Trade is capital intensive, even more so when transit times are slower or the distances vaster. Products sitting in warehouses, ships, and ports are deadweight, tying up capital until they are finally sold and used. Merchant banks, as their name implies, serve merchants and for centuries that meant devising a solution to the financial problems intrinsic to world trade. The solution London merchant banks settled on was the ‘bill on London’, a bill of exchange guaranteed by a London banking house. This was in essence a form of trade credit, but one so trusted that it could trade on the market itself, turning into a kind of money that can be used in lieu of cash more generally.
After the War
The Napoleonic Wars were trying times to be either a merchant or a merchant banker. Embargos were included amongst the weapons of war, blocking merchants from accessing their traditional markets. In search of new outlets for their product after being cut off from European trade, British merchants turned to Latin America to replace established European destinations for their goods. But Latin America was a novel destination for British products and new relationships with buyers there would have to be built at long distance.
War related deflation and disruption continued after Napoleon’s defeat. British exports actually fell in the decade after the final peace, from £44.5 million in the years 1814-16 to £35.3 million in 1824–6. French defeat at Waterloo ended a quarter-century of war; during this time, a generation of merchants were either depleted, bankrupted, or retired from trade. Those leaving the business often took their capital with them as they left the trade centers for their new country estates.
The wars had also transformed business life; international trade was turned into a speculative operation. Scarcity would repeatedly give way to gluts which would give way to scarcity again. This encouraged stockpiling of goods and more speculative trading practices in general. After the war, there would be increased competition among merchants amidst a stagnant volume of world trade; this meant lower profits and thus an inability to accumulate capital. More trade, especially trans-Atlantic trade, was now conducted by small new merchants, often young and lacking in accumulated capital. So, credit from third parties became vital.
Bills on London
The lack of capital in the hands of the new merchants posed a problem because manufacturers typically required payment upfront. A merchant might set up as a commission agent abroad, selling goods on consignment. This allowed them to reduce the amount of money tied up in inventories, a logical strategy for traders with scarce funds. Nonetheless, a manufacturer would still demand an advance from these agents so that not all their income was dependent on the success of a new and unknown merchant.
An exporter in Britain selling product to a customer in America would be unwilling to offer credit to a client he did not know well, yet the buyer would often require some financing to make his purchase. Filling this gap was the bill of exchange, a form of trade credit commonly used to transact both within and across countries. It allowed for payment in cash at a later date and their use surged in the late 18th and early 19th centuries.
If the American buyer in our earlier example purchased a bill from a London banker, perhaps through a correspondent in America, and delivered this to the exporter, the exporter could rely on the creditworthiness of the banker, of whom he would have been familiar. By essentially guaranteeing the payment, the London banker was said to have ‘accepted’ the bill, making it suitable for payment in lieu of cash.
Bills commonly had terms of sixty or ninety days. Those ‘accepted’ by a reputable financial institution could be traded in London and thus liquidated before their maturity. In London, the payee could liquidate the bill early by selling it to a discounter who would buy the bill at some price less than face value. By selling the bill to a discounter, the exporter would be paid immediately.
What made a bill valuable was the standing of the accepting bank, which ultimately bore the obligation of paying the payee. The bank, or ‘acceptance house’, was essentially guaranteeing the payment to the payee and would charge a fee for this service. The amount of any discount charged by a discounter largely depended on the standing of the payee. The discount rate on the best bills would average 0.72% per quarter or about 2.9% per year in the 1830s. Because the bill would be accepted by a London merchant bank, the instrument would be known as a ‘bill on London’ and ‘bills on London’ became a preferred payment method of British exporters.
“There are persons in Birmingham who are designated as merchants … highly respectable in their character and conduct, although generally speaking not possessed of much property. They are paid by a commission on the transactions which they effect and for the most part, when they receive orders from abroad, particularly from America, they are furnished with bills on London and Liverpool [merchant] houses … The paper which these mercantile agents negotiate is held in high estimation by the banks here”Report of a Bank of England agent in Birmingham, England (1827)
Bills were commonly accepted as money, at least for transactions between firms. They were thus a monetary invention as much as an innovation in credit. An exporter might use the bills obtained in his sales to an importer abroad as a means of payment when buying new raw materials or inventories. Thus, they circulated in the economy alongside coins and Bank of England notes and, outside the control of the Bank, they frustrated the ability of the latter to regulate the money supply in Britain, perhaps contributing to money market crises in the 1830s. Nonetheless, the Bank of England could regulate the money markets by adjusting its own discounting of bills and thus the size of its balance sheet.
Together with discounters, merchant banks which played the role of ‘acceptance houses’, were the backbone of this system of trade credit. Barings, Rothschilds, and Schroders were among the largest of London’s merchant banks engaged in acceptances, though there were many others in the same business as well.
They were not necessarily large by the standards of a modern bank. A typical ‘first-class’ merchant bank at this time might employ just ten to fifteen clerks; even the London Rothschilds would employ just forty to fifty by 1845. The larger two of the aforementioned set, Barings and Rothschilds, had outstanding acceptances of only £520,000 and £300,000 respectively in 1825. While not impressive sums compared to the large state loans arranged by these same banks at around the same time, managing this portfolio was the everyday task of the bankers. While Baron Schroeder would, decades later in 1910, refer to floating large loans as the ‘jam’ of his business, granting acceptances was its ‘bread and butter’ as he put it.
Make no mistake; being an acceptance house was not simple or easy. The business required a detailed knowledge of international trade: the goods, their markets, the merchants, and their creditworthiness. It was typical for at least some partners in an acceptance house to have experience working abroad. Even clerks at these firms would complete mercantile apprenticeships overseas. New partners might also be recruited from mercantile firms elsewhere.
Though the partners and clerks might be based in London, these banks had exposure to clients in distant lands. They served these clients through foreign branches and, more commonly, through a network of foreign correspondents.
Barings’ network of correspondents dated to Sir Francis Baring’s work at the East India Company, where he developed many contacts. His bank specialized in American trade. Other banks had their own specialties; Schroders was judged to be particularly strong in Russian trade. The London Rothschilds meanwhile had family in four other European financial centers to leverage in their business.
Through their acceptance work, merchant banks were crucial in keeping London at the center of world trade. Indeed, while Liverpool may have overtaken London in trading volume in the early 19th century, trade remained dependent on London financiers. Financial crises in 1825-26 and 1836-7 did not destroy this arrangement. Trade credit helped keep London the preeminent financial center of the 19th century and trade finance remained a core service it provided to the world economy. The Bank of England would continue to use its own trading in private bills as a means of adjusting the country’s money supply through the 1990s.
Not just a logistical challenge, trade also poses a financial problem, namely how to finance inventories while they are in transit, awaiting sale, or awaiting delivery of final payment by the buyer. The financial dimension to the everyday workings of international trade acquired greater significance during the depressed trading environment after the Napoleonic Wars.
The bill of exchange only partially solved the financial problem by creating a credit instrument for trade. Acceptance by a reputable firm was also essential to satisfying the needs of exporters and importers. Hardly exciting, simple routine transactions like accepting bills of exchange were the day-to-day work of banking houses in London, but also among their most significant to the development of a global economy.
More from the Tontine Coffee-House
1. Cassis, Youssef, and Philip L. Cottrell. Private Banking in Europe: Rise, Retreat, and Resurgence. Oxford University Press, 2015.
2. Chapman, Stanley D. “British Marketing Enterprise: The Changing Roles of Merchants, Manufacturers, and Financiers, 1700–1860.” Business History Review, vol. 53, no. 2, 1979, pp. 205–234.
3. Collins, Michael. “Monetary Policy and the Supply of Trade Credit, 1830-1844.” Economica, vol. 45, no. 180, Nov. 1978, pp. 379–389.
4. Ryland, Philip. “50 Objects: The Bill on London.” Investors’ Chronicle, 27 Oct. 2017.