Published by EH.Net (November 2020)
Ulrich Bindseil, Central Banking before 1800: A Rehabilitation. Oxford: Oxford University Press, 2019. xiii + 322 pp. $80 (hardcover), ISBN: 978-0-19-884999-5.
Reviewed for EH.Net by Anthony C. Hotson, Centre for Financial History, University of Cambridge.
It is not clear who coined the term “central banking” but it came into common usage in the 1920s with the emergence of national monetary institutions serving an explicit public purpose. Many of these institutions had antecedents as commercial banks and the term provided a means of distinguishing them from the generality of private banks. M. H. De Kock’s influential book published in 1939 suggested that the origins of central banking could be traced back to the nineteenth century with the Bank of England and the Riksbank of Sweden as leading models.
Mainstream views about the function of central banks remained largely unchanged until the 1990s when increased emphasis came to be placed on their role as bulwarks against financial instability. Deregulation in the 1980s had rendered the banking system more competitive and more exposed to the risks of maturity transformation. Central banks were seen to be the saviors of a potentially fragile system, providing liquidity in times of crisis. Modern-day lender of last resort (LOLR) facilities were said to have developed from arrangements established in the late nineteenth century, a key historical antecedent being Walter Bagehot’s advocacy of the Bank of England’s role as LOLR in Lombard Street (1873).
Ulrich Bindseil’s book provides an important contribution to a revisionist history of central banks, suggesting that their origins can be found in institutions sponsored by European city governments — Barcelona, Genoa, Naples, Venice, Amsterdam, Hamburg, Stockholm — from the fifteenth century. Notwithstanding its name, the Bank of England operated as the City of London’s bank during its early years and was popularly known as the Bank of London. The national banking model came later with Napoleon’s creation of the Banque de France in 1800.
Bindseil and the revisionist school argue that proto-central banks set up before 1800 had a civic purpose, usually being owned by a municipality or a charitable foundation. In many cases, these banks enjoyed municipal guarantees. Private ownership developed later, most notably by the Bank of England in the late seventeenth century. The civic banks issued banknotes and pioneered the creation of paper money of undoubted credit standing. Their banknotes were to be distinguished from other forms of mercantile paper — bills and promissory notes issued by the generality of merchants. Banknotes started to displace specie as the main means of mercantile payment and provided a more resilient settlement asset, particularly during credit crises.
A number of civic banks started as full-reserve banks, but fractional reserve banking offered the benefits of a more elastic supply of money and credit. From time-to-time, some banknotes ceased to be convertible (at par) into specie and this could lead to insolvency. There were multiple reasons for a loss of confidence leading to failure, but a well-known one was political pressure to fund the state and favored corporations, beyond prudent bounds. The holy grail was to build and maintain fractional reserve banks that retained public confidence and paper convertibility.
Bindseil demonstrates that civic banks took an eclectic approach to stabilizing credit and facilitating payment. A recurrent theme was the protection of sound merchants from usurers in distressed markets, e.g. the Nürnberg public bank charter of 1498. The Banco di Rialto was established in Venice in 1587 to help stabilize credit. The Bank of Amsterdam was founded in 1609 to facilitate mercantile payments. It was meant to be fully reserved, but it was drawn into municipal lending and loans to the Dutch East India Company. Examples of systemic LOLR support during the eighteenth century include the response of the Hamburg authorities to the financial crisis of 1763, the role of the Bank of England in 1772 and Bank of Amsterdam in 1773. Bindseil’s book includes an excellent annex that provides a catalogue of 25 pre-1800 civic, public and chartered banks that operated as proto-central banks. The overriding point is that there was a longstanding tradition that predates the nineteenth century whereby civic authorities and their banks were willing to pre-empt and mitigate credit crises.
Bindseil cites arguments presented by Ralph Hawtrey (1932) and Paul Tucker (2014) to the effect that “LOLR operations should define central banking.” This is a popular contemporary view, but is it a step too far? By the late nineteenth century London’s commercial banking sector had grown to the point where the Bank of England’s balance sheet lacked the capacity of stabilize credit markets by resort to LOLR alone. The century of stability of London’s money markets from the 1870s until 1971 depended not just on Bagehot’s LOLR but also on an elaborate system of market demarcations between sectors — discount houses, accepting houses, clearing banks and building societies — each with their own trade association with responsibility for maintaining market discipline and cartelized prices. The exponents of deregulation in the 1980s discarded market demarcations and came to rely on state guarantees for LOLR facilities with an overlay of balance sheet regulation focused on capital requirements.
The experience of 2007/8 has led some, including this reviewer, to conclude that reliance on LOLR for maintaining stability is insufficient. Mervyn King’s The End of Alchemy (2016) has suggested a replacement role for central banks as pawnbrokers for all seasons (PFAS). Under the King plan, collateral rules for central bank borrowing would eventually replace bank capital requirements. In some respects, this brings us back full circle to Bindseil’s world of pre-1800 civic banks that lent for the most part against security or self-liquidating bills. A key difference between then and now is the dominance of residential mortgage lending with its heroic levels of maturity transformation. Solving the problem of home finance may require a further evolution in the role of central banks and possibly the reintroduction specialist mortgage lenders subject to their own rules.
Bindseil’s history of early central banking is a refreshing corrective to the mannerist orthodoxy that still prevails. He resists formulaic views about financial developments and embraces the vagaries of market practice, perhaps reflecting his experience as a practitioner in the European Central Bank. There are some editorial lapses — for example, specie money is systematically referred to as “species money” and the metallic fineness of specie as “finesse” — but the thesis of the book is important and the message is clear.
Anthony C. Hotson is Deputy Director of the Centre for Financial History and a member of Darwin College, Cambridge. His book, Respectable Banking: The Search for Stability in London’s Money and Credit Markets since 1695, was published by Cambridge University Press in 2017.
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