tournois (£25 sterling) we could not find them'

Comparisons With Today

However, like the banks today, the Ricciardi argued that their difficulties were merely a short-term mismatch and that, overall, their assets matched their liabilities. Unfortunately, owing to the political uncertainty caused by the conflict between England and France, the Ricciardi were unable to collect on debts owed to them while their own creditors sought to withdraw sums deposited with or loaned to the Ricciardi. As a result, the Ricciardi were unable to provide the English king with the financial support that he desperately needed. In response, Edward removed the Ricciardi from their position as collectors of the customs on wool and, in an attempt to recover some of his losses, ordered the seizure of the assets (mainly wool but also debts owed to the merchants by private individuals) held by the Ricciardi and other merchant societies. As a result, they were unable to meet their obligations and the society was ruined.

As we have seen, Edward dealt with the Ricciardi decisively and, as a result, he was able to recover some of his lost deposits. However, the fall of the Ricciardi had further costs, since Edward was subsequently forced to impose heavy taxation and to rely on moneylenders, who both lacked the resources of the Italians and charged much higher rates of interest (40%-80%). In the same way, taking punitive action against the banks today would further reduce access to credit and, given the greater reliance of the modern economy on debt, this would have much more serious consequences for the country as a whole. Edward himself may have come to the same conclusion and, when the Frescobaldi (who succeeded the Ricciardi as royal bankers) complained that their involvement with Edward had led to a run on their bank, Edward recognised their claim and promised them £10,000 in compensation. Although far smaller in absolute terms, when compared to annual government income of about £40,000, this commitment is relatively greater than the initial £50 billion recapitalisation provided by the British government in 2008.