THE RÔLE OF THE MERCHANT BANKER

THE RÔLE OF THE MERCHANT BANKERAuthor(s): GERALD THOMPSONSource: Journal of the Royal Society of Arts, Vol. 114, No. 5121 (AUGUST 1966), pp. 736-749Published by: Royal Society for the Encouragement of Arts, Manufactures and CommerceStable URL: http://www.jstor.org/stable/41371599 .

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THE RÔLE OF THE MERCHANT

BANKER

A paper by GERALD THOMPSON

of Kleinwort , Benson Ltd., read to the Society on

Wednesday lbth March 1966, with G. E. Liar de t, Chairman and Managing Director , Simms Motor and

Electronics Corporation Ltd., in the Chair

the chairman : I can think of few people better able to deal with this subject of 'The Rôle of the Merchant Banker' than Mr. Gerald Thompson. His family has been connected with banking for several generations. His great-grandfather, for example, was the Thompson part of Smith and Thompson, who were bankers in Hull as long ago as 1774. Mr. Thompson himself was educated at Repton, read classics at Cambridge and then for a short period attended the London School of Economics. He joined Kleinwort and Sons in 1933. During the war he served as a Wing-Commander in the R.A.F., mainly in the Middle East. Now, as you know, he is a Director of Klein wort, Benson Ltd. He is Chairman of the firm's banking committee, and in that capacity he is very much concerned with international banking activities and some quite major overseas contracts, such as the Algerian Pipeline. Those of you who are television viewers may recognize him from his recent appearance on television - but he tells me he is not a viewer himself, he doesn't even have a television set because he spends all his time working !

I think in the last two decades or so we have seen quite a definite increase in the scope and the activities of the merchant bank. We have also seen some unveiling of those activities which previously were somewhat shrouded in mystery. The merchant bankers were quick to note the pressing need of industry for advice and guidance as to how to approach the investing public, and as to the merits or otherwise, and the timing and form, of calls for new capital; they also, of course, advise industry on international trade. The reason for the great increase in the business of merchant bankers in relation to the progress of clearing banks is something I am sure Mr. Thompson will tell us, and much else besides.

The following paper was then read.

THE PAPER

It is, I understand, the practice of your Society to descend occasionally from more elevated realms of discourse and turn its attention to the phenomena of the market place. By an unexpected chain of causality, the details of which I shall spare you, it has fallen to me to be your guide on this particular visit and I should like first of all to express the sense of privilege which is mine in speaking to you in this beautiful and historic room.

THE ORIGINS

The real essence of the merchant banker's rôle is difficult to capture, and a definition valid for all time can be ruled out. At present the name is applied to

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AUGUST 1966 THE RÔLE OF THE MERCHANT BANKER

many companies who have no more to do with merchanting than a duke with leading armies or a marquess with guarding frontiers. Even the big houses - and it is with the big comprehensive merchant banks represented on the Accepting Houses Committee that I am chiefly concerned - even these big houses, who were merchants at their origin, are now principally engaged in financial activities. Some of them have connections with commodity trading, but I do not think I should cause offence if Г described them as 'vestigial'. Yet the work which they now do has evolved from merchanting and, in tracing this evolution, a common thread is evident, uniting the past with the present and auguring well for a lively continuation in the future. Unfortunately, to pick up the origin of this thread, one scarcely knows where to begin. If one traces it through to all the multifarious activities of merchant banks to-day, one will not know where to end. One must compromise as best one can.

I propose, therefore, to leave aside any biblical evidence of merchant banking activity and just alight for a moment in seventeenth-century France, where, on the evidence of an old engraving, the actual term marchand banquier was already known. There he sits at his table, surrounded by his documents and coin, his business described by precisely that term.

It is a natural connection because, in any period, merchanting leads to banking. You may remember the character in Evelyn Waugh's novel advising the young man going up to Oxford: 'Go to a London tailor. You get better cut and longer credit/ What was true of the merchant tailors of the 1920s is true of merchants at all times, be they commodity traders of the eighteenth century or the motor traders of our own day. Credit and finance play an ever more important part in their activities.

Between credit and finance a distinction must be carefully drawn, because it was credit and not finance which drew the merchants into the banking business. In everyday speech, and often, I think, in academic economics, the terms are confused and sometimes made to do duty for each other. They are not strictly academic concepts, and in the index to Keynes' General Theory you will not find either of them, except indirectly. But in the general practice of merchant banking the distinction between them is significant.

Let me explain. In a monetary economy everything produced has to be paid for, whether it is sold or not. Not everything is sold: some find no buyers; others, like the Forth Bridge, are produced to order. But, sold or not sold, they have to be paid for. From the first days on the drawing board to the last moment of obsolescence their cost will be borne by someone: someone, in other words, will be financing them. It may be the owner who has paid for them, or someone from whom he has borrowed the money, or an institution using the money of third parties. The burden of finance may be shared or transferred, but, however borne, it will continue as long as the goods retain any economic value - that is to say, until they are finally consumed or become totally useless and are written off.

That is finance - the provision of money. Credit is something quite different. Basically it is the feeling of trust and confidence born of knowledge which inclines one to lend money. Evidently finance is never provided without credit, but credit is often provided without finance, as when someone guarantees the obligation of a

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JOURNAL OF THE ROYAL SOCIETY OF ARTS AUGUST 1 966 third party or undertakes to make payments on his behalf at a future date, thereby enabling him to obtain finance from other sources.

This distinction between credit and finance has an important bearing on the development of merchant banking. The keynote is credit. A merchant gets to know people well - both those from whom he buys and those to whom he sells. He is not like a retailer who deals for cash with a largely anonymous public. He knows those to whom he sells. He gets to know how they pay. And those from whom he buys know him, and, as like as not, they get together and pool their knowledge. All his activities are rooted in credit. Apart from the question of payment, his dealings with his suppliers and his customers depend on trust and confidence as to quality, availability, etc. And, perhaps because of this, his dealings are very rarely against cash. He takes delivery of goods and makes delivery of goods. Payment follows later and, when it is made, the burden of finance is transferred. Until it is made, the merchant is either receiving finance from his suppliers or giving it to his customers. Most of the time he is doing both. At this stage of merchanting, credit and finance are intertwined.

The next stage, where credit and finance part company, follows closely. One can see that, however certain the merchant may be of receiving payment or of making payment for goods delivered, he has to know exactly when and exactly where the payment is to be made. The Bill of Exchange met this requirement by expressing the payment arrangements in the simplest possible terms. The seller wrote to the buyer Tay me so much money on such a date in respect of such and such goods', and the buyer either made the payment against the discharged bill, or, if the payment was in the future, confirmed his readiness to do so by accepting the bill.

It is easy to see how the merchant got drawn into the banking business. The bill of exchange constitutes the most lucid and comprehensive financial instrument that man has ever devised. It expresses the nature and amount of the transaction which is to be financed and identifies the parties concerned, and the agreed period of credit. Nothing could make it simpler for the burden of finance to be assumed by a third party. The sale of a bill to a third party enables the seller of the goods to receive cash, leaving the buyer with the full period of the credit allowed to him. The financial burden is lifted from the merchants and can be carried by the spare cash of others who have no part in the original transaction.

The point I wish to stress is that in the evolution of this banking business the merchants provided credit not finance. The finance came from the discounters, and in the nineteenth century it was to the London Discount market that the spare cash of the English countryside and of the world in general came to find employment. The employment it found was in financing the bills of exchange of the London merchants accepted by the most powerful amongst them. It was the credit of these merchant bankers, the certainty that they would meet their engage- ments, which was their specific contribution to the monetary system.

It was natural of course that the most powerful and well known merchants should have taken to accepting bills on behalf of their less well known competitors. The development of commerce had multiplied the merchants in all parts of the world. Not all of them could enjoy international credit; that is to say, be equally well known

738




and trusted in London, Melbourne or Havana. Most found it convenient to draw their bills on the great houses, obtaining from them letters of credit which enabled them, when shipping, to sell their bills for cash to the exchange banks, who mailed them to London and discounted them after acceptance by the drawees. Gradually those London merchants who achieved international status - and London in the nineteenth century was a good place to do so - found that they had a more important task to perform as guarantors of credit than as dealers in commodities. But, let me repeat, it was credit not finance which they provided. On the strength of the merchant bankers' letters of credit the exchange banks financed the goods during the long weeks of their voyage, and when the bills reached London the discount market took over the finance on the strength again of the merchant bankers' acceptances, and the loose cash of the banking system was set to work.

I must resist the temptation to dwell too long on the splendours of the financial system which grew up in this way when the spare cash of the world, drawn in such quantities to London, served to finance the flow of international trade. The bills of exchange which evidenced that trade were drawn in all countries of the world, but, for the most part, payable here in London under the guarantee of the great merchant bankers. Their expert knowledge of credit extended to all countries, and it was this that enabled the liquid cash of the world to find safe employment in the most liquid of all investments, the finance of the basic elements of wealth. The particular virtue of the system, as it seems to me, was that under it the true assets of the London money market were in the main commodities in the early stages of production, so that the pressure exerted on the system by Bank rate variations influenced the economic machine at the point of input, rather than, as to-day, at the point of the finished article. The proof is that the system was so economical of reserves. Thirty million pounds or so was sufficient, and the bulk of the world's gold was free, as it should be, to gleam on the shoulders of women or jingle in the pockets of men instead of being locked away unseen in the dark unfathomed vaults of the Central Banks. But I must not dwell too long on the virtues of this Golden Age, for 1914 was at hand, when the Angel with the Flaming Sword once more reported for duty at the Gates.

THE FIRST WORLD WAR

The First World War marked a turning point in the history of the London merchant banks. Until that time London had been unquestionably the centre of the commercial and financial world. In comparison with Great Britain, America was just another under- developed country, happy to obtain finance in London for many of its great enterprises. It was only in 1893 that our Legation in Washington was raised to the dignity of an Embassy. The 191 1 edition of the Encyclopedia Britannica described London unhesitatingly as the Greatest City of the world', and no doubt had in mind much more than its population or territorial extent; certainly its financial predominance, for the bill on London was the international currency of the world, and when in those days a predecessor of mine embarked

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JOURNAL OF THE ROYAL SOCIETY OF ARTS AUGUST 1 966 towards the end of his career on a voyage round the world, the only provision he had to make for his expenses was to slip into his pocket a Kleinwort cheque book - at least as valuable as a modern passport.

But by 1918 these days were over. It was not immediately apparent. The bill on London continued to finance most seaborne cargoes, but there had been two developments of great importance for the merchant banks. One was the big domestic bank amalgamations which followed the war and brought into existence the nation- wide clearing banks which we know to-day. These new institutions no longer limited themselves to domestic business, and the proud notice 'Foreign business transacted', which to-day may seem somewhat superfluous, began to appear in branch bank windows. Foreign business was no longer the preserve of the merchant banks.

Nor was the London discount market. The Treasury bill had begun to play an increasing part in financial affairs. Introduced in 1877, the Treasury bill had originally performed a useful purpose in ironing out discrepancies arising from the irregular inflow of Government revenue. But in the 1914-18 war it had become established as a regular instrument of Government finance, which by the 1920s, already absorbed nearly half of the short-term funds in the London discount market. The process was taken further in the Second World War, by the end of which Treasury bills and Government bonds constituted virtually all the current assets of the Discount houses. They still account for about two-thirds of those assets.

Now it is clear that a money market which is subordinated to the domestic requirements of the State in whose territory it is situated cannot properly serve the needs of an international business community or be controlled by exerting or relaxing pressure on that community. As a result, the mechanisms evolved in the nineteenth century, depending on the credit expertise of the merchant banks, lost much of their relevance, and the chaos of 1929-31 may be taken as marking the end of the old system. As international trade shrank to a minimum it was hoped that the techniques of the merchant bankers might be used to revive British industry, and in the depression of the thirties some influence was brought to bear on them to transfer their attention to the domestic economy. The low discount rates of the time in fact enabled merchant bankers to offer short-term finance on advantageous terms, but it was not the cost of the money which hamstrung the economy in those years: it was the paralysis of initiative caused by the debacle of 1931 and the forebodings which were to find their grim confirmation in 1939. By that time the rôle of the London merchant banks was indeed hard to discern and, if I remember aright, the London Economist was confidently predicting their disappearance.

But the seed of their renaissance was there, and can be found, I think, in that one word 'credit' - that intuitive conviction that someone or some body of men will repay money lent; the awareness that an enterprise is sound and those who run it able and willing to account for the finance which it requires. It was this which had enabled the merchant bankers to act as the pivot of the nineteenth century system ; this trustworthiness which they can claim to have exemplified themselves and the presence or absence of which in others they had an uncanny knack of discerning. It was to prove an invaluable and continuing asset after the Second World War.

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THE POST-WAR WORLD

With the recovery of the war-stricken countries and the renewal of contacts between them, the merchant bankers gradually resumed their traditional activities -

acceptance credits, foreign exchange, company finance - but the economic revolution which was taking place produced new requirements. It is easy to overlook this revolution. We take it for granted. When I was at school it took three weeks for a letter to reach me from my parents in India. Even in 1939 the international air mail was still in its infancy and duplicate copies of all correspondence were normally sent by surface. Machine book-keeping was only just establishing itself by 1930, and the words 'electronics' and 'automation' were unknown. The impact on business of these new techniques was revolutionary. Both their existence and their cost led inexorably to larger business organizations. They alone could permit a larger organization to operate and only a large organization could absorb the overhead cost which they involve.

This revolution opened up three important fields of activity for the merchant banks, in all of which their basic discipline of credit and their wide network of financial relationships enabled them to play a pre-eminent rôle.

Let us start first with the creation of the new business units - the activity which perhaps attracts the most publicity. This can take various forms. The merger of units of comparable size, the absorption of small units by larger ones, or the simple expansion of existing concerns by the raising of more capital. Such operations are not undertaken from motives of simple aggrandisement or the pursuit of growth for growth's sake. They are, on the contrary, essential developments if the benefits of modern technological progress are to be exploited. Occasionally mergers and takeovers involve trials of strength and dramatic tussles to determine the proper basis of the new development and the proper satisfaction of all legitimate interests. But what they achieve is of lasting economic value, and this achievement is in great measure the work of the merchant bankers. What has qualified them for undertaking it is, I believe, the knowledge of credit which they have amassed through the generations, the ability to discern the true worth and potentialities of any business undertaking, the contribution made to it by the various interests involved and their just recompense when new combinations have to be formed.

But the emergence of these larger units creates new problems in other fields and particularly that of investment. In the early stages of industrial and commercial development the progress of companies depended on the general circumstances of a trade and the character and abilities of those in charge. All these could be well known, especially in localities where some particular trade had had reason to develop. But this is no longer the case. The personalities who direct the great international corporations and the scale and diversity of their business can be little known to the multiplicity of shareholders who invest in them. Investment has become a highly specialized task, and in this field, too, the merchant banker has been called on to play an important part as counsellor to Pension Funds, Investment Trusts, and all those undertakings through whom the long-term savings of the community are channelled into productive investment.

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JOURNAL OF THE ROYAL SOCIETY OF ARTS AUGUST 1 966

This activity was also a natural by-product of merchant bank experience. Merchant bankers had been not only, as I suggested earlier, shrewd judges of credit-worthiness. They were also, if I may say so, exemplars of the same thing. This meant having substantial resources. All business undertakings make their mistakes and have their misfortunes. They must be in a position to pay for both and, if they are bankers, must be seen to be in this position. In the past a princely display of personal wealth might suffice. To-day, when bankers publish their balance sheets, liquid assets and marketable securities are more impressive than palaces and yachts. But, like palaces and yachts, they take a good deal of looking after. So that before the day of Investment Trusts and Pension Funds, the merchant bankers perforce had acquired much knowledge of investment, and their knowledge has been eagerly sought and used in the world of giant undertakings which has grown up around us.

A third consequence of the alteration of scale which the technological revolution has thrust upon us has been a big change in the structure of international business and the nature of international trade. At the beginning of the century international trade was conducted in the main between independent entities in the importing and exporting countries, many of such entities competing fiercely at each end of the process. A port like Liverpool was a community of merchants importing and stocking a wide variety of commodities and merchandise for re-sale to the manufacturing interests in the home country or for export to a chain of customers abroad. With the growth of the great industrial units the pattern has changed. It would be a big merchant indeed who could meet from stock the cotton requirements of the mammoth industrial amalgamations, the cocoa requirements of a Rowntree or Cadbury. The independent merchant at the port has largely disappeared, and such merchanting as is done is for the most part concentrated in capital cities in the hands of powerful international trading groups. Many of the big industrial users have their own buying and shipping companies overseas. Many have a wide network of manufacturing subsidiaries established in the principal countries where their products are consumed. The great units have in fact grown out of their national confines and been forced to organize themselves on an international scale. This is one more facet of the technological revolution which has come with the jet airliner, the international telex and the international telephone. It may cause much weeping and gnashing of teeth amongst the nationally based tax gatherers, one of whom burst into violent reaction as recently as last April. But this revolution is something stronger than nationally based Socialism, and any administration with pretensions to technological enlightenment will have to come to terms with it.

The merchant bankers at least were not slow to do so. Side by side with the original international monetary system based on the bill on London, severely maimed by two European wars and the emergence of nationally based Socialism, a new system has come into being, largely developed by the merchant banks. Like the old system, it enables the spare cash of the world to play its part in financing the newly emergent pattern of the world economy. I refer to what is called, I think misleadingly, 'The Euro-dollar or Euro-currency market'. I say 'misleadingly' because there is no difference between the Euro- dollar and the American dollar.

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The Euro-dollar is simply that part of the worlďs international spare cash which is held in dollars, as most (though not all) of it is. Gradually, as the amount of dollar cash created has come to exceed the requirement of the U.S. domestic economy, more and more has found employment outside America. Some is used for the financing of international trade between non-American countries, but a great deal is transmuted by exchange transactions into other currencies and serves the domestic requirements of other economies. Many of our own municipal authorities have been indebted to this system for their finance, and so have many industrial and financial concerns, often no doubt quite unaware of the original source of their funds.

When the market started, loans were in the main for short term, but as the volume of funds grew and their permanence seemed assured, operations went beyond the normal short-term advances of the banking world. International bond issues expressed in American dollars have been floated in steadily growing amounts without any recourse to the American capital markets. Such issues, though not of course confined to the London market, have been made in most cases with the co-operation of the London merchant banks and often under their leadership.

But it is not only in foreign currency operations of this kind that the merchant banks have served the international economy. The new economic pattern of the world has had a profound effect on the export trade of a country like our own. Instead of exporting manufactured goods for immediate consumption, we are now called on to supply the world with capital goods and installations which will require many years of use to defray their initial cost. But such things have to be paid for by someone before they can pay for themselves, and in few of the countries where they are required are the necessary funds available. Now it may be possible for a merchant to finance sales of consumer goods for a period appropriate to the trade, even at the risk of becoming a merchant banker, but it is quite another thing for a contractor to finance his products for any significant period. He must be paid, and as often as not it is a merchant banker who makes the necessary arrangements. I can assure you that they are not simple, but they show the merchant banker in his natural rôle of arranging credit rather than providing finance.

One more feature of the post-war world must be mentioned - the growth of hire-purchase or consumer credit. I have left it to the last because its importance for my purpose is that of the dog that didn't bark. Merchant bankers' incursions in this field have been few and never outstandingly successful. The reason I think is simple enough and illustrates an important point. Merchant bankers are not retailers but wholesalers. Their customers are firms and institutions ; not the general public. This distinguishes their rôle from that of the clearing banks and explains why the clearing banks have taken a much bigger part in the field of hire-purchase.

THE FUTURE

What then of the future? I have tried to indicate the main activities of the modern merchant banker - company finance, banking operations (national and international), investment advice. All, as it seems to me, derive from a certain expertise

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JOURNAL OF THE ROYAL SOCIETY OF ARTS AUGUST 1 966

in credit, developed over many generations and particularly applicable to the modern world of technological revolution. Are these activities likely to continue and will they remain the particular preserve of the merchant banker?

To the first question there can be only one answer. The technological revolution is in its early years. The international nexus which it presupposes must go on growing and developing. In consequence, the services which it requires must grow as well. The capital structure of companies, national and international, will continue to require the constant transformation inseparable from growth. The goods and services which they exchange will need increasing finance, and the investment funds which they both generate and absorb will need more and more analysis and supervision. These are the precise fields in which the merchant banker exercises his main activity to-day. In the natural course of events they should expand, and the work of the merchant banker expand with them, unless the Four Horsemen of the Apocalypse should ride again.

What then of competition? Fortunately it exists in all these fields of activity. There are many issuing houses which are not merchant banks. There are stock- broking firms active in this field, and other great entities poised to enter it. Investment advice is available from many sources, here and abroad, and in the City of London alone there are 179 banks, all potential (or actual) competitors in the national and international sphere.

This is as it should be. What then gives the merchant banker his peculiar rôle? Is it some capacity for taking risk handed down from the merchant adventurers? Perhaps a little, but not as much as is supposed. The task of the banker is not to run risks but to eliminate them. The funds which he employs are not in the main his own, and whether he is raising capital, financing trade or supervising investment, the risks he can afford to take are very marginal. Even his own money must be readily available in liquid assets or marketable securities to take care of his mistakes and his misfortunes. The equity risks involved in fostering infant processes and inventions cannot be his daily bread. That is the field of the financier.

The merchant banker is primarily concerned not with finance but with credit, with that proper ordering of affairs which naturally draws the required finance from the saving community and provides it with secure and fruitful employment. That is and always has been the essence of his work, from its origins in the acceptance of bills to be discounted by others. Through the years the field has widened until to-day the distinctive feature of the great comprehensive merchant banking houses lies in the scope of their activities, the combination of services and techniques offered from within the same organization: domestic and foreign, long-term and short-term technicality and commonsense. The merchant banker is not tied to any area or to any type of business. He can take the initiative anywhere. But 'Credit' remains the essence of his work. Wherever credit and not compulsion governs the activities of men his rôle is assured.

DISCUSSION MR. L. p. THOMPSON-MCCAUSLAND (H.M. Treasury): Given the greatly increased

scope of the merchant banker in giving credit to industry, how does Mr. Thompson

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see the merchant banker's credit information developing so as to maintain what is ultimately a moral judgement by the banker of his customer's credit- worthiness?

the lecturer : We still maintain the old tradition of personal knowledge. This, I would say, is something which no mechanical system can easily replace. I know that therfc are distinguished companies affording credit information and the basic statistics necessary to judge any individual or perhaps unknown organization. This information is extremely valuable, but we continue to believe that the fortunes of all companies depend on the character of the people who run them. More and more, even in giving investment advice, we find it necessary to visit those who manage and run large companies, even if they are not banking customers of ours, so that we may form an opinion not only of those men who are running them now but those who are likely to be running them in ten years' time. So I believe we are exactly where we were a hundred years ago in that all our most important credit decisions are based on moral judgements of those who determine the activities of a company, and not only on the statistical information which goes to show how they have fared in recent years.

sir ERNEST GOODALE, C.B.E., M.c. (a Vice-President of the Society): Is the rôle of the merchant banker peculiar to Britain and Europe, or is it developing in the United States?

the lecturer : The name of merchant banker or its equivalent is used in all parts of the world, but not so much in the United States of America, which has its own terms, such as 'investment banker'. On the Continent the term Banque d'Affaires is fairly widely used. I believe that the activities of such institutions are all, so far, less widespread and comprehensive than those of the London merchant bankers, but I think there are few international trading centres where there is not some firm which does not lay claim to the name of merchant banker, with more or less justification.

mr. s. j. c. MINOPRIO: In view of the rather greater emphasis which the merchant banks have laid on domestic affairs in recent years, is there some basis for thinking that their rôle is not as well known in this country as it might be, particularly among less well developed companies, and that more local representation of these banks in various parts of the country would be advantageous?

the lecturer: There is no doubt that the image of the old merchant bankers, crystallized in the stories of the Rothschild pigeons, has been impressed deeply on the mind of this country, and in the years since the war, when the merchant banks have come to play a far more important part in the domestic field, their activities have been less widely known than we should have liked. My own house Has produced an elegant brochure with the precise purpose of enlightening the British public and others as to the fairly wide range of its own activities.

Whether the opening of provincial offices also serves that purpose is an open question. Many of the merchant banks, ourselves included, have done so. Such offices make us more accessible and they bring our customers nearer to us without, perhaps, bringing us nearer to our customers! This may sound ridiculous, but though it is easier for a customer to make a preliminary inquiry at a branch office, I think most of those in this country who have occasion to make use of the services of a merchant bank prefer to come to London. It is, of course, extremely difficult to produce enough working bankers in London as it is, without having to disperse them all over the countryside as well, so the possibility of having a really active provincial merchant banker as part of the London organization is perhaps limited.

mr. т. N. Clarke : I was interested to hear Mr. Thompson talk about the invasion of the domestic front following the Macmillan report. More recently, particularly since the war, the merchant banks have been actively seeking deposits from the

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JOURNAL OF THE ROYAL SOCIETY OF ARTS AUGUST 1 966 domestic public. Very recently, one of the big clearing banks apparently encroached on the merchant banking business by sponsoring an issue. I understand that the merchant banks, together with other issuing houses, complained about this to the Governor of the Bank of England. How does Mr. Thompson reconcile this action with his view that competition in the City is desirable?

the lecturer: There are two types of deposit; there is the spare cash of the community, the type of deposit which we all of us can have with our clearing bankers, and superimposed over that there are sums available for greater or lesser periods for which the clearing banks offer deposit account facilities at a rate sub- stantially under Bank rate. I think one must distinguish between that type of deposit and the large masses of spare cash generated by a system which has been inundated with newly created cash in the years of inflation since the war. The merchant bankers would never operate a system of current accounts because they have not the personnel or mechanism to handle them. Handling such accounts is a specialized occupation in which the great British deposit banks stand head and shoulders above those of any other country. They earn their deposits, not by paying interest on them so much as by the services which they render in connection with them. The merchant banker earns his deposits by hiring them, and he hires them in large amounts for fixed periods at fixed rates. It is not very easy for the clearing banks to obtain deposits in such ways because they conflict with their own arrangements regarding payment on the multiplicity of small term deposits arising for instance from solicitors' and estate accounts, on which they give a rate of deposit interest. We do not compete with the clearing banks in what I call retail trade ; we have concentrated on the wholesale trade.

With regard to the more contentious issue of company finance to which I referred perhaps a little glibly in my paper, I should not say that 'complain' was the right word to apply to the discussions held in the City at the time, and with, amongst others, the Governor of the Bank of England. There are various points to be made, and one only has to look abroad to see what they are. In many countries the functions of the Banque d'Affaires, the industrial banker, and those of the Banque de Depots, or the clearing banker, are not only distinguished but divided by law, because in many parts of the world people have had the experience of seeing their great national banks becoming too closely committed to a limited range of customers and their policies influenced by commitments which are not properly those of a big nation-wide clearing bank. There are positive dangers to the economic system in blurring or not defining the functions of institutions which may be approaching the public for permanent finance for a customer who is already heavily indebted to them in over- draft. It is questionable whether in these circumstances they can speak with exactly the same independence as a merchant bank.

The other point is a purely practical one. Another man's job always looks easy; no doubt the work of a merchant banker is no more difficult than anybody else's, but, like all jobs that are worth doing, it requires and deserves a lifetime of application. Those who join merchant banks may be a curious breed, but at least they are in the game from their infancy. Those who specialize in company finance (which I, not being a specialist in that field, always regard as far more difficult than anything I do), serve a very rigorous training and apprenticeship in it. It may be difficult to create such a team of expertise other than over a long period of time and in an institution of which that is one of the main preoccupations. It is not a thing to be undertaken as a parergon. It is a life's work.

MR. Claude A. ROBERTS: Mr. Thompson mentioned that there are 179 banks in the City of London. This I imagine is a good deal fewer than there were at the beginning of the century or before the last war. A good many mergers have taken place. I wonder whether Mr. Thompson envisages that this trend will continue? I

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presume that some of the mergers have taken place in order to amalgamate expertise, others in order to strengthen finance. If this process continues, competition will no doubt suffer. Very few merchant banks have started their life since the war, or during the last fifteen years, because the essence of merchant banking, as Mr. Thompson so rightly emphasized, lies in its family and international connections and expertise which cannot be gained overnight. What will happen to the merchant bankers in fifteen years time? Will there still be 179 in the City of London?

the lecturer: That figure refers to the total number of banks in the City of London, and includes, of course, a large number of foreign banks which have either branches or subsidiaries established in London. Every few months, it seems, a bank is to be welcomed from some new area of the world. I believe that Kuwait may be adding to the number shortly. As regards competition in international banking business, naturally these banks have their own spheres of influence. For instance, the presence of large and distinguished French banks in London clearly affects the amount of business which merchant banks will do with France.

But leaving aside numbers, the question of amalgamations between merchant banks is an extremely interesting one and raises the further important question of scope. At what point does an institution become too big to have a character of its own? I think it depends largely on how big a man you have got at the top, and more important still, how big a man you can maintain at the top. That is one of tlhe limitations. Another is the possibility of knowing the staff and management of an enterprise. I believe that when size becomes too big for human relationships to survive, then probably the limit has been reached. I wouldn't know at what point that limit is reached, because human relationships remain extremely active within a firm of our own size.

MR. D. R. w. potter, B.A. : To what extent and in what manner are the activities of merchant bankers susceptible to control by the Government, and to what extent does Mr. Thompson feel this is desirable?

the lecturer: Traditionally they are subject to a very accurate control, because the activities of the merchant bankers are determined by the fact that their acceptances are rediscounted without question by the Bank of England. An organization which is willing to rediscount one's acceptances without question on first presentation is clearly going to have some say in how one conducts one's business. The relationship between the merchant banker and the Bank of England is extremely close.

Apart from that relationship, there are certain norms and ratios which we apply, and which the Bank of England will apply in criticizing our figures, not only year by year but month by month. So that in times of a credit squeeze, for instance, it will obviously be known whether we are being squeezed or not ! In that respect the lines within which we operate are clearly limited. Control, I think, is therefore the right word. It means drawing the line heycmd which not , and also signifies Over- looking' our affairs. This, I think, is a good thing. If it were to develop into an attempt, not to say what we should not do, but what we should do, then I think it would approach dangerous ground. But I am glad to say that there is very little area of disagreement, if any, between the merchant banks and the authorities, and I don't think the contrary is likely to arise.

sir ERNEST GOODALE : May I ask what is the effect of the Export Credits Guarantee Department on the work of the merchant banks?

the lecturer: Many merchant banks, including my own, have occasion to work very closely with the Export Credits Guarantee Department. It is, if I may say so, a most human organization which has now amassed a great deal of knowledge and technique and its existence opens up fields of activity in which the merchant banker

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JOURNAL OF THE ROYAL SOCIETY OF ARTS AUGUST 1 966 is perhaps uniquely qualified to play a part ; in two respects particularly. The sources of information open to the Export Credits are extremely good, and this is a very useful additional check on one's own sources of information. Also, it enables the merchant bank - and more importantly, the clearing bank - to finance in confidence a great deal of business which they would otherwise have to devote a great deal of time to proving. In those large areas of export activity involving big overseas contracts, the rôle of the merchant banker is particularly interesting - I have often compared with it that of Toomai and the Elephants. The finance that you have to put together for these large contracts comes from very large organizations, and it is sometimes easier for the relatively smaller ones, like merchant banks, to act as a catalyst.

MR. I. H. benjamin : In view of the recent legal decision, involving the United Dominions T rust, when the courts tried to declare what a bank really was, does Mr. Thompson think that the expression 'merchant bank' is a euphemistic expression which describes neither a merchant nor a bank - in the same way as salmon trout is described as a fish which is neither salmon nor trout?

the lecturer: I am glad to say that under our own roof there are still activities surviving which are 'mer chanting' and they keep one on one's toes. There are certain activities which nobody could deny were banking - basically the receiving of other people's spare cash and the lending of it to third parties - but there are also a great many organizations now to which the name merchant bank is applied and which do not have even vestigial connections with merchandizing. They are perhaps less conspicuous for the amount of money entrusted to them than for the amount of money on which they advise.

MR. bent SUENSON : If I understood the Lecturer correctly, he said that in the work of the merchant banker the emphasis continues to be very much on credit and on technical help rather than on providing finance. Is that true to such an extent that, when estimating the future relative importance of the rôle of the merchant bankers in Britain in relation to the whole banking field, the merchant bankers do not foresee a problem in the facility of obtaining funds which the enormous organization of the clearing banks, with their many branches, have established? In other words will the wholesale sources of funds on which the merchant banker relies continue to compare favourably with the abundance of capital which flows through many branches of the clearing bank?

the lecturer: Time will show, but I have no worries on that score. Money is a curious substance in that, when it has been expended in finance, it reappears again to be used by somebody else. I would say that the merchant banks never cast their eyes at the spare cash of the general public, but over and above that spare cash there are large sums not only in this country but in the world at large. A great deal of the deposits used by the merchant banks are in fact foreign currency deposits which do not compete with the funds in which the clearing banks specialize. That is not to say that we don't have large sterling deposits as well - inevitably they come our way - but we also, through the mechanism of the acceptance credit, use the funds which have been garnered by the clearing banks. The clearing banks lend those funds to the discount market, and the discount market uses them to finance our own acceptances. By this mechanism we render services to ourselves, to our customers, to the discount market and to the clearing banks through the discount market. The whole system works beautifully together.

sir William carrón, m. a. (a Member of Council of the Society) : I want to know if I can tempt Mr. Thompson to look into the future. Leaving aside the purely accounting aspect of the newer technologies, does he envisage that the utilization of

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these new advanced techniques, coupled with the increased availability of statistics iri all directions, will tend to diminish the significance of the old skills of the merchant banker?

the lecturer: I don't think so. New techniques would simply give you a wider field in which to exercise them, and perhaps greater precision and control in doing so. But ultimately, order is of human origin and is not a matter of statistics. We have more statistics at our disposal in this country than we ever had before, but have we more order?

the chairman : I think we must bring this very interesting discussion to a close. I said earlier that some of the activities of the merchant bankers were mysterious to the man in the street. This evening Mr. Thompson really has lifted the veil. We have certainly gained a lot of information, and while we may not be better people we are certainly wiser. It was fascinating in particular to hear him describe the evolution of the merchant banker from the days of the nineteenth-century merchants right through two world wars up to the present technological age, with credit, of course, always the theme rather than finance. I think part of the reason for the success of the merchant bankers must be their ability to adapt themselves to change.

Change is more rapid than ever before. No longer can we think only of the home market, or even of the home market and the export market - we must think of wor|d markets, and if we are to survive as a nation we have got to go out and capture those markets. This is not the place to talk about prices and incomes and productivity, but in assuming a solution to those problems I feel that we are certainly going to be involved in much larger industrial units, sometimes on an international scale, if we are to produce and market effectively against world competition. So here again we look to the merchant banker to guide and advise us on amalgamations, and maybe on acquisitions too, and to bring together those who have money and those who

% need money. The merchant bankers' intimate knowledge of industry, and perhaps what is even more important, their intimate knowledge of management, can help to raise the capital required for expansion in the most appropriate way.

On your behalf and my own I thank Mr. Gerald Thompson very much. The vote of thanks to the Lecturer was carried with acclamation andy another having

been proposed to the Chairman by Mr . Brian F. Macdona, a Member of Council of the Society y the meeting then ended.

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THE RÔLE OF THE MERCHANT BANKER

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