In the midst of the banking turmoil of the 21st century, some look back more than 600 years to one of the most powerful banks of its time, the Bank of Medici. In its heyday, the prominent Italian banking family became one of the most respected banks in Europe and was an early adopter of fractional reserve banking. This practice was unknown to the Medici bank’s clients and ultimately led to the institution’s failure.
Nothing New” – how the failure of the Medici Bank is closely related to modern banking today
The failure of the three largest banks in mid-March 2023 has brought the risks of fractional reserve banking into the spotlight. Fractional reserve banking is essentially the practice of a financial institution holding only a portion of its deposits in the bank and then lending or investing the remaining funds to earn a yield. The earliestexampleof fractional reserve banking is the Medici Bank, founded in Florence, Italy, in 1397 by Giovanni di Bicci de Medici.
Within five years of its founding, the Medici Bank grew rapidly, establishing branches throughout Western Europe before the demise of the financial institution; like early 20th century bankers such as J.P. Morgan, Jacob Schiff, Paul Warburg, and George F. Baker, the Medici family members were were extremely powerful. The Medici Bank was known as one of the largest businesses during the Renaissance, but ultimately failed after nearly 100 years of operation.
Philip J. Weitz, president of the Swiss Financial Technology Association (SFTA), explains in2015 Linkedin post how the weight of “over-lending” and “insufficient reserves” led to the bank’s eventual demise.Published in 1963 The Rise and Fall of the Bank of Medici (1397-1494)” by Raymond De Roover, published in 1963, liquidity was a problem from the bank’s inception. De Roover’s book details that the Medici family’s reserves were less than 10% of deposits, due to the family’s ability to manage the bank.
28}, this 380-page bookdescribes how the Medici Bank experienced a period of decline between 1463 and 1490 due to dubious and corrupt banking practices. Due to fraudulent schemes, several Medici branches were liquidated and sold to other banks. De Roover argued that despite being a powerful member of the Medici family and a successful banker, Francesco Sassetti “could not avoid the disastrous liquidation of the Bruges, London, and Milan branches.” De Roover’s book points out that lending large sums of money was a popular practice that attracted high interest rates.
Shortly after this method became popular, Giovanni de Medici introduced the concept to his family’s bank. This allowed the Medici family to operate with less than 10% of its deposits and to expand its lending widely until its liquidity was completely depleted. More than 600 years later, an anonymous person or grouppublished a paperintroducing the concept of triple bookkeeping. In addition to both debit and credit records, a third element was added: encrypted receipts verified by a third party to verify the entries in the ledger.
Satoshi Nakamoto’s invention created a system that does not require reliance on double-entry bookkeeping now that improved ledger accounting methods exist. While single- and double-entry bookkeeping can be forged and manipulated, the cryptic assurance provided by triple-entry bookkeeping makes it much more difficult to add fraudulent data. Bianco is right that there is nothing new in the way bankers operate today compared to Medici’s time, but Nakamoto’s invention, like the invention of double-entry bookkeeping, gave us a new accounting system that could change the world.
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