Temin P. and Voth H.-J. (2008) A case for deregulation… in 18th-century Britain

Temin, Peter and Voth, Hans-Joachim (2008) “Private borrowing during the financial revolution: Hoare’s Bank and its customers, 1702-24”, Economic History Review, 61/3, 541-564.

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Introduction

The Financial Revolution is said to have allowed the British government to borrow widely and cheaply. Famously, North and Weingast added that it also had a profound and beneficial effect on private businesses (p.541). To assess the latter claim, the authors use data collected from the archives of a small London goldsmith bank, Hoare’s (p.542). It is likely that their sample is fairly representative since there were only a dozen such establishments around 1700s. The key event of the period is the lowering of the legal maximum interest rate from 6 to 5% in 1714 by the heavily indebted British government at the end of the War of Spanish Succession (p.543).

Policy overview

Hoare’s seems to have seldom offered loans beyond the legal interest rates (p.544). The bank deliberately concentrated its lending on a small number of customers, the most important clients secured the bulk of the capital borrowed (Gini coefficient = 0.73). All these important customers borrowed without collaterals (p.547). The high-profile gentry was not the only group to have access to these loans, over half the important customers were members of the economic elite but did not enjoy an elevated social status (p.548). The peers enjoyed the largest loans but usually against collaterals. The clientele was at 90% male.

The only advantage repeat customers could apparently count on was a reduced need for collateral. However, as regular clients borrowed often, they ended loaning significantly higher amounts than the average customers (p.549). Customers with multiple loans, new customers and to a lesser extent the aristocracy borrowed for longer periods. New customers also enjoyed more frequently a zero per cent interest. “Interest rates fell sharply after the lowering of the usury limit in 1714” (p.551). So the English financial system seems to have been particularly open but also displays a reluctance to lend for commercial purposes, most loans were meant to cover consumption expenses.

The effects of lower interest rates

As finance is essentially a fixed-cost industry (assessing collaterals, getting to know a client, learning about his trustworthiness), diminishing the interest rates, inter paribus, forces the bank to increase the minimum size of the individual loans (p.553). So “while those from noble background and with considerable wealth maintained easy access to credit, smaller borrowers were cut off.” After 1714, the typical loan amount increased markedly and smaller loans nearly disappeared.

From 1695 to 1714, the share of the 20 top borrowers had declined from 90% to less than 40. In the decade following 1714, it climbed back to 70-80%. Those of an elevated social status received roughly double the average amount borrowed before 1714, but nearly three times that amount after. Average maturity declined as well, borrowers had to repay their loans faster, but much less so for the more privileged groups. “Investment in England’s nascent industries would have required much longer commitments than two or three years” (p.557).

Holding back on modernity

“The move from collateralized lending to unsecured intermediation is a key step in the evolution of a financial system.” Unsecure loans allow real intermediation, i.e. giving access to capital to those who do not yet own it. As expected, the proportion of unsecured loans increased over time (25% of value in 1690-9 to 90% in 1710-4). But it collapsed after the usury limit was lowered (32% in 1715-24; p.558). So the reform “led to a ‘roll-back’ of earlier accomplishments”.

While the soundness of government’s credit may have helped to create a trustful environment, the development of public finance had no observable direct impact on the liquidity of capital. Forty percents of the collateralized loans were backed by securities in 1711-24 (from 16% in 1700-10), but almost all these securities were shares, there nearly no government-issued annuities. Admittedly most of these shares were from public companies (East India, South Sea, BoE; p.559), but one of the most commonly referred to effects of the financial revolution – ability to raise funds against securities thus keeping interest rates low – was already in place before the government started to float its own debt. At best it enhanced liquidity.

Conclusion

Like in developing countries nowadays, the Hoare’s Bank’s main objective was to keep default very low, but – unlike current Indian or African financial establishments – as they couldn’t charge high interests, they had to screen clients carefully before accepting a loan and monitor them carefully afterward (p.560). “While the state was the main beneficiary of the usury laws, the merchants and aristocrats to whom Hoare’s lent in peacetime also benefited from low interest rates. However, the hidden macroeconomic costs of such a system were possibly high” (p.561).

For more: please have a look at the bank’s history page.

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