Amsterdam banking crisis of 1763

The Amsterdam banking crisis of 1763 in the Netherlands followed the end of the Seven Years' War. At this time prices of grain and other commodities were falling sharply, and the supply of credit dried up due to the decreased value of collateral goods. Many of the banks based in Amsterdam were over-leveraged and were interlinked by complex financial instruments, making them vulnerable to a sudden tightening of credit availability. The crisis was marked by the failure of one large bank - that of De Neufville - and many smaller financial enterprises. The extent of the crisis was mitigated by the provision of extra liquidity by the Bank of Amsterdam, the Dutch central bank. Similarities have been identified between these events and the financial crisis of 2007-08.[1] [2] [3]

Background

On February 10, 1763, the Treaty of Hubertusburg was signed between Prussia, Austria and Saxony. This Treaty marked the end of the Seven Years' War, a war from 1756 to 1763 that involved all of the major European powers of the period. Berlin then became an emerging market, and Amsterdam’s merchant bankers were the primary sources of credit, with the Hamburg banking houses serving as intermediaries between the two. But early 1763, because of the end of the war, the abnormal high war prices plummeted with 30%; grain lost its value rapidly in May. Two months later more than 30 banking and trade firms went bankrupt, with an estimated debt of 10 million Dutch guilders.

Some Amsterdam merchant bankers were leveraged far beyond their capacity. Financial activity in late-eighteenth century Amsterdam was controlled by a group of merchant banking firms. These “bankers” were proprietary firms that dealt in trade goods and that also provided financing to other merchants. These firms were not deposit banks in the English conventional tradition, as deposit taking was viewed as incredibly risky. Since deposits were scarce, financial intermediation was accomplished through a securitization scheme known as the acceptance loan. The building block of the acceptance loan was an instrument known as the bill of exchange — ultimately a contract to pay a fixed sum of money at a future date. Bills of exchange were originally designed as short-term contracts but gradually became heavily used for long-term borrowing. They were typically rolled over and became de facto short-term loans to finance longer-term projects, which resulted in the creation of a classic balance sheet maturity mismatch. At that time, bills of exchange could be re-sold, with each seller serving as a guarantor to the bill and, by implication, insuring the buyer of the bill against default. This practice prevented the circulation of low-credit-quality bills among market participants and created a kind of “credit wrapper”—a guarantee for the specific loan—by making all signatories jointly liable for a particular bill. In addition, low acceptance fees—the fees paid to market participants for taking on the obligation to pay the bill of exchange—implied a perceived negligible risk. However, the complexity of this system had underlying ramifications - the practice also resulted in binding market participants together through their balance sheets: one bank might have a receivable asset and a payable liability for the same bill of exchange, even when no goods were traded. By the end of the Seven Years' War in 1763, high leverage and balance sheet interconnectedness left merchant bankers highly vulnerable to any slowdown in credit availability.[4]

Merchant bankers believed that their balance sheet growth and leverage were hedged and insured through offsetting claims and liabilities. And while some of the more conservative Dutch bankers were wary in growing their wartime business, others expanded quickly. One of the fastest growing merchant banks belonged to the De Neufville brothers, who speculated in depreciating currencies and endorsed a large number of bills of exchange. Leendert Pieter de Neufville was the leading perpetrator of the proliferation of the faulty bills of exchange. Noting his success, other merchant bankers followed suit. The crisis was triggered when De Neufville entered with 100.000 guilders into a deal by Johann Ernst Gotzkowsky to buy grain stored in Kolberg, etc., worth almost 1,2 million guilders, from the Russian army, c.q. Vasily Dolgorukov-Krymsky, as he left Poland.[5] Frederick the Great ordered the grain traders to sell it on the Prussian market,[6] but in May 1763 grain prices collapsed by more than 75 percent.[7] The dealers that had not followed his advise, made heavy losses.

The Dutch financing structure, of issuing securitized debt before the original borrowers were paid, came to a halt in late July 1763 when the De Neufville bank house failed in conjunction with failed payments to a minor firm called Aron Joseph & Compagnie. Their failure caused the failure of all their creditors around Amsterdam as well, as well as failure in Hamburg, Bremen, Frankfurt, Stockholm and Berlin.

The failure of a firm of De Neufville’s size – almost half as large as the Bank of Amsterdam itself – shocked the markets. The immediate victims were a group of firms known as “cashiers.” The cashiers were about 30-40 financial intermediaries whose activities formed a bridge between the large banks and merchants. Traditionally, the cashiers had served as brokers in the market for bank funds. By the last half of the eighteenth century, their activities had expanded to include settlement of bills denominated in current guilders, deposit taking, and even the issue of cashier’s receipts that circulated locally as bank notes. The cashiers were run hard during the first days of the crisis, as panicked holders of cashier’s receipts demanded coin from the issuers. The contraction of the bill market put the Amsterdam merchant bankers under heavy pressure, as their ability to roll over funding was several constricted.

References

  1. ↑ Narron, James, and David Skeie. "Crisis Chronicles: The Commercial Credit Crisis of 1763 and Today’s Tri-Party Repo Market."
  2. ↑ Lessons from the Seven Years War by Isabel Schnabel and Hyun Song Shin
  3. ↑ Quinn, Stephen, and Williams Roberds. "Responding to a Shadow Banking Crisis: The Lessons of 1763."
  4. ↑ Narron, James, and David Skeie. "Crisis Chronicles: The Commercial Credit Crisis of 1763 and Today’s Tri-Party Repo Market."
  5. ↑ Johann Ernst Gotzkowsky. Kunstagent und Gemäldesammler im friderizianischen Berlin by Nina Simone Schepkowski, p. 341.
  6. ↑ Studies in the Economic Policy of Frederick the Great by W.O. Henderson
  7. ↑ Lessons from the Seven Years War by Isabel Schnabel and Hyun Song Shin

Sources

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