Foreign exchange market and financial engineering in the Middle Ages

"Greed". Manuscript thumbnail. Genoa, approx. 1330, British Library

As you know, in the Middle Ages, the Roman Catholic Church did not really favor usurers. As punishment for the sin of usury, one could get out excommunication, which guaranteed to go to hell after death. According to Dante, on the seventh circle of the hell of usurers (as well as blasphemers and sodomites), deserted combustible sand and fire rain awaited. It is worth noting that if today we usually call usury the collection of unjustifiably high, predatory, interest, then in the Middle Ages the Church considered it a sin and punished for demanding any amount over the body of debt, even the most insignificant. In addition, not only the moneylender himself became a sinner, but also his debtor, who agreed to pay interest.

Is it necessary to say that medieval bankers showed remarkable resourcefulness in order to lend to customers in such an unfavorable investment climate? By the fourteenth century, collective thought came up with several tricks at once to circumvent a religious ban.

First, the Church did not forbid gifts. The client had every right from the bottom of his heart to thank the banker for the service provided, paying a little more than the body of the loan. Of course, the client and the banker in no case should have agreed ahead of time on the exact size of the gift. It is curious that bankers could give gifts to investors. It is known that time deposits in Florence banks brought interest a discrezione , that is, at the discretion of the banker, as a gesture of goodwill. Of course, a banker who didn’t pay generously enough “voluntary” interest, sooner or later lost to competitors.

Secondly, the Church allowed fines and damages. If the client did not have time to repay the debt on time, then he had to pay a fine, since the banker could miss the opportunity to invest money profitably during the delay. It remains only to indicate in the contract and in the bank ledger one repayment date, earlier, and in words to agree on another, later. Penalties accumulated during an imaginary delay will become a disguised interest rate. Amazingly, we hear echoes of this scheme almost every day: the English word interest comes from the medieval Latin interesse (reparation).

Thirdly, the banker could hide the true size of the debt. In the ledger, he wrote down the amount equal to the future payment, but in reality he gave the client a little less. Such “creative” account management is dangerous because it requires fraud not only in the banker's records, but also in the bookkeeping of a client who may not have a balance. Nevertheless, researchers found traces of fraud even in the documents of the English royal treasury (the Exchequer): in the XIII-XIV centuries, the English monarchs, starting with Edward I, often used the services of Italian banks.

Finally, fourthly, bankers learned to use the foreign exchange market to create synthetic loans, just like real-life financial engineers with PhD and MBA. We will consider this method below.

Medieval currency market

The main instrument of currency traders of the XIV century was a bill or, more simply, a bill of exchange. According to the receipt, it was possible to get the currency in one city, and to pay with the second currency in another city after a fixed period. The payout period in the second city usually depended on the distance. For example, for transactions between Florence and Venice, the standard term was 10 days, and for transactions between Venice and London - three months.

Consider an example. If a certain merchant was going to buy goods in Venice and sell them in London, then he could come to a Venetian bank and ask for 100 Venetian ducats. In return, the merchant gave the banker a receipt, according to which he could receive in a London bank 20 pounds in 3 months. The merchant was also called the seller of the receipt, and the banker was the buyer, because on the day of the transaction, the banker “bought” the receipt from the merchant for real money. In modern terms, the banker bought the GBPDUC currency pair at the rate of 5 ducats today for 1 pound in three months. However, unlike modern currency transactions, the exchange was stretched over time. All three months, the banker had to wait patiently and hope that the seller would safely get to London and fulfill his obligations.

If everything went well, then three months was enough for the merchant to purchase goods in Venice for ducats, arrive with them in London, sell them for pounds and pay the required 20 pounds to a local bank. Meanwhile, the banker was sending the receipt to his London colleague. Having received a receipt and money, the London banker transferred pounds from the merchant's account to the account of the Venetian banker, and everyone was satisfied. The church did not object to such a transaction, following the principle of cambium non est mutuum (exchange is not a duty).

XIV century financial engineering

What if the merchant could not collect 20 pounds by the agreed date or did not appear at all in London? The Bank of London had the right to “protest” the receipt, that is, to force a reverse transaction between the Venetian banker and the merchant on their behalf. In this new transaction, the merchant received the missing 20 pounds, and paid a receipt for ducats another 3 months later. For example, if at the time of the conclusion of the reverse transaction (three months after the transaction in Venice), the market rate in London was 5.3 ducats per 1 pound, then the merchant was obliged to pay 106 ducats to the Venetian banker another three months later. In other words, the London bank did not risk anything and offered the Venetian banker to independently deal with his unlucky client.

dateDirect dealReverse transaction
0 month+100 ducats
3 months–20 pounds+20 pounds
6 months–106 ducats
Payments by the merchant as a result of direct and reverse transactions

It sounds complicated, but it is important for us to trace the total effect of direct and reverse transactions. What’s called, watch your hands. The merchant received 100 ducats in a bank in Venice, and six months later he paid 106 ducats in Venice to the same bank. Payments in pounds as it did, they collapsed to zero. Moreover, it was not necessary at all to buy goods and drag oneself to distant lands in dank London, because an English bank could start the process of protesting a receipt on its own. It is much more pleasant to stay in sunny Italy and to spend 100 ducats on the development of business in Venice. What is this if not a loan at 12% per annum? Thus, two currency transactions permitted by the Church with a flick of the hand turned into a forbidden loan.

Strictly speaking, a double currency transaction is not a fixed rate loan. The percentage that the banker earns depends on the rate at which he will be able to conclude a second deal in London. If during these three months the medieval Brexit happens and the pound drops to 4 ducats, then the banker will not only not earn, but also lose 20 ducats. The uncertainty of future profits, by the way, was an important argument in the dispute over the sinfulness of double currency transactions. What usury, dear Church, if the client could potentially return less than he lent ?!

Of course, the banker had to lay currency risk in the very first transaction. Even then, people understood that money now and money in three months is not the same thing. For example, if the market rate of the pound to ducat when exchanging coin for coin was 5.15 ducat per pound, then in Venice, bankers bought receipts for future pounds at 5.0 (a little cheaper), and in London they sold pounds for future ducats at 5, 3 (slightly more expensive). It is very similar to modern exchangers with their wide spread between buy and sell rates, isn't it?

To remain competitive in the foreign exchange market, everyone - both bankers and merchants - needed up-to-date information on exchange rates in all major cities. It was considered good form at the end of each business letter to add the latest quotes of the local currency market. Letters, preserved from those times, allowed scientists to compile quite long time series of exchange rates in the main financial centers of Europe, as well as evaluate the profitability of loans created from foreign exchange transactions.

It turned out that the difference between the purchase and sale rates allowed bankers to earn 10-16% per annum, no matter which two cities participated in the transaction - that Florence and Venice (on average 10.9% per annum, 30 days for two transactions), that Genoa and London (average 14.5% per annum, 180 days for two transactions). Of course, there were losses, but at a long distance the strategy worked. For comparison, in the same period, land rent in Italy brought 8-10% per annum, and Florentine deposits a discrezione - from 6% to 10%. There is evidence that the Medici bank requested 10-12% per annum for loans fully secured by collateral. Therefore, the aforementioned 10-16% per annum seems quite reasonable rate for an unsecured loan, which also carries currency risk.

We do not know for sure how much of the foreign exchange transactions were used to create loans. Not all receipts went through a protest procedure, moreover, usually records in bank books do not answer the question why the seller could not fulfill his obligations. Maybe he lost a load in a storm, or maybe it was part of an oral agreement with a banker. On the other hand, evidence was preserved of completely artificial transactions, when the banker did not even bother sending receipts to another city, but simply entered a direct and reverse transaction into his books at the courses he had invented. Most likely, in most cases, merchants used the foreign exchange market for its intended purpose, for international trade, and only occasionally in order to take a loan.


I find it difficult to formulate a personal attitude to everything that I told you about. On the one hand, ingenuity is a great quality. Particular admiration is caused by the fact that these gentlemen made deals when not fines and years in prison were at stake, but immortal souls and eternal torment of hell. On the other hand, I plunge into sad thoughts about the nature of man. It turns out that the possibility of abuse is an inevitable flip side of financial innovation and economic growth.


1. Bell, Adrian R., Chris Brooks, and Tony K. Moore. “Cambium non est mutuum: exchange and interest rates in medieval Europe.” The Economic History Review 70.2 (2017): 373–396
2. Bell, Adrian R., Chris Brooks, and Tony K. Moore. “Interest in medieval accounts: examples from England, 1272–1340.” History 94.316 (2009): 411–433
3. Goldthwaite, Richard A. “Local banking in renaissance Florence.” Journal of European Economic History 14.1 (1985): 5–55
4. Alighieri, Dante. La Comedia di Dante Alleghieri . Johann Numeister and Evangelista Angelini da Trevi, 1472


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