Lombard Street: A Description of the Money Market

The court of directors would choose better; a small body of men of business would not easily be persuaded to choose an extremely unfit man. But they would not often choose an extremely good man. The really best man would probably not be so rich as the majority of the directors, nor of so much standing, and not unnaturally they would much dislike to elevate to the headship of the City, one who was much less in the estimation of the City than themselves. And they would be canvassed in every way and on every side to appoint a man of mercantile dignity or mercantile influence. Many people of the greatest prestige and rank in the City would covet so great a dignity; if not for themselves, at least for some friend, or some relative, and so the directors would be set upon from every side.

An election so liable to be disturbed by powerful vitiating causes would rarely end in a good choice. The best candidate would almost never be chosen; often, I fear, one would be chosen altogether unfit for a post so important. And the excitement of so keen an election would altogether disturb the quiet of the Bank. The good and efficient working of a board of Bank directors depends on its internal harmony, and that harmony would be broken for ever by the excitement, the sayings, and the acts of a great election. The board of directors would almost certainly be demoralised by having to choose a sovereign, and there is no certainty, nor any great likelihood, indeed, that they would choose a good one. In France the difficulty of finding a good body to choose the Governor of the Bank has been met characteristically. The Bank of France keeps the money of the State, and the State appoints its governor. The French have generally a logical reason to give for all they do, though perhaps the results of their actions are not always so good as the reasons for them. The Governor of the Bank of France has not always, I am told, been a very competent person; the Sub-Governor, whom the State also appoints, is, as we might expect, usually better. But for our English purposes it would be useless to inquire minutely into this. No English statesman would consent to be responsible for the choice of the Governor of the Bank of England. After every panic, the Opposition would say in Parliament that the calamity had been 'grievously aggravated,' if not wholly caused, by the 'gross misconduct' of the Governor appointed by the ministry. Or, possibly, offices may have changed occupants and the ministry in power at the panic would be the opponents of the ministry which at a former time appointed the Governor. In that case they would be apt to feel, and to intimate, a 'grave regret' at the course which the nominee of their adversaries had 'thought it desirable to pursue.' They would not much mind hurting his feelings, and if he resigned they would have themselves a valuable piece of patronage to confer on one of their own friends. No result could be worse than that the conduct of the Bank and the management should be made a matter of party politics, and men of all parties would agree in this, even if they agreed in almost nothing else.

I am therefore afraid that we must abandon the plan of improving the government of the Bank of England by the appointment of a permanent Governor, because we should not be sure of choosing a good governor, and should indeed run a great risk, for the most part, of choosing a bad one.

I think, however, that much of the advantage, with little of the risk, might be secured by a humbler scheme. In English political offices, as was observed before, the evil of a changing head is made possible by the permanence of a dignified subordinate. Though the Parliamentary Secretary of State and the Parliamentary Under-Secretary go in and out with each administration, another Under-Secretary remains through all such changes, and is on that account called 'permanent.' Now this system seems to me in its principle perfectly applicable to the administration of the Bank of England. For the reasons which have just been given, a permanent ruler of the Bank of England cannot be appointed; for other reasons, which were just before given, some most influential permanent functionary is essential in the proper conduct of the business of the Bank; and, mutatis mutandis, these are the very difficulties, and the very advantages which have led us to frame our principal offices of state in the present fashion.

Such a Deputy-Governor would not be at all a 'king' in the City. There would be no mischievous prestige about the office; there would be no attraction in it for a vain man; and there would be nothing to make it an object of a violent canvass or of unscrupulous electioneering. The office would be essentially subordinate in its character, just like the permanent secretary in a political office. The pay should be high, for good ability is wanted—but no pay would attract the most dangerous class of people. The very influential, but not very wise, City dignitary who would be so very dangerous is usually very opulent; he would hardly have such influence he were not opulent: what he wants is not money, but 'position.' A Governorship of the Bank of England he would take almost without salary; perhaps he would even pay to get it: but a minor office of essential subordination would not attract him at all. We may augment the pay enough to get a good man, without fearing that by such pay we may tempt—as by social privilege we should tempt—exactly the sort of man we do not want.

Undoubtedly such a permanent official should be a trained banker. There is a cardinal difference between banking and other kinds of commerce; you can afford to run much less risk in banking than in commerce, and you must take much greater precautions. In common business, the trader can add to the cost price of the goods he sells a large mercantile profit, say 10 to 15 per cent; but the banker has to be content with the interest of money, which in England is not so much as per cent upon the average. The business of a banker therefore cannot bear so many bad debts as that of a merchant, and he must be much more cautious to whom he gives credit. Real money is a commodity much more coveted than common goods: for one deceit which is attempted on a manufacturer or a merchant, twenty or more are attempted on a banker. And besides, a banker, dealing with the money of others, and money payable on demand, must be always, as it were, looking behind him and seeing that he has reserve enough in store if payment should be asked for, which a merchant dealing mostly with his own capital need not think of. Adventure is the life of commerce, but caution, I had almost said timidity, is the life of banking; and I cannot imagine that the long series of great errors made by the Bank of England in the management of its reserve till after 1857, would have been possible if the merchants in the Bank court had not erroneously taken the same view of the Bank's business that they must properly take of their own mercantile business. The Bank directors have almost always been too cheerful as to the Bank's business, and too little disposed to take alarm. What we want to introduce into the Bank court is a wise apprehensiveness, and this every trained banker is taught by the habits of his trade, and the atmosphere of his life.

The permanent Governor ought to give his whole time to the business of the Bank. He ought to be forbidden to engage in any other concern. All the present directors, including the Governor and Deputy-Governor, are engaged in their own business, and it is very possible, indeed it must perpetually have happened, that their own business as merchants most occupied the minds of most of them just when it was most important that the business of the Bank should occupy them. It is at a panic and just before a panic that the business of the Bank is most exacting and most engrossing. But just at that time the business of most merchants must be unusually occupying and may be exceedingly critical. By the present constitution of the Bank, the attention of its sole rulers is most apt to be diverted from the Bank's affairs just when those affairs require that attention the most. And the only remedy is the appointment of a permanent and influential man, who will have no business save that of the Bank, and who therefore presumably will attend most to it at the critical instant when attention is most required. His mind, at any rate, will in a panic be free from pecuniary anxiety, whereas many, if not all, of the present directors must be incessantly thinking of their own affairs and unable to banish them from their minds.

The permanent Deputy-Governor must be a director and a man of fair position. He must not have to say 'Sir' to the Governor. There is no fair argument between an inferior who has to exhibit respect and a superior who has to receive respect. The superior can always, and does mostly, refute the bad arguments of his inferior; but the inferior rarely ventures to try to refute the bad arguments of his superior. And he still more rarely states his case effectually; he pauses, hesitates, does not use the best word or the most apt illustration, perhaps he uses a faulty illustration or a wrong word, and so fails because the superior immediately exposes him. Important business can only be sufficiently discussed by persons who can say very much what they like very much as they like to one another. The thought of the speaker should come out as it was in his mind, and not be hidden in respectful expressions or enfeebled by affected doubt. What is wanted at the Bank is not a new clerk to the directors—they have excellent clerks of great experience now—but a permanent equal to the directors, who shall be able to discuss on equal terms with them the business of the Bank, and have this advantage over them in discussion, that he has no other business than that of the Bank to think of.

The formal duties of such a permanent officer could only be defined by some one conversant with the business of the Bank, and could scarcely be intelligibly discussed before the public. Nor are the precise duties of the least importance. Such an officer, if sound, able, and industrious, would soon rule the affairs of the Bank. He would be acquainted better than anyone else, both with the traditions of the past and with the facts of the present; he would have a great experience; he would have seen many anxious times; he would always be on the watch for their recurrence. And he would have a peculiar power of guidance at such moments from the nature of the men with whom he has most to deal. Most Governors of the Bank of England are cautious merchants, not profoundly skilled in banking, but most anxious that their period of office should be prosperous and that they should themselves escape censure. If a 'safe' course is pressed upon them they are likely to take that course. Now it would almost always be 'safe' to follow the advice of the great standing 'authority'; it would always be most 'unsafe' not to follow it. If the changing Governor act on the advice of the permanent Deputy-Governor, most of the blame in case of mischance would fall on the latter; it would be said that a shifting officer like the Governor might very likely not know what should be done, but that the permanent official was put there to know it and paid to know it. But if, on the other hand, the changing Governor should disregard the advice of his permanent colleague, and the consequence should be bad, he would be blamed exceedingly. It would be said that, 'being without experience, he had taken upon him to overrule men who had much experience; that when the constitution of the Bank had provided them with skilled counsel, he had taken on himself to act of his own head, and to disregard that counsel;' and so on ad infinitum. And there could be no sort of conversation more injurious to a man in the City; the world there would say, rightly or wrongly, 'We must never be too severe on errors of judgment; we are all making them every day; if responsible persons do their best we can expect no more. But this case is different: the Governor acted on a wrong system; he took upon himself an unnecessary responsibility:' and so a Governor who incurred disaster by disregarding his skilled counsellor would be thought a fool in the City for ever. In consequence, the one skilled counsellor would in fact rule the Bank. I believe that the appointment of the new permanent and skilled authority at the Bank is the greatest reform which can be made there, and that which is most wanted. I believe that such a person would give to the decision of the Bank that foresight, that quickness, and that consistency in which those decisions are undeniably now deficient. As far as I can judge, this change in the constitution of the Bank is by far the most necessary, and is perhaps more important even than all other changes. But, nevertheless, we should reform the other points which we have seen to be defective.

First, the London bankers should not be altogether excluded from the court of directors. The old idea, as I have explained, was that the London bankers were the competitors of the Bank of England, and would hurt it if they could. But now the London bankers have another relation to the Bank which did not then exist, and was not then imagined. Among private people they are the principal depositors in the Bank; they are therefore particularly interested in its stability; they are especially interested in the maintenance of a good banking reserve, for their own credit and the safety of their large deposits depend on it. And they can bring to the court of directors an experience of banking itself, got outside the Bank of England, which none of the present directors possess, for they have learned all they know of banking at the Bank itself. There was also an old notion that the secrets of the Bank would be divulged if they were imparted to bankers. But probably bankers are better trained to silence and secrecy than most people. And there is only a thin partition now between the bankers and the secrets of the Bank. Only lately a firm failed of which one partner was a director of the London and Westminster Bank, and another a director of the Bank of England. Who can define or class the confidential communications of such persons under such circumstances?

As I observed before, the line drawn at present against bankers is very technical and exclusively English. According to continental ideas, Messrs. Rothschild are bankers, if any one is a banker. But the house of Rothschild is represented on the Bank direction. And it is most desirable that it should be represented, for members of that firm can give if they choose confidential information of great value to the Bank. But, nevertheless, the objection which is urged against English bankers is at least equally applicable to these foreign bankers. They have, or may have, at certain periods an interest opposite to the policy of the Bank. As the greatest Exchange dealers, they may wish to export gold just when the Bank of England is raising its rate of interest to prevent anyone from exporting gold. The vote of a great Exchange dealer might be objected to for plausible reasons of contrary interest, if any such reasons were worth regarding. But in fact the particular interest of single directors is not to be regarded; almost all directors who bring special information labour under a suspicion of interest; they can only have acquired that information in present business, and such business may very possibly be affected for good or evil by the policy of the Bank. But you must not on this account seal up the Bank hermetically against living information; you must make a fair body of directors upon the whole, and trust that the bias of some individual interests will disappear and be lost in the whole. And if this is to be the guiding principle, it is not consistent to exclude English bankers from the court.

Objection is often also taken to the constitution of the Committee of Treasury. That body is composed of the Governor and Deputy-Governor and all the directors who have held those offices; but as those offices in the main pass in rotation, this mode of election very much comes to an election by seniority, and there are obvious objections to giving, not only a preponderance to age, but a monopoly to age. In some cases, indeed, this monopoly I believe has already been infringed. When directors have on account of the magnitude of their transactions, and the consequent engrossing nature of their business, declined to fill the chair, in some cases they have been asked to be members of the Committee of Treasury notwithstanding. And it would certainly upon principle seem wiser to choose a committee which for some purposes approximates to a committee of management by competence rather than by seniority.

An objection is also taken to the large number of Bank directors. There are twenty-four directors, a Governor and a Deputy-Governor, making a total court of twenty-six persons, which is obviously too large for the real discussion of any difficult business. And the case is worse because the court only meets once a week, and only sits a very short time. It has been said, with exaggeration, but not without a basis of truth, that if the Bank directors were to sit for four hours, there would be 'a panic solely from that.' 'The court,' says Mr. Tooke, 'meets at half-past eleven or twelve; and, if the sitting be prolonged beyond half-past one, the Stock Exchange and the money market become excited, under the idea that a change of importance is under discussion; and persons congregate about the doors of the Bank parlour to obtain the earliest intimation of the decision.' And he proceeds to conjecture that the knowledge of the impatience without must cause haste, if not impatience, within. That the decisions of such a court should be of incalculable importance is plainly very strange.

There should be no delicacy as to altering the constitution of the Bank of England. The existing constitution was framed in times that have passed away, and was intended to be used for purposes very different from the present. The founders may have considered that it would lend money to the Government, that it would keep the money of the Government, that it would issue notes payable to bearer, but that it would keep the 'Banking reserve' of a great nation no one in the seventeenth century imagined. And when the use to which we are putting an old thing is a new use, in common sense we should think whether the old thing is quite fit for the use to which we are setting it. 'Putting new wine into old bottles' is safe only when you watch the condition of the bottle, and adapt its structure most carefully.

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 pre-conceived 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; anyone 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 CapitalL

Above 20 per cent 15 5,302,767

Between 15 and 20 per cent 20 5,439,439

" 10 and 15 per cent 36 14,056,950

" 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 62 1/2 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 L., or nearly 1/3 rd 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.