# Lombard Street: A Description of the Money Market/Chapter 9

CHAPTER IX
the joint stock banks
The Joint Stock Banks of this country are a most remarkable success. Generally speaking the career of Joint Stock Companies in this country has been chequered. Adam Smith, many years since, threw out many pregnant hints on the difficulty of such undertakings—hints which even after so many years will well repay perusal. But joint stock banking has been an exception to this rule. Four years ago I threw together the facts on the subject and the reasons for them; and I venture to quote the article, because subsequent experience suggests, I think, little to be added to it.
"The main classes of joint stock companies which have answered are three:—1st. Those, in which the capital is used not to work the business but to guarantee the business. Thus a banker's business—his proper business—does not begin while he is using his own money; it commences when he begins to use the capital of others. An insurance office in the long run needs no capital; ​the premiums which are received ought to exceed the claims which accrue. In both cases, the capital is wanted to assure the public and to induce it to trust the concern. 2ndly. Those companies have answered which have an exclusive privilege which they have used with judgment, or which possibly was so very profitable as to enable them to thrive with little judgment. 3rdly. Those which have undertaken a business both large and simple—employing more money than most individuals or private firms have at command, and yet such that, in Adam Smith's words, 'the operations are capable of being reduced to a routine, or such an uniformity of method as admits of no variation.'
"As a rule, the most profitable of these companies are banks. Indeed, all the favouring conditions just mentioned concur in many banks. An old-established bank has a 'prestige,' which amounts to a 'privileged opportunity'; though no exclusive right is given to it by law, a peculiar power is given to it by opinion. The business of banking ought to be simple; if it is hard it is wrong. The only securities which a banker, using money that he may be asked at short notice to repay, ought to touch, are those which are easily saleable and easily intelligible. If there is a difficulty or a doubt, the security should be declined. No business can of course be quite reduced to fixed ​rules. There must be occasional cases which no preconceived theory can define. But banking comes as near to fixed rules certainly as any existing business, perhaps as any possible business. The business of an old-established bank has the full advantage of being a simple business, and in part the advantage of being a monopoly business. Competition with it is only open in the sense in which competition with 'the London Tavern' is open; any one that has to do with either will pay dear for it.
"But the main source of the profitableness of established banking is the smallness of the requisite capital. Being only wanted as a 'moral influence,' it need not be more than is necessary to secure that influence. Although, therefore, a banker deals only with the most sure securities, and with those which yield the least interest, he can nevertheless gain and divide a very large profit upon his own capital, because the money in his hands is so much larger than that capital.
"Experience as shown by plain figures, confirms these conclusions. We print at the end of this article the respective profits of 110 banks in England, and Scotland, and Ireland, being all in those countries of which we have sufficient information—the Bank of England excepted. There are no doubt others, but they are not quoted even on local Stock Exchange lists, and in most cases ​publish no reports. The result of these banks, as regards the dividends they pay, is—
| | No. of Companies. | Capital. |
| Above 20 per cent. | 15 | £5,302,767 |
| Between 15 and 20 per cent. | 20 | 5,439,439 |
| Between„ 10 and 15 per cent. | 36 | 14,056,950 |
| Between„ 5 and 10 per cent. | 36 | 14,182,379 |
| Under 5 per cent. | 3 | 1,350,000 |
| | 110 | 40,331,535 |
—that is to say, above 25 per cent. of the capital employed in these banks pays over 15 per cent. and 621/2 per cent. of the capital pays more than 10 per cent. So striking a result is not to be shown in any other joint stock trade.
"The period to which these accounts refer was certainly not a particularly profitable one—on the contrary, it has been specially unprofitable. The rate of interest has been very low, and the amount of good security in the market small. Many banks—to some extent most banks—probably had in their books painful reminiscences of 1866. The fever of excitement which passed over the nation ​was strongest in the classes to whom banks lent most, and consequently the losses of even the most careful banks (save of those in rural and sheltered situations) were probably greater than usual. But even tried by this very unfavourable test banking is a trade profitable far beyond the average of trades.
"There is no attempt in these banks on the whole and as a rule to divide too much—on the contrary, they have accumulated about £13,000,000, or nearly one-third of their capital, principally out of undivided profits. The directors of some of them have been anxious to put away as much as possible and to divide as little as possible.
"The reason is plain: out of the banks which pay more than 20 per cent., all but one were old-established banks, and all those paying between 15 and 20 per cent. were old banks too. The 'privileged opportunity' of which we spoke is singularly conspicuous in such figures; it enables banks to pay much, which without it would not have paid much. The amount of the profit is clearly proportional to the value of the 'privileged opportunity.' All the banks which pay above 20 per cent., save one, are banks more than 25 years ​old; all those which pay between 15 and 20 are so too. A new bank could not make these profits, or even by its competition much reduce these profits; in attempting to do so, it would simply ruin itself. Not possessing the accumulated credit of years, it would have to wind up before it attained that credit.
"The value of the opportunity too is proportioned to what has to be paid for it. Some old banks have to pay interest for all their money; some have much for which they pay nothing. Those who give much to their customers have of course less left for their shareholders. Thus Scotland, where there is always a daily interest, has no bank in the lists paying over 15 per cent. The profits of Scotch banks run thus:—
| | Capital. | Dividend. |
| Bank of Scotland | £1,500,000 | 12 |
| British Linen Company | 1,000,000 | 13 |
| Caledonian | 125,000 | 10 |
| Clydesdale | 900,000 | 10 |
| Commercial Bank of Scotland | 1,000,000 | 13 |
| National Bank of Scotland | 1,000,000 | 12 |
| North of Scotland | 280,000 | 10 |
| Union Bank of Scotland | 1,000,000 | 10 |
| City of Glasgow | 870,000 | 8 |
| Royal Bank | 2,000,000 | 8 |
| | £9,675,000 |
of the London and Westminster, or the other most lucrative banks of the South.
"The Bank of England, it is true, does not seem to pay so much as other English banks in this way of reckoning. It makes an immense profit, but then its capital is immense too. In fact, the Bank of England suffers under two difficulties. Being much older than the other joint stock banks, it belongs to a less profitable era. When it was founded, banks looked rather to the profit on their own capital, and to the gains of note issue, than to the use of deposits. The first relations with the State were more like those of a finance company than of a bank, as we now think of banking. If the Bank had not made loans to the Government, which we should now think dubious, the Bank would not have existed, for the Government would never have permitted it. Not only is the capital of the Bank of England relatively greater, but the means of making profit in the Bank of England are relatively less also. By custom and understanding the Bank of England keep a much greater reserve in unprofitable cash than other banks; if they do not keep it, either our whole system must be changed or we should break up in utter bankruptcy. The earning faculty of the Bank of England is in proportion less than that of other banks, and also the sum on which it ​has to pay dividend is altogether greater than theirs.
"It is interesting to compare the facts of joint stock banking with the fears of it which were felt. In 1832, Lord Overstone observed:—'I think that joint stock banks are deficient in everything requisite for the conduct of the banking business except extended responsibility; the banking business requires peculiarly persons attentive to all its details, constantly, daily, and hourly watchful of every transaction, much more than mercantile or trading business. It also requires immediate prompt decisions upon circumstances when they arise, in many cases a decision that does not admit of delay for consultation; it also requires a discretion to be exercised with reference to the special circumstances of each case. Joint stock banks being of course obliged to act through agents, and not by a principal, and therefore under the restraint of general rules, cannot be guided by so nice a reference to degrees of difference in the character of responsibility of parties; nor can they undertake to regulate the assistance to be granted to concerns under temporary embarrassment by so accurate a reference to the circumstances, favourable or unfavourable, of each case.'
"But in this very respect, joint stock banks have probably improved the business of banking. The old private banks in former times used to lend ​much to private individuals; the banker, as Lord Overstone on another occasion explained, could have no security, but he formed his judgment of the discretion, the sense, and the solvency of those to whom he lent. And when London was by comparison a small city, and when by comparison every one stuck to his proper business, this practice might have been safe. But now that London is enormous and that no one can watch any one, such a trade would be disastrous; at present, it would hardly be safe in a country town. The joint stock banks were quite unfit for the business Lord Overstone meant, but then that business is quite unfit for the present time."
This success of Joint Stock Banking is very contrary to the general expectation at its origin. Not only private bankers, such as Lord Overstone then was, but a great number of thinking persons feared that the joint stock banks would fast ruin themselves, and then cause a collapse and panic in the country. The whole of English commercial literature between 1830 and 1840 is filled with that idea. Nor did it cease in 1840. So late as 1845, Sir R. Peel thought the foundation of joint stock banks so dangerous that he subjected it to grave and exceptional difficulty. Under the Act of 1845, which he proposed, no such companies could be founded except with shares of £100 with £50 paid ​up on each; which effectually checked the progress of such banks, for few new ones were established for many years, or till that Act had been repealed. But in this, as in many other cases, perhaps Sir R. Peel will be found to have been clear-sighted rather than far-sighted. He was afraid of certain joint stock banks which he saw rising around him; but the effect of his legislation was to give to these very banks, if not a monopoly, at any rate an exemption from new rivals. No one now founds or can found a new private bank, and Sir R. Peel by law prevented new joint stock banks from being established. Though he was exceedingly distrustful of the joint stock banks founded between 1826 and 1845, yet in fact he was their especial patron, and he more than any other man encouraged and protected them.
But in this wonderful success there are two dubious points, two considerations of different kinds which forbid us to say that in other countries, even in countries with the capacity of co-operation, joint stock banks would succeed as well as we have seen that they succeed in England. 1st. These great banks have not had to keep so large a reserve against their liabilities as it was natural that they should, being of first-rate magnitude, keep. They were, at first, of course, very small in comparison with what they are now. They found a number of private bankers grouped round the ​Bank of England, and they added themselves to the group. Not only did they keep their reserve from the beginning at the Bank of England, but they did not keep so much reserve as they would have kept if there had been no Bank of England. For a long time this was hardly noticed. For many years questions of the "currency," particularly questions as to the Act of 1844, engrossed the attention of all who were occupied with these subjects. Even those who were most anxious to speak evil of joint stock banks did not mention this particular evil. The first time, as far as I know, that it was commented on in any important document, was in an official letter written in 1857 by Mr. Weguelin, who was then Governor of the Bank, to Sir George Lewis, who was then Chancellor of the Exchequer. The Governor and the Directors of the Bank of England had been asked by Sir George Lewis severally to give their opinions on the Act of 1844, and all their replies were published. In his, Mr. Weguelin says:—
"If the amount of the reserve kept by the Bank of England be contrasted with the reserve kept by the joint stock banks, a new and hitherto little-considered source of danger to the credit of the country will present itself. The joint stock banks of London, judging by their published accounts, have deposits to the amount of £30,000,000. Their capital is not more than £3,000,000, and they have ​on an average £31,000,000, invested in one way or another, leaving only £2,000,000 as a reserve against all this mass of liabilities."
But these remarkable words were little observed in the discussions of that time. The air was obscured by other matters. But in this work I have said so much on the subject that I need say little now. The joint stock banks now keep a main part of their reserve on deposit with the bill brokers, or in good and convertible interest-bearing securities. From these they obtain a large income, and that income swells their profits. If they had to keep a much larger part than now of that reserve in barren cash, their dividends would be reduced, and their present success would become less conspicuous.
The second misgiving, which many calm observers more and more feel as to our largest joint stock banks, fastens itself on their government. Is that government sufficient to lend well and keep safe so many millions? They are governed, as every one knows, by a board of directors, assisted by a general manager, and there are in London unrivalled materials for composing good boards of directors. There are very many men of good means, of great sagacity, and great experience in business, who are obliged to be in the City every day, and to remain there during the day, but who have very much time on their hands. A merchant ​employing solely or principally his own capital has often a great deal of leisure. He is obliged to be on the market, and to hear what is doing. Every day he has some business to transact, but his transactions can be but few. His capital can bear only a limited number of purchases; if he bought as much as would fill his time from day to day he would soon be ruined, for he could not pay for it. Accordingly, many excellent men of business are quite ready to become members of boards of directors, and to attend to the business of companies, a good deal for the employment's sake. To have an interesting occupation which brings dignity and power with it pleases them very much. As the aggregation of commerce in great cities grows, the number of such men augments. A council of grave, careful, and experienced men can, without difficulty, be collected for a great Bank in London, such as never could have been collected before, and such as cannot now be collected elsewhere.
There are facilities, too, for engaging a good banker to be a manager such as there never were before in the world. The number of such persons is much on the increase. Any careful person who is experienced in figures, and has real sound sense, may easily make himself a good banker. The modes in which money can be safely lent by a banker are not many, and a clear-headed, quiet, industrious person may soon learn all that is ​necessary about them. Our intricate law of real property is an impediment in country banking, for it requires some special study even to comprehend the elements of a law which is full of technical words, and which can only be explained by narrating its history. But the banking of great cities is little concerned with loans on landed property. And all the rest of the knowledge requisite for a banker can easily be obtained by any one who has the sort of mind which takes to it. No doubt there is a vast routine of work to be learned, and the manager of a large bank must have a great facility in transacting business rapidly. But a great number of persons are now bred from their earliest manhood in the very midst of that routine; they learn it as they would learn a language, and come to be no more able to unlearn it than they could unlearn a language. And the able ones among them acquire an almost magical rapidity in effecting the business connected with that routine. A very good manager and very good board of directors can, without unreasonable difficulty, be provided for a bank at present in London.
It will be asked, What more can be required? I reply, a great deal. All that the best board of directors can really accomplish is to form a good decision on the points which the manager presents to them, and perhaps on a few others which one or two zealous members of their body ​may select for discussion. A meeting of fifteen or eighteen persons is wholly unequal to the transaction of more business than this; it will be fortunate, and it must be well guided, if it should be found to be equal to so much. The discussion even of simple practical points by such a number of persons is a somewhat tedious affair. Many of them will wish to speak on every decision of moment, and some of them—some of the best of them perhaps—will only speak with difficulty and slowly. Very generally, several points will be started at once, unless the discussion is strictly watched by a rigid chairman; and even on a single point the arguments will often raise grave questions which cannot be answered, and suggest many more issues than can be advantageously decided by the meeting. The time required by many persons for discussing many questions would alone prevent an assembly of many persons from overlooking a large and complicated business.
Nor is this the only difficulty. Not only would a real supervision of a large business by a board of directors require much more time than the board would consent to occupy in meeting, it would also require much more time and much more thought than the individual directors would consent to give. These directors are only employing on the business of the bank the vacant moments of their time, and the spare energies ​of their minds. They cannot give the bank more; the rest is required for the safe conduct of their own affairs, and if they diverted it from these affairs they would be ruined. A few of them may have little other business, or they may have other partners in the business, on whose industry they can rely, and whose judgment they can trust; one or two may have retired from business. But for the most part, directors of a company cannot attend principally and anxiously to the affairs of a company without so far neglecting their own business as to run great risk of ruin; and if they are ruined, their trustworthiness ceases, and they are no longer permitted by custom to be directors.
Nor, even if it were possible really to supervise a business by the effectual and constant inspection of fifteen or sixteen rich and capable persons, would even the largest business easily bear the expense of such a supervision. I say rich, because the members of a board governing a large bank must be men of standing and note besides, or they would discredit the bank; they need not be rich in the sense of being worth millions, but they must be known to possess a fair amount of capital and be seen to be transacting a fair quantity of business. But the labour of such persons, I do not say their spare powers, but their principal energies, fetches a high price. ​Business is really a profession often requiring for its practice quite as much knowledge, and quite as much skill, as law and medicine; and requiring also the possession of money. A thorough man of business, employing a fair capital in a trade which he thoroughly comprehends, not only earns a profit on the capital, but really makes of his professional skill a large income. He has a revenue from talent as well as from money; and to induce sixteen or eighteen persons to abandon such a position and such an income in order to devote their entire attention to the affairs of a joint stock company, a salary must be given too large for the bank to pay or for any one to wish to propose.
And an effectual supervision by the whole board being impossible, there is a great risk that the whole business may fall to the general manager. Many unhappy cases have proved this to be very dangerous. Even when the business of joint stock banks was far less, and when the deposits entrusted to them were very much smaller, a manager sometimes committed frauds which were dangerous and still oftener made mistakes that were ruinous. Actual crime will always be rare; but, as an uninspected manager of a great bank has the control of untold millions, sometimes we must expect to see it: the magnitude of the temptation will occasionally prevail over the feebleness of human nature. ​But error is far more formidable than fraud: the mistakes of a sanguine manager are far more to be dreaded than the theft of a dishonest manager. Easy misconception is far more common than long-sighted deceit. And the losses to which an adventurous and plausible manager, in complete good faith, would readily commit a bank, are beyond comparison greater than any which a fraudulent manager would be able to conceal, even with the utmost ingenuity. If the losses by mistake in banking and the losses by fraud were put side by side, those by mistake would be incomparably the greater. There is no more unsafe government for a bank than that of an eager and active manager, subject only to the supervision of a numerous board of directors, even though that board be excellent, for the manager may easily glide into dangerous and insecure transactions, nor can the board effectually check him.
The remedy is this: a certain number of the directors, either those who have more spare time than others, or those who are more ready to sell a large part of their time to the bank, must be formed into a real working committee, which must meet constantly, must investigate every large transaction, must be acquainted with the means and standing of every large borrower, and must be in such incessant communication with the manager that it will be impossible for him to ​engage in hazardous enterprises of dangerous magnitude without their knowing it and having an opportunity of forbidding it. In almost all cases they would forbid it; all committees are cautious, and a committee of careful men of business, picked from a large city, will usually err on the side of caution if it err at all. The daily attention of a small but competent minor council, to whom most of the powers of the directors are delegated, and who, like a cabinet, guide the deliberations of the board at its meetings, is the only adequate security of a large bank from the rash engagements of a despotic and active general manager. Fraud, in the face of such a committee, would probably never be attempted, and even now it is a rare and minor evil.
Some such committees are vaguely known to exist in most, if not all, our large joint stock banks. But their real constitution is not known. No customer and no shareholder knows the names of the managing committee, perhaps, in any of these large banks. And this is a grave error. A large depositor ought to be able to ascertain who really are the persons that dispose of his money; and still more a large shareholder ought not to rest till he knows who it is that makes engagements on his behalf, and who it is that may ruin him if they choose. The committee ought to be composed of quiet men of business, who can be ​ascertained by inquiry to be of high character and well-judging mind. And if the public and the shareholder knew that there was such a committee, they would have sufficient reasons for the confidence which now is given without such reasons.
A certain number of directors attending daily by rotation is, it should be said, no substitute for a permanent committee. It has no sufficient responsibility. A changing body cannot have any responsibility. The transactions which were agreed to by one set of directors present on the Monday might be exactly those which would be much disapproved by directors present on the Wednesday. It is essential to the decisions of most business, and not least of the banking business, that they should be made constantly by the same persons; the chain of transactions must pass through the same minds. A large business may be managed tolerably by a quiet group of second-rate men if those men be always the same; but it cannot be managed at all by a fluctuating body, even of the very cleverest men. You might as well attempt to guide the affairs of the nation by means of a cabinet similarly changing.
Our great joint stock banks are imprudent in so carefully concealing the details of their government, and in secluding those details from the risk of discussion. The answer, no doubt, will be, "Let ​well alone; as you have admitted, there hardly ever before was so great a success as these banks of ours; what more do you or can you want? "I can only say that I want further to confirm this great success and to make it secure for the future. At present there is at least the possibility of a great reaction. Supposing that, owing to defects in its government, one even of the greater London joint stock banks failed, there would be an instant suspicion of the whole system. One terra incognita being seen to be faulty, every other terra incognita would be suspected. If the real government of these banks had for years been known, and if the subsisting banks had been known not to be ruled by the bad mode of government which had ruined the bank that had fallen, then the ruin of that bank would not be hurtful. The other banks would be seen to be exempt from the cause which had destroyed it. But at present the ruin of one of these great banks would greatly impair the credit of all. Scarcely any one knows the precise government of any one; in no case has that government been described on authority; and the fall of one by grave misgovernment would be taken to show that the others might as easily be misgoverned also. And a tardy disclosure even of an admirable constitution would not much help the surviving banks: as it was extracted by necessity, it would be received with suspicion. A sceptical world would say, "Of ​course they say they are all perfect now; it would not do for them to say anything else."
And not only the depositors and the shareholders of these large banks have a grave interest in their good government, but the public also. We have seen that our banking reserve is, as compared with our liabilities, singularly small; we have seen that the rise of these great banks has lessened the proportion of that reserve to those liabilities; we have seen that the greatest strain on the banking reserve is a "panic." Now, no cause is more capable of producing a panic, perhaps none is so capable, as the failure of a first-rate joint stock bank in London. Such an event would have something like the effect of the failure of Overend, Gurney and Co.; scarcely any other event would have an equal effect. And therefore, under the existing constitution of our banking system, the government of these great banks is of primary importance to us all.
* ↑ The profits of all the joint stock banks of the United Kingdom that publish profit and loss accounts amounted for the year 1913 to £13,400,000, of which £9,100,000 was distributed in dividends. The average dividend of the banks of England and Wales was 15·2 per cent.; of the Scottish banks 15·8 per cent.; and of the Irish banks 10·4 per cent. The average dividend on the aggregate paid-up capital of £62,400,000 was 14·65 per cent.
* ↑ At the end of 1913 the accumulated reserves of all the joint stock banks of the United Kingdom (exclusive of the Bank of England) amounted to about £45,400,000 paid up, the capital being £65,000,000.
* ↑ In 1913, upon a paid-up capital of £9,241,070, the Scottish banks distributed dividends to the amount of £1,437,200. The rates of distribution ranged from 20 per cent. free of income tax to 5 per cent. free of income tax, this rate being paid by a relatively young and unimportant bank.