Freebanking and free banking

[Dave Birch] Foreign readers may be unaware that banks in Scotland and Northern Ireland issue their own banknotes. In the England and Wales (and everywhere else in the entire world), banknotes are issued by the central bank. As The Economist points out, feelings run deep. Sir Walter Scott is commemorated on banknotes in Scotland precisely because he fought off the Bank of England's 1826 attempt to stop Scottish banks from issuing their own notes.
There are nearly £3 billion-worth of Scottish banknotes in circulation (and half as much in Northern Irish banknotes). For odd historical reasons, the issuing banks have to back their note issue with a deposit of 95% the value of notes outstanding, but only at the weekends! Seriously. So during the week they can lend the money out and earn seigniorage. The Scottish banks currently earn good money this way so the change

would lose Scottish banks some of the £65m they now earn in interest and “seigniorage” (income from selling their notes to other banks).

[From Scottish banknotes | Under threat | Economist.com]

The Treasury, presumably still wondering what to do about Northern Rock, wants to spoil the party and force Scottish and Northern Irish note-issuing banks to keep the deposit backing the note issue at the Bank of England all the time, just in case (eg) RBS goes bankrupt but not on Saturday or Sunday. In the England and Wales there is a different system: the Bank of England, the most profitable nationalised industry in British history, backs its notes not with deposits of euros or gold bars but with fixed-interest instruments bought from the British government and remits the interest earned to the Treasury.

I don't imagine that I might agree with Alex Salmond, leader of the Scottish National Party, on much beyond the issue of independence for Scotland, but I do agree with him on his defence of the Scottish note issue: he said that there's no need for the Treasury to take this action because Scottish banks are among the most stable in the world. The SNP's defence is robust...

The changes suggested will cost Scotland's financial sector £80 million a year. This is daylight robbery by the UK Treasury and will provide Scotland's financial sector no advantage whatsoever.

[From MP Warns Treasury - 'Hands Off Scottish Bank Notes' — SNP - Scottish National Party]

As it happens, I have a particular interest in the history of Scottish banks because of the lessons of that period of "free banking". This does not, as you might think, mean that Scottish banks were once operated as charities but that they were free to compete in note issue. And the result, as most historians would confirm, was a period of incredible innovation when the more tightly regulated London and country banks failed more often than the less tightly regulated Scottish banks did (I know this is an appalling precis of a complicated and interesting period, but I'm trying to make a bigger point).

Scotland had an enviable track record of innovation in the finance and banking sector right up until the time when the Bank of England's outrageous monopoly was extended north of the border, this prompting Sir Walter Scott's famous last-ditch defence of Scottish notes. Lawrence White's fascinating "Free Banking in Britain: Theory, Experience and Debate, 1800-1845" is a great place to begin if you're interested in delving further into this period in the history of money. Anyway, here's your handy cut-out-n-keep guide to innovation in Scottish banking:

1695	Britain’s first joint stock clearing bank, the Bank of Scotland, created by the Scots parliament.
1728	The first overdraft is granted by the Royal Bank of Scotland
1750	The British Linen Bank (Scottish, despite the name) starts to build the world’s first branch network.
1777	World’s first multi–coloured bank notes printed by the Royal Bank.
1810	First savings bank established in Ruthwell.
1826	Royal Bank of Scotland launches banknotes printed on both sides.
1845	Westminster, despite Scottish protests, legislates against private note issue. Since this date no major commercial banks have been formed in Scotland.

The connection between freebanking and innovation seems clear. When a previous wave of innovation (paper money) swept through the British economy, freebanking Scotland was far more successful than England in exploiting that technological change to make the economy more efficient (and more stable). By 1850, when 90% of all commercial transactions in France were still being settled in gold or silver (as were a third of those in England), 90% of all commercial transactions in Scotland were being settled with paper (see Niall Ferguson, "The Cash Nexus". I wonder if regulation might prevent innovation in the next wave of technological change around NFC and mobiles, pre-paid and e-gold? That's just the sort of thing I'll be asking the panelists in the "Omlettes and Eggs" session about innovation and this year's Digital Money Forum in London on 23rd/24th April 2008.

These opinions are my own (I think) and presented solely in my capacity as an interested member of the general public [posted with ecto]

Comments

[Oscar]

go to www.typepad.com . goodluck!

[David Watts]

Currency in Hong Kong is issued by HSBC and Standard Chartered. Don't know if they get to keep the seigniorage or have to turn it over to the HKMA.

[Iang]

Hear hear!

Releasing innovation to the British banks would not be a loss to the Central Bank, unless the interests of the Central Bank are so tied to those of the banks that it can't be unravelled.

What might be a loss is the seignorage. However, that is no loss to society, it is simply returned to the people, who are undeniably better placed to enjoy it. One tax gone, and more efficiency all round. One way to argue this is that with the Euro zone diving deeper into stifling regulation, a competitive strategy is to adopt a more innovative finance sector.

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