July 27 (Bloomberg) -- The financial news has recently been dominated by the scandal over the London interbank offered rate (known as Libor), with allegations that leading banks have manipulated a financial benchmark determining the interest rates charged to millions of borrowers and used in derivatives contracts worth hundreds of trillions of dollars.
The U.K. Parliament has become involved, grilling the former chief executive officer of Barclays Plc, Bob Diamond, over these events. But none of this is entirely without precedent.
A new study of the foreign-exchange market in the Middle Ages, conducted by the University of Reading’s ICMA Centre, has documented a medieval system of exchange-rate manipulation similar to today’s.
That system also led to public outcry, a parliamentary investigation and the impeachment of a famous financier.
A major aim of financial innovation throughout history has been to circumvent regulations and restrictions placed on the industry. In the Middle Ages, an important obstacle was the religious disapproval of usury -- the charging of interest or “making money from money.” Dante condemned the usurer to the lowest level of the seventh circle of Hell. To avoid the “taint of usury,” medieval financiers developed various methods of disguising interest within other transactions.
The simplest method was for the borrower to recognize a debt of 15 pounds when he had borrowed only 10, the 5 pound difference being the lender’s profit. Or the borrower could pay the lender a “voluntary” gift on top of the principal. Alternatively, the lender could impose a penalty in case of “late” repayment, where the loan was deliberately intended to be repaid late.
Another medieval practice that might resonate today was “chevisance,” or in modern parlance, a repurchase arrangement. Here, a borrower would sell goods to the lender at one price with the understanding that the borrower would buy them back at a higher price. This is similar to our contemporary repo market, which underpins the shadow banking system.
Perhaps the most sophisticated method of disguising usury involved foreign-exchange transactions. The pound sterling, for example, was always valued higher in Venice than in London. These differentials (or spreads) enabled bankers to profit by moving money from one place to another and back.
To produce and maintain these spreads, however, required systematic “rigging” of exchange rates across Europe. In essence, banks and currency brokers in London always had to deduct a few pence from the rate with Venice, and their counterparts in Venice had to add a few pence.
But was this wrong? Without these exchange-rate adjustments, it would have been much more difficult to profit from foreign-exchange transactions. There would have been no incentive for medieval bankers to engage in the foreign-exchange market, which would have reduced the ability of merchants to fund their trading ventures or to transfer money internationally. Similarly, without the methods described above to disguise interest payments, there could have been no credit market. Although such techniques may have been essential for the functioning of medieval finance, and perhaps came to be viewed as normal business practice to those involved, the wider public was less understanding.
During the “Good Parliament” of 1376, public discontent over such perceived financial abuses came to a head. The Commons, represented by the speaker, Peter de la Mare, accused leading members of the royal court of abusing their position to profit from public funds.
Next page: Foreign Exchange
Copyright 2014 Bloomberg. All rights reserved. This material may not be published, broadcast, rewritten, or redistributed.