# Lombard Street: A Description of the Money Market/Chapter 3

CHAPTER III
how lombard street came to exist, and why it assumed its present form
I
In the last century, a favourite subject of literary ingenuity was "conjectural history," as it was then called. Upon grounds of probability a fictitious sketch was made of the possible origin of things existing. If this kind of speculation were now applied to banking, the natural and first idea would be that large systems of deposit banking grew up in the early world, just as they grow up now in any large English colony. As soon as any such community becomes rich enough to have much money, and compact enough to be able to lodge its money in single banks, it at once begins so to do. English colonists do not like the risk of keeping their money, and they wish to make an interest on it. They carry from home the idea and the habit of banking, and they take to it as soon as they can in their new world. Conjectural history would be inclined to say that all banking began thus: but such history is rarely of any value. ​The basis of it is false. It assumes that what works most easily when established is that which it would be the most easy to establish, and that what seems simplest when familiar would be most easily appreciated by the mind though unfamiliar. But exactly the contrary is true. Many things which seem simple and which work well when firmly established, are very hard to establish among new people, and not very easy to explain to them. Deposit banking is of this sort. Its essence is that a very large number of persons agree to trust a very few persons, or some one person. Banking would not be a profitable trade if bankers were not a small number, and depositors in comparison an immense number. But to get a great number of persons to do exactly the same thing is always very difficult, and nothing but a very palpable necessity will make them on a sudden begin to do it. And there is no such palpable necessity in banking. If you take a country town in France, even now, you will not find any such system of banking as ours. Chequebooks are unknown, and money kept on running account by bankers is rare. People store their money in a caisse at their houses. Steady savings, which are waiting for investment, and which are sure not to be soon wanted, may be lodged with bankers; but the common floating cash of the community is kept by the community themselves ​at home. They prefer to keep it so, and it would not answer a banker's purpose to make expensive arrangements for keeping it otherwise. If a "branch,' such as the National Provincial Bank opens in an English country town, were opened in a corresponding French one, it would not pay its expenses. You could not get any sufficient number of Frenchmen to agree to put their money there. And so it is in all countries not of British descent, though in various degrees. Deposit banking is a very difficult thing to begin, because people do not like to let their money out of their sight—especially do not like to let it out of sight without security—still more, cannot all at once agree on any single person to whom they are content to trust it unseen and unsecured. Hypothetical history, which explains the past by what is simplest and commonest in the present, is in banking, as in most things, quite untrue.
The real history is very different. New wants are mostly supplied by adaptation, not by creation or foundation. Something having been created to satisfy an extreme want, it is used to satisfy less pressing wants, or to supply additional conveniences. On this account, political Government—the oldest institution in the world—has been the hardest worked. At the beginning of history, we find it doing everything which society wants done, and forbidding everything which society does not ​wish done. In trade, at present, the first commerce in a new place is a general shop, which, beginning with articles of real necessity, comes shortly to supply the oddest accumulation of petty comforts. And the history of banking has been the same. The first banks were not founded for our system of deposit banking, or for anything like it. They were founded for much more pressing reasons, and having been founded, they, or copies from them, were applied to our modern uses.
The earliest banks of Italy, where the name began, were finance companies. The Bank of St. George, at Genoa, and other banks founded in imitation of it, were at first only companies to make loans to, and float loans for, the Governments of the cities in which they were formed. The want of money is an urgent want of Governments at most periods, and seldom more urgent than it was in the tumultuous Italian Republics of the Middle Ages. After these banks had been long established, they began to do what we call banking business; but at first they never thought of it. The great banks of the North of Europe had their origin in a want still more curious. The notion of its being a prime business of a bank to give good coin has passed out of men's memories; but wherever it is felt, there is no want of business more keen and urgent. Adam Smith describes it so admirably that it would be stupid not to quote his words:— ​"The currency of a great State, such as France or England, generally consists almost entirely of its own coin. Should this currency, therefore, be at any time worn, clipt, or otherwise degraded below its standard value, the State by a reformation of its coin can effectually re-establish its currency. But the currency of a small State, such as Genoa or Hamburgh, can seldom consist altogether in its own coin, but must be made up, in a great measure, of the coins of all the neighbouring States with which its inhabitants have a continual intercourse. Such a State, therefore, by reforming its coin, will not always be able to reform its currency. If foreign bills of exchange are paid in this currency, the uncertain value of any sum, of what is in its own nature so uncertain, must render the exchange always very much against such a State, its currency being, in all foreign States, necessarily valued even below what it is worth.
"In order to remedy the inconvenience to which this disadvantageous exchange must have subjected their merchants, such small States, when they began to attend to the interest of trade, have frequently enacted, that foreign bills of exchange of a certain value should be paid, not in common currency, but by an order upon, or by a transfer in, the books of a certain bank, established upon the credit and under the protection of the State, this bank being always obliged to pay, in good ​and true money, exactly according to the standard of the State. The Banks of Venice, Genoa, Amsterdam, Hamburg, and Nuremberg seem to have been all originally established with this view, though some of them may have afterwards been made subservient to other purposes. The money of such banks, being better than the common currency of the country, necessarily bore an agio, which was greater or smaller, according as the currency was supposed to be more or less degraded below the standard of the State. The agio of the Bank of Hamburg, for example, which is said to be commonly about 14 per cent, is the supposed difference between the good standard money of the State, and the clipt, worn, and diminished currency poured into it from all the neighbouring States.
"Before 1609 the great quantity of clipt and worn foreign coin, which the extensive trade of Amsterdam brought from all parts of Europe, reduced the value of its currency about 9 per cent, below that of good money fresh from the mint. Such money no sooner appeared than it was melted down or carried away, as it always is in such circumstances. The merchants, with plenty of currency, could not always find a sufficient quantity of good money to pay their bills of exchange; and the value of those bills, in spite of several regulations which were made to prevent it, became in a great measure uncertain.
​"In order to remedy these inconveniences, a bank was established in 1609 under the guarantee of the City. This bank received both foreign coin, and the light and worn coin of the country at its real intrinsic value in the good standard money of the country, deducting only so much as was necessary for defraying the expense of coinage, and the other necessary expense of management. For the value which remained, after this small deduction was made, it gave a credit in its books. This credit was called bank money, which, as it represented money exactly according to the standard of the mint, was always of the same real value, and intrinsically worth more than current money. It was at the same time enacted, that all bills drawn upon or negotiated at Amsterdam of the value of six hundred guilders and upwards should be paid in bank money, which at once took away all uncertainty in the value of those bills. Every merchant, in consequence of this regulation, was obliged to keep an account with the bank in order to pay his foreign bills of exchange, which necessarily occasioned a certain demand for bank money."
Again, a most important function of early banks is one which the present banks retain, though it is ​subsidiary to their main use; viz. the function of remitting money. A man brings money to the bank to meet a payment which he desires to make at a great distance, and the bank, having a connection with other banks, sends it where it is wanted. As soon as bills of exchange are given upon a large scale, this remittance is a very pressing requirement. Such bills must be made payable at a place convenient to the seller of the goods in payment of which they are given, perhaps at the great town where his warehouse is. But this may be very far from the retail shop of the buyer who bought those goods to sell them again in the country. For these, and a multitude of purposes, the instant and regular remittance of money is an early necessity of growing trade; and that remittance it was a first object of early banks to accomplish.
These are all uses other than those of deposit banking which banks supplied that afterwards became in our English sense deposit banks. By supplying these uses, they gained the credit that afterwards enabled them to gain a living as deposit banks. Being trusted for one purpose, they came to be trusted for a purpose quite different, ultimately far more important, though at first less keenly pressing. But these wants only affect a few persons, and therefore bring the bank under ​the notice of a few only. The real introductory function which deposit banks at first perform is much more popular, and it is only when they can perform this more popular kind of business that deposit banking ever spreads quickly and extensively. This function is the supply of the paper circulation to the country, and it will be observed that I am not about to overstep my limits and discuss this as a question of currency. In what form the best paper currency can be supplied to a country is a question of economical theory with which I do not meddle here. I am only narrating unquestionable history, not dealing with an argument where every step is disputed. And part of this certain history is that the best way to diffuse banking in a community is to allow the banker to issue bank notes of small amount that can supersede the metal currency. This amounts to a subsidy to each banker to enable him to keep open a bank till depositors choose to come to it. The country where deposit banking is most diffused is Scotland, and there the original profits were entirely derived from the circulation. The note issue is now a most trifling part of the liabilities of the Scotch banks, but it was once their mainstay and source of profit. A curious book, lately published, has enabled us to follow the course of this in detail. The Bank of Dundee, now amalgamated with the Royal Bank of Scotland, was ​founded in 1763, and had become before its amalgamation, eight or nine years since, a bank of considerable deposits. But for twenty-five years from its foundation it had no deposits at all. It subsisted mostly on its note issue, and a little on its remittance business. Only in 1792, after nearly thirty years, it began to gain deposits, but from that time they augmented very rapidly. The banking history of England has been the same, though we have no country bank accounts in detail which go back so far. But probably up to 1830 in England, or thereabouts, the main profit of banks was derived from the circulation, and for many years after that the deposits were treated as very minor matters, and the whole of so-called banking discussion turned on questions of circulation. We are still living in the débris of that controversy, for, as I have so often said, people can hardly think of the structure of Lombard Street, except with reference to the paper currency and to the Act of 1844, which regulates it now. The French are still in the same epoch of the subject. Their great enquête of 1865 is almost wholly taken up with currency matters, and mere banking is treated as subordinate. And the accounts of the Bank of France show why. The last weekly statement before the German war showed that the circulation of the Bank of France was as much as £59,244,000, ​and that the private deposits were only £17,127,000. Now the private deposits are about the same, and the circulation is £112,000,000. So difficult is it in even a great country like France for the deposit system of banking to take root, and establish itself with the strength and vigour that it has in England.
The experience of Germany is the same. The accounts preceding the war in North Germany showed the circulation of the issuing banks to be £39,875,000, and the deposits to be £6,472,000, while the corresponding figures at the present moment are—circulation £60,000,000, and deposits £8,000,000. It would be idle to multiply instances.
The reason why the use of bank paper commonly precedes the habit of making deposits in banks is very plain. It is a far easier habit to establish. In the issue of notes the banker, the person to be most benefited, can do something. He can pay away his own "promises" in loans, in wages, or in payment of debts. But in the getting of deposits he is passive. His issues depend on himself; his deposits on the favour of others. And to the public the change is far easier too. To collect a great mass of deposits with the same ​banker, a great number of persons must agree to do something. But to establish a note circulation, a large number of persons need only do nothing. They receive the banker's notes in the common course of their business, and they have only not to take those notes to the banker for payment. If the public refrain from taking trouble, a paper circulation is immediately in existence. A paper circulation is begun by the banker, and requires no effort on the part of the public; on the contrary, it needs an effort of the public to be rid of notes once issued; but deposit banking cannot be begun by the banker, and requires a spontaneous and consistent effort in the community. And therefore paper issue is the natural prelude to deposit banking.
The way in which the issue of notes by a banker prepares the way for the deposit of money with him is very plain. When a private person begins to possess a great heap of bank notes, it will soon strike him that he is trusting the banker very much, and that in return he is getting nothing. He runs the risk of loss and robbery just as if he were hoarding coin. He would run no more risk by the failure of the bank if he made a deposit there, and he would be free from the risk of keeping the cash. No doubt it takes time before even this simple reasoning is understood by uneducated minds. So strong is the wish of most people to see their money that they for some time continue to hoard ​bank notes: for a long period a few do so. But in the end common sense conquers. The circulation of bank notes decreases and the deposit of money with the banker increases. The credit of the banker having been efficiently advertised by the note, and accepted by the public, he lives on the credit so gained years after the note issue itself has ceased to be very important to him.
The efficiency of this introduction is proportional to the diffusion of the right of note issue. A single monopolist issuer, like the Bank of France, works its way with difficulty through a country, and advertises banking very slowly. Even now the Bank of France, which, I believe, by law ought to have a branch in each Department, has only branches in sixty out of eighty-six. On the other hand, the Swiss banks, where there is always one or more to every Canton, diffuse banking rapidly. We have seen that the liabilities of the Bank of France stand thus—
| Notes | £112,000,000 |
| Deposits | £15,000,000 |
But the aggregate Swiss banks, on the contrary, stand—
| Notes | £761,000 |
| Deposits | £4,709,000 |
The reason is that a central bank, which is governed in the capital and descends on a country district, has much fewer modes of lending money safely than a bank of which the partners belong to that district, and know the men and things in it. A note issue is mainly begun by loans: there are then no deposits to be paid. But the mass of loans in a rural district are of small amount; the bills to be discounted are trifling; the persons borrowing are of small means and only local repute; the value of any property they wish to pledge depends on local changes and local circumstances. A banker who lives in the district, who has always lived there, whose whole mind is a history of the district and its changes, is easily able to lend money safely there. But a manager deputed by a single central establishment does so with difficulty. The worst people will come to him and ask for loans. His ignorance is a mark for all the shrewd and crafty people thereabouts. He will have endless difficulties in establishing the circulation of the distant ​bank, because he has not the local knowledge which alone can teach him how to issue that circulation with safety.
A system of note issues is therefore the best introduction to a large system of deposit banking. As yet, historically, it is the only introduction: no nation as yet has arrived at a great system of deposit banking without going first through the preliminary stage of note issue, and of such note issues the quickest and most efficient in this way is one made by individuals resident in the district, and conversant with it.
And this explains why deposit banking is so rare. Such a note issue as has been described is possible only in a country exempt from invasion, and free from revolution. During an invasion note-issuing banks must stop payment; a run is nearly inevitable at such a time, and in a revolution too. In such great and close civil dangers a nation is always demoralised; everyone looks to himself, and every one likes to possess himself of the precious metals. These are sure to be valuable, invasion or no invasion, revolution or no revolution. But the goodness of bank notes depends on the solvency of the banker, and that solvency may be impaired if the invasion is not repelled or the revolution resisted.
Hardly any continental country has been till now exempt for long periods both from invasion ​and revolution. In Holland and Germany—two countries where note issue and deposit banking would seem as natural as in England and Scotland—there was never any security from foreign war. A profound apprehension of external invasion penetrated their whole habits, and men of business would have thought it insane not to contemplate a contingency so frequent in their history, and perhaps witnessed by themselves.
France indeed, before 1789, was an exception. For many years under the old régime she was exempt from serious invasion or attempted revolution. Her Government was fixed, as was then thought, and powerful; it could resist any external enemy, and the prestige on which it rested seemed too firm to fear any enemy from within. But then it was not an honest Government, and it had shown its dishonesty in this particular matter of note issue. The regent in Law's time had given a monopoly of note issue to a bad bank, and had paid off the debts of the nation in worthless paper. The Government had created a machinery of ruin, and had thriven on it. Among so apprehensive a race as the French the result was fatal. For many years no attempt at note issue or deposit banking was possible in France. So late as the foundation of the Caisse a'Escompte, in Turgot's time, the remembrance of Law's failure was distinctly felt, and impeded the commencement of better attempts.
​This, therefore, is the reason why Lombard Street exists; that is, why England is a very great Money Market, and other European countries but small ones in comparison. In England and Scotland a diffused system of note issues started banks all over the country; in these banks the savings of the country have been lodged, and by these they have been sent to London. No similar system arose elsewhere, and in consequence London is full of money, and all continental cities are empty as compared with it.
ii
The monarchical form of Lombard Street is due also to the note issue. The origin of the Bank of England has been told by Macaulay, and it is never wise for an ordinary writer to tell again what he has told so much better. Nor is it necessary, for his writings are in every one's hands. Still I must remind my readers of the curious story.
Of all institutions in the world the Bank of England is now probably the most remote from party politics and from "financing." But in its origin it was not only a finance company, but a Whig finance company. It was founded by a Whig Government because it was in desperate want of money, and supported by the "City" because the "City "was Whig. Very briefly, the story was this. ​The Government of Charles II. (under the Cabal Ministry) had brought the credit of the English State to the lowest possible point. It had perpetrated one of those monstrous frauds which are likewise gross blunders. The goldsmiths, who then carried on upon a trifling scale what we should now call banking, used to deposit their reserve of treasure in the "Exchequer," with the sanction and under the care of the Government. In many European countries the credit of the State had been so much better than any other credit, that it had been used to strengthen the beginnings of banking. The credit of the State had been so used in England: though there had lately been a civil war and several revolutions, the honesty of the English Government was trusted implicitly. But Charles II. showed that it was trusted undeservedly. He shut up the "Exchequer," would pay no one, and so the "goldsmiths" were ruined.
The credit of the Stuart Government never recovered from this monstrous robbery, and the Government created by the Revolution of 1688 could hardly expect to be more trusted with money than its predecessor. A Government created by a revolution hardly ever is. There is a taint of violence which capitalists dread instinctively, and there is always a rational apprehension that the Government which one revolution thought fit to set up another revolution may think fit to pull down. ​In 1694, the credit of William III.'s Government was so low in London that it was impossible for it to borrow any large sum; and the evil was the greater, because in consequence of the French war the financial straits of the Government were extreme. At last a scheme was hit upon which would relieve their necessities. "The plan," says Macaulay, "was that twelve hundred thousand pounds should be raised at what was then considered as the moderate rate of 8 per cent." In order to induce the subscribers to advance the money promptly on terms so unfavourable to the public, the subscribers were to be incorporated by the name of the Governor and Company of the Bank of England. They were so incorporated, and the £1,200,000 was obtained.
On many succeeding occasions, their credit was of essential use to the Government. Without their aid, our National Debt could not have been borrowed; and if we had not been able to raise that money we should have been conquered by France and compelled to take back James II. And for many years afterwards the existence of that debt was a main reason why the industrial classes never would think of recalling the Pretender or of upsetting the revolution settlement. The "fund-holder" is always considered in the books of that time as opposed to his "legitimate" sovereign, because it was to be feared that this sovereign would ​repudiate the debt which was raised by those who dethroned him, and which was spent in resisting him and his allies. For a long time the Bank of England was the focus of London Liberalism, and in that capacity rendered to the State inestimable services. In return for these substantial benefits the Bank of England received from the Government, either at first or afterwards, three most important privileges.
First. The Bank of England had the exclusive possession of the Government balances. In its first period, as I have shown, the Bank gave credit to the Government, but afterwards it derived credit from the Government. There is a natural tendency in men to follow the example of the Government under which they live. The Government is the largest, most important, and most conspicuous entity with which the mass of any people are acquainted; its range of knowledge must always be infinitely greater than the average of their knowledge, and therefore, unless there is a conspicuous warning to the contrary, most men are inclined to think their Government right, and when they can, to do what it does. Especially in money matters a man might fairly reason—"If the Government is right in trusting the Bank of England with the great balance of the nation, I cannot be wrong in trusting it with my little balance."
​Secondly. The Bank of England had, till lately, the monopoly of limited liability in England. The common law of England knows nothing of any such principle. It is only possible by Royal Charter or Statute Law. And by neither of these was any real bank (I do not count absurd schemes such as Chamberlayne's Land Bank) permitted with limited liability in England till within these few years. Indeed, a good many people thought it was right for the Bank of England, but not right for any other bank. I remember hearing the conversation of a distinguished merchant in the City of London, who well represented the ideas then most current. He was declaiming against banks of limited liability, and some one asked "Why, what do you say, then, to the Bank of England, where you keep your own account?" "Oh!" he replied, "that is an exceptional case." But no doubt it was an exception of the greatest value to the Bank of England, because it induced many quiet and careful merchants to be directors of the Bank, who certainly would not have joined any bank where all their fortunes were liable, and where the liability was not limited.
Thirdly. The Bank of England had the privilege of being the sole joint stock company permitted to issue bank notes in England. Private London bankers did indeed issue notes down to the middle of the last century, but no joint stock company could ​do so. The explanatory clause of the Act of 1742 sounds most curiously to our modern ears. "And to prevent any doubt that may arise concerning the privilege or power given to the said governor and company"—that is, the Bank of England "of exclusive banking; and also in regard to creating any other bank or banks by Parliament, or restraining other persons from banking during the continuance of the said privilege granted to the governor and company of the Bank of England, as before recited;—it is hereby further enacted and declared by the authority aforesaid, that it is the true intent and meaning of the said Act that no other bank shall be created, established, or allowed by Parliament, and that it shall not be lawful for any body politic or corporate whatsoever created or to be created, or for any other persons whatsoever united or to be united in covenants or partnership exceeding the number of six persons in that part of Great Britain called England, to borrow, owe, or take up any sum or sums of money on their bills or notes payable on demand or at any less time than six months from the borrowing thereof during the continuance of such said privilege to the said governor and company, who are hereby declared to be and remain a corporation with the privilege of exclusive banking, as before recited." To our modern ears these words seem to mean more than they did. The term banking was then applied only to the issue of ​notes and the taking up of money on bills on demand. Our present system of deposit banking, in which no bills or promissory notes are issued, was not then known on a great scale, and was not called banking. But its effect was very important. It in time gave the Bank of England the monopoly of the note issue of the Metropolis. It had at that time no branches, and so it did not compete for the country circulation. But in the Metropolis, where it did compete, it was completely victorious. No company but the Bank of England could issue notes, and unincorporated individuals gradually gave way, and ceased to do so. Up to 1844 London private bankers might have issued notes if they pleased, but almost a hundred years ago they were forced out of the field. The Bank of England has so long had a practical monopoly of the circulation, that it is commonly believed always to have had a legal monopoly.
And the practical effect of the clause went further: it was believed to make the Bank of England the only joint stock company that could receive deposits, as well as the only company that could issue notes. The gift of "exclusive banking" to the Bank of England was read in its most natural modern sense: it was thought to prohibit any other banking company from carrying on our present system of banking. After joint stock banking was permitted in the country, people began ​ to inquire why it should not exist in the Metropolis too? And then it was seen that the words I have quoted only forbid the issue of negotiable instruments, and not the receiving of money when no such instrument is given. Upon this construction, the London and Westminster Bank and all our older joint stock banks were founded. But till they began, the Bank of England had among companies not only the exclusive privilege of note issue, but that of deposit banking too. It was in every sense the only banking company in London.
* ↑ Smith's "Wealth of Nations," Book IV. chap. iii. "Digression concerning Banks of Deposit," etc.
* ↑ See Note C, in Appendix I.
* ↑ This is still true at the end of 1913 the private deposits were £23,013,000 and the circulation £228,542,000.
* ↑ On Dec. 31st, 1913, the Imperial Bank of Germany held deposits to the amount of £37,159,000, and its note circulation stood at £102,115,000.
* ↑ At the end of 1913 the Bank of France had offices as follows:— Head Office 1 Branches 139 Auxiliary Offices 71 Agencies 360 Total 571
* ↑ Note to 12th Edition. These are the amounts at December 31st, 1865. See "Grundzuge der National-Oekonomie," von Max Wirth, Dritter Band, p. 491.  Note to 14th Edition. The Swiss National Bank is now the only Swiss Bank authorised to issue notes. At the end of 1913 it had— Notes £1,880,000 Deposits £10,999,000