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The Fall of Medici Bank: Lessons on Fractional Reserve Banking From 15th Century Italy

Amid the banking chaos of the 21st century, some are looking back more than 600 years ago, to the Medici Bank — one of the most powerful banks of its time. It established its business and became one of the most respected banks in Europe during its prime, and the prominent Italian family of bankers were early adopters of fractional reserve banking, a practice that Medici Bank customers were unaware of, and that ultimately led to the financial institution’s failure.

‘Nothing New’— How the Medici Bank Failure Is Still Very Relevant to Today’s Modern Banking Practices

The collapse of three major banks in mid-March 2023 has caused people to scrutinize the risks of fractional reserve banking. The practice of fractional reserve banking is essentially when a financial institution holds only a fraction of deposits in the bank, and the remaining funds are used to lend or invest in order to obtain a yield. One of the earliest known examples of fractional reserve banking was the Medici Bank, founded in Florence, Italy, in 1397 by Giovanni di Bicci de’ Medici.

In the first five years of operation, the Medici Bank grew rapidly, and before the financial institution’s demise, it established branches all over Western Europe. Similar to bankers in the early 20th century like J.P. Morgan, Jacob Schiff, Paul Warburg, and George F. Baker, members of the House of Medici were extremely powerful. The Medici Bank was known to be one of the largest business enterprises during the Renaissance but ultimately failed after close to 100 years of operation.

Philip J. Weights, the president of the Swiss Finance and Technology Association (SFTA), explained in a 2015 Linkedin post how the weight of “excessive lending” and “insufficient reserves” led to the bank’s ultimate demise. According to Raymond De Roover’s book “The Rise and Decline of the Medici Bank (1397-1494),” published in 1963, liquidity was an issue from the bank’s inception. De Roover’s book details that the Medicis’ reserves held less than 10% of deposits due to the family members’ managerial abilities.

The 380-page book explains how the Medici Bank experienced a period of decline between 1463 and 1490 due to shady and corrupt banking practices. The fraudulent schemes caused several Medici branches to be liquidated and sold off to other banks. De Roover argued that despite being a prominent member of the House of Medici and a successful banker, Francesco Sassetti “was unable to avoid the disastrous liquidation of the Bruges, London, and Milan branches.” De Roover’s book notes that significant lending was a popular practice that gathered high-interest rates.

Florins, gold coins minted by the Republic of Florence, were often held on the Medici Bank balance sheet. However, the lack of reserves was a constant source of frustration for both Medici banking partners, and government officials and customers. In a 2018 editorial on bigthink.com, author Mike Colagrossi detailed that “it was due to advancements and financial solutions like these that the Medici bank became so powerful” as the Medicis received high interest on loaned payments. Colagrossi notes that the downfall of the bank took place after the death of Cosimo Medici in 1464, who was the bank’s boss at the time.

After the fall of three major banks in 2023, Jim Bianco, president of Bianco Research, a firm that specializes in macro analysis for institutional investors, explained how fractional reserve banking “was invented by the Medicis in Florence in the late 15th century.” In his Twitter post, Bianco also mentions the “tuppence” scene in the 1960s Disney musical film “Mary Poppins” and the bank run scene from “It’s a Wonderful Life” filmed in the 1930s, stating that “all of these are still very relevant depictions of what is happening today.”

Bianco opined:

Nothing that is happening is new. Our banking system is several hundred years old and has constantly had these issues.

Triple-Entry Bookkeeping — A New System of Accounting

Bianco also mentioned that double-entry bookkeeping was the “technology” used to enable the Medici Bank’s fractional reserve banking practices. The double-entry scheme involves a ledger that records both debits and credits and is still used in the modern financial world today. At the time, the Franciscan Friar Luca Pacioli wrote a book about double-entry accounting with help from the well-known Renaissance artist Leonardo da Vinci. Although Pacioli and da Vinci did not claim to invent the new system, their research led to the wider and more structured use of double-entry bookkeeping that’s still used today.

Soon after the method was popularized, Giovanni de Medici implemented the concept into his family’s bank. It allowed the House of Medici to operate with less than 10% of deposits and extend its lending practices far and wide until liquidity completely dried up. More than 600 years later, an anonymous person or group released a paper that introduced the concept of triple-entry bookkeeping. In addition to records of both debits and credits, a third component was added, which is a cryptographic receipt verified by a third party to validate the ledger’s entries.

Satoshi Nakamoto’s invention has produced a system where a double-entry bookkeeping system doesn’t need to be trusted now that an improved ledger accounting scheme exists. A single-entry or double-entry accounting system can be forged and manipulated, but the cryptographic assurance from a triple-entry bookkeeping system is much harder to add fraudulent data to. While Bianco is correct that there is nothing new with the way bankers operate today, compared to the days of Medici, Nakamoto’s invention has given the world a new method of accounting that can transform it a great deal, just as the invention of double-entry bookkeeping has done.

What lessons can be learned from the fall of the Medici Bank? Share your thoughts in the comments section below.

Source

Н News

The Fall of Medici Bank: Lessons on Fractional Reserve Banking From 15th Century Italy

‘Nothing New’— How the Medici Bank Failure Is Still Very Relevant to Today’s Modern Banking Practices

Triple-Entry Bookkeeping — A New System of Accounting

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Н News

The Fall of Medici Bank: Lessons on Fractional Reserve Banking From 15th Century Italy

‘Nothing New’— How the Medici Bank Failure Is Still Very Relevant to Today’s Modern Banking Practices

Triple-Entry Bookkeeping — A New System of Accounting

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