The title of this book, From Crisis to Crisis: The Transformation of Merchant Banking, might refer to a number of crisis events that affected the British merchant banks. A neat periodisation might be provided by the Barings â crises of 1890 and 1995âa period of one hundred and five years beginning and ending with high-risk misjudgements. Alternatively, the much shorter period between the financial crises in 1914 and in 1931 might be considered or, indeed, the beginning of the First World War and the end of the Second World War . However, the focus of the research for this book has been the interwar period of the 1920s and 1930sâa period of significant economic strain and considerable social change. The story would be incomplete without considering the periods before and afterâthe prelude leading to the outbreak of war in 1914 and the endgame in the latter decades of the twentieth century.
The main aim of this work is to examine how the merchant banks responded to the radical shift in economic conditions during the interwar period. It aims to show that those merchant banks that survived into the late twentieth century began the process of transforming their businesses in the interwar period; those that failed to do so either went out of business quickly or experienced lengthy struggles and eventual decline over a number of decades. Some of the merchant banks that survived into the late twentieth century later made poor strategic choices and exhibited characteristics that had led to the demise of so many other merchant banks in the past, including adopting high-risk strategies without adequate capital backing or operating with poor financial controls. Those that learnt the lessons of the interwar period managed to survive by transforming their businesses to lower-risk, less capital-intensive advisory services. These changes did not follow a linear pattern; they either evolved gradually or usually occurred in response to crisis events, but their origins can be traced to the interwar period.
During the late nineteenth century, Britainâs merchant banks had become pre-eminent in a world of fixed exchange rates, free trade and the unfettered mobility of international capital. 1 These features of the economy were increasingly challenged in the interwar period and were eventually replaced by floating exchange rates, trade protectionism and restrictions on capital movements. During the interwar period, Britainâs role as international financial hegemon came under growing pressure from the USA, and, as a consequence, Anglo-American relations were put under strain. 2 The threat to Britainâs established role as banker to the world was echoed in other shifts of power in Britain between social groups and different sectors of its economy. Britainâs overseas investment and its imperial obligations had to be balanced against the growing demands for domestic social spending. 3 The need to rebuild Britainâs staple industries after the First World War against a backdrop of changing international demand gave rise to stresses in the balance of power between industry and finance. 4 The rise of the corporate economy also produced some fundamental changes not only in British industry, but in its financial sector. 5 The growth of the domestic joint-stock banks in particular created competitive pressures for the merchant banks. 6
Many of the merchant banks that were in business during the interwar period could trace their heritage back to the mid-nineteenth century; some even earlier. Some of these firms have long since been forgotten such as W. Ladenburg & Co. and Mildred, Goyeneche & Co. , founded in 1785 and 1796, respectively, and Samuel DobrĂ©e & Sons , which was established in about 1720âover forty years before Barings started business in London. 7 A few of the names were regarded as being at the heart of the British financial establishment, such as Rothschilds , Schroders , Hambros and Barings. Although several merchant banking firms survived the interwar periodâindeed some new ones were establishedâthe mortality rate was high. By the end of the millennium, the merchant banking sector had to all intents disappeared.
In 1931, the Committee on Finance and Industry acknowledged that the merchant banks were an important part of the British monetary system. In their role as accepting houses, together with the discount houses, they provided the function of accepting and discounting bills of exchange. These firms were described as âhighly specialisedâ and of âworld-wide standingâ. 8 Similarly, in 1959 the Committee on the Workings of the Monetary System described the accepting houses as âdomestic bankers on only a minimal scaleâ that were nevertheless âan important elementâ in Londonâs money market. 9 Generally, the financial services sector has been an important part of the UK economy since the eighteenth century. 10 As the merchant banks played a key role in this success, it is important to know what happened to this once-thriving sector. It is my contention that the answers can be found in the interwar period.
In the interwar period, the traditional business model of the British merchant banks came under severe pressure. Undertaking activities that put a firmâs capital at risk became untenable for many of the merchant banks as they simply had insufficient capital to absorb the scale of losses that they were exposed to. These activities included highly concentrated exposures in acceptance financing, the warehousing of new issues of securities and acting as principals in commodity trading. The inherent risks in such activities were exposed during the financial crises of 1914 and 1931. The poor risk management and lax financial controls of many firms combined with an inadequate regulatory regime allowed these practices to flourish. Although such risks had been exposed before, such as during the Barings crisis of 1890, it was only during the interwar period that circumstances dictated a gradual shift by the merchant banks towards advisory and agency services, which were reasonably low-risk and required only relatively modest amounts of capital. These changes continued to unfold in the second half of the twentieth century.
While the merchant banks played an important role in Britainâs financial system, their ability to cope with financial upheavals was generally poor. Many of those that survived did so as a result of support from the Bank of England (hereafter BoE ) or the larger clearing banks . This support was usually given to avoid financial contagion, which might have caused widespread damage in the economy. There was an implicit recognition of the vulnerability of the merchant banks despite being a key component in Britainâs banking system. A better understanding of the evolution of merchant banking in the interwar period should provide a vital missing piece in the story of the British banking system. It should not only give insights into broader changes in Britainâs international role and in its economy at that time, but also highlight parallels with a number of issues currently faced in the financial sector.
In the light of the significant role played by the merchant banks in Britainâs interwar economy, it is surprising that their history in this period has been under-researched. It is hoped that this book will address this gap in the historiography. However, before proceeding further an attempt will be made to define what is meant by a merchant bank.
What Is a Merchant Bank?
The meaning of the term merchant bank has changed over time; indeed, most of the firms that became known as merchant banks frequently referred to themselves as merchants or accepting houses. The confused state of affairs was well summarised by Edward Reid, a former director of Barings , in an address to the Institute of Bankers in 1963 in which he said that the term merchant ban...