UK: LENDING IS A LONG-TERM BUSINESS.

UK: LENDING IS A LONG-TERM BUSINESS. - 'Neither a borrower, nor a lender be' is a view ignored both before and since Shakespeare's time. Rhymer Rigby discovers that lending at a premium is as old as civilisation itself.

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Last Updated: 31 Aug 2010

'Neither a borrower, nor a lender be' is a view ignored both before and since Shakespeare's time. Rhymer Rigby discovers that lending at a premium is as old as civilisation itself.

An ancient Sumerian, depending on his creditworthiness, could expect to pay annual interest of around 20% on a loan of silver. Over 4,000 years later the medium of exchange may have changed but the principle is the same: the practice of lending at a premium is as old as civilisation itself - older, even, than any formal currency.

Around 1900 BC one of the earliest legal systems, the Code of Hammurabi, recognised the 'customary' rates of the day and enshrined them as legal maxima. These limits - 33.3% for grain and 20% for silver - endured for well over 1,000 years. Records of this type were widely if not systematically kept until the 5th century AD when the Roman empire fell and Europe's economy promptly collapsed. As the little commercial activity that did take place over the next 500 years was tightly bound to the church and feudal system, economic data for this period is almost non-existent.

Recovery's 'green shoots' first appeared in 10th century Venice, which, due to its trading ties with the East, suffered less than most during the Dark Ages. Economic revival - and with it money-lending - came to England some 200 years later when the Norman Conquest served to strengthen links with the Continent. Interest on loans was then typically calculated at the rate of two pence in the pound per week; an annualised 40-50%. Although this figure may appear high it reflected the risk taken by the lender and the short repayment period, which was usually measured in weeks, not years. English deposit rates do not exist for this period: 'formal' banking was a long way off and money was usually stockpiled or held in precious metals.

By the 13th century, a legal limit of 43.3% had been set for English pawnbrokers. The Italians and the Dutch, with their better developed banking systems, charged a relatively low 10%. At the other end of the scale, maximum rates in Provence and Germany stood at 300% and 173% respectively. Although only borrowing rates are recorded for this country, short-term deposits in Florentine banks typically attracted between 10% and 20%.

Two major setbacks made for a dearth of English data in the 14th century: the Black Death decimated the populace, particularly in the major financial centres, while the cost of the Hundred Years' War caused both the English and French crowns to default on loans, sinking several major banks in the process. Contemporary records from Italy, the then centre of European finance, show rates of between 5% and 12% on deposits and from 5% to 15% on loans.

Rates in 15th century London ranged from 10% upwards: deposits were usually made with 'special partnerships' who would then lend to the Crown at a higher rate. By the 16th century the English financial system had evolved with the emergence of a deposit-based banking system under the control of London's goldsmiths. Loans, such as those from goldsmiths to the Crown, carried an annual charge of 10-14%, as did mortgages on London property. Deposits with the goldsmiths attracted interest of between 4 and 6%. Legal maximum interest rates intended to combat usury - the practice of lending at exorbitant rates - were only introduced in the latter half of this century. These limits applied to all but Crown loans and ranged from 6-10%. Enforcement, however, was lax and loans carrying over 100% interest were far from unusual.

Sir Thomas Culpeper's Treatise Against The High Rate Of Usurie, published in 1623, is typical of the criticism then directed at moneylenders. Stealing a four-century march on modern critics of short-termism, Culpeper commented that English merchants, having made their fortunes, would sell up and move into usury. Here, he observed, the gains were 'easie, certain, and greate'. In contrast he cited the example of their Continental counterparts, whose mercantile dynasties passed 'from generation to generation to the enriching of themselves and the state'.

William of Orange's 1688 ascension to the throne ushered in an era of political stability in which commerce was able to thrive. The goldsmiths' banking system had been damaged by the Stuart kings' poor management to such an extent that a national bank was needed to stabilise the nation's finances. This took the form of a £1.2 million loan to the government, the providers of which were incorporated as The Governor and Company of the Bank of England. The graph on the previous page starts from 1694, when the Bank opened for business, and shows both nominal interest rates and the rate of inflation, the difference between the two representing the real rate of interest - the amount by which a deposit's actual value increases.

Perhaps the most striking feature of the graph is the near uniformity of the Bank of England's discount rate from its foundation until the early 19th century. Rather than being indicative of financial stability - as the line representing inflation shows, this was hardly the case - it was due to the fact that, along with every other lender, the Bank came under the remit of the usury laws. Indeed, it was not until 1833 that the Bank's short-term bills were freed from their control.

By the 1850s, interest rates were being used as a means of economic control in much the same way as they are today. The relative stability that this, together with Britain's robust economy, afforded is clearly visible on the graph: it lasted until the first world war, when massive inflation threw real interest rates sharply into deficit. The subsequent deflation of the 1920s and 1930s caused a corresponding period of high positive interest rates - good news for savers but disastrous for borrowers and business alike.

Reverting to the policies of a century earlier, the Bank set a flat base rate for nearly two decades, while the period from the 1950s until the early 1970s was one of low positive real interest rates - conditions conducive to economic growth. All this changed with the oil crisis and the corresponding economic upheaval of the early 1970s. Inflation soared above 20% and for much of the decade real inflation outstripped interest rates - often by a considerable margin.

By the 1980s inflation had fallen sufficiently to allow the return of positive real interest rates. Both interest and inflation were then running at historically high levels and would continue to do so for the rest of the decade, buoyed up by the economic boom, a runaway housing market and the periodic need to defend the pound on the foreign exchanges. When recession struck, both rates plummeted. The Bank base rate fell to 5.25%, its lowest for 16 years. Inflation fell similarly, touching zero, albeit briefly. Although both have now crept up - largely as a result of recovery - the economic outlook is still one of low interest and low inflation.

Will it stay that way? From the 1850s onwards - and eliminating the influence of two world wars, the oil crisis, and the 1980s boom, all of which seem unlikely to recur in the next few years - low real rates have been the normal state of affairs. The answer, then, would seem to be yes.

RATES OF HISTORICAL INTEREST IN THE UK

Rate % Comments

12th century 43-120 First records of money lending. Rates depend

on security

1546 10 Legislated as the maximum chargeable rate

1624 8 Legal rate

1660-1690 4-6 Rate paid on deposits by the London goldsmiths

1746-1822 5 BOE's discount rate fixed at the usury limit of 5%

1866 10 Failure of London's largest discount house

1900 3.9 Bank rate (average)

1914 4 First world war: real rates are sharply negative

1920 6.7 Deflation results in very high real rates

1933-1950 2 Bank rate fixed (except 1939 when it averaged 2.2%)

1960 5.3 Bank rate (average)

1973 9 Minimum lending rate. Oil crisis

1980 16 Minimum lending rate

1985 12.5 Bank rate

1990 14 Bank rate

1995 6.75 Bank rate relatively stable and low for third year.

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