The Bear’s Lair: Land of a thousand banks

Around 1760, the English banking system, which had been concentrated in London, sprouted a plethora of country banks in provincial towns, over 800 by 1813, That produced a unique financial environment, in which both expertise and money were readily available locally for new projects throughout provincial England and Wales. This greatly facilitated the Industrial Revolution, but should we replicate it today, and if so, how?

At the time of the 1660 Restoration, the English financial system was relatively undeveloped. However, in the next 30 years, two groups of financial intermediaries began to emerge. One, based on goldsmiths, specialized in foreign exchange and national money markets, financing the growing government debt (they got in difficulties with the 1672 Stop of the Exchequer, a partial government default, but mostly survived). The goldsmith-bankers dealt little outside London, or with individual clients, except the very rich and those with influence at Court.

The other financial intermediaries grew up from “scriveners” – specialist drafters of legal and other documents. They became active in broking mortgages on gentry estates, then went into the deposit taking business.

After 1688, the predominantly Whig governments, in an era of almost continual war, created for the first time a “funded” long-term government debt, but did so through an extraordinary array of lotteries, tontines, annuities and SPACs that were hugely lucrative for the Whigs’ cosmopolitan allies in the emerging “City of London.” Consequently, the goldsmith-bankers became dominant and the scrivener-bankers, without financial markets know-how, mostly disappeared. For half a century to 1760, there were almost no provincial financial service providers; the industry was wholly oriented towards London, the international markets and the very rich.

Then around 1760, as the country’s political complexion changed with a new King who favored the Tories, representing rural squires and tradespeople, country banks sprang up outside London – over 300 of them by 1790. By a 1708 Whig law, these could have no more than 6 partners, each with unlimited liability. They were formed, not by the aristocracy but by local tradesmen and the country attorneys who had succeeded the scriveners in the mortgage business. Their capital was normally quite small, below 10,000 pounds (about $3 million in today’s money) and often less than half that amount. Socially, country bankers were not the aristocracy, or the equivalent of 1914 merchant bankers; they were regarded only as superior tradesmen – the local squire might invite them to dinner occasionally, but the local Earl would invite them only when he held Open House for the entire neighborhood.

These country banks did NOT directly provide long-term finance of debt or equity; they did not have the balance sheets to do so (if a client needed a mortgage, they acted as broker, finding an investor who wanted a reliable long-term investment). However, they arranged payments, took deposits, and issued bank notes, which were used in business transactions and as a substitute for currency, which was in short supply until the recoinage of 1816. Their most important function was to issue and discount bills of exchange, thus facilitating trade finance. In addition, they made personal “overdraft” loans to their clients, which were secured against promissory notes of twice the amount of the loan, so if you defaulted on a 1,000-pound overdraft, the bank could come after you for 2,000 pounds – these were useful for financing short-term assets such as inventory, etc. There was no “junk” long-term bond market, because of the Usury Act of 1714, which limited interest rates to 5%, making high-risk debt unfinanceable. Given the extremely limited credit assessment capabilities of the period, this was probably a good thing.

If a client needed modest outside financing for a new venture, his country bank’s partners’ meeting, generally over a well-lubricated lunch, could either finance the need out of their own resources or find investors for it from among the bank’s other customers. Watchers of the BBC-TV series “Poldark” can see how this worked; it functioned just as well for textile mills as for tin mines. The pioneer textile manufacturer Sir Richard Arkwright got early-stage financing from Wright & Co., of Nottingham, for example.

The advantages of country banks to the embryonic industrialists of the late 18th Century are clear. At a time when London was two days’ journey from many places where industrialization was happening, the local bank with its local network enabled quite poor people of good reputation to get business finance from local bankers who knew them. Industrial development happened primarily outside London; the amounts required for the early industrialists were quite small, and mostly short-term. Even for larger amounts, the system managed canal developments well through country banks along the projected route of the canal, but national railroads in the following century would need the London public bond market. For example, the first such railroad, the Liverpool and Manchester Railway did an IPO in 1825 in which the diarist Mrs. Harriet Arbuthnot invested. Using the country bank system, skilled working men with a good idea could get local finance, which would have been unobtainable from London houses for such people without extensive social connections in the capital.

In 1712, before country banks existed, the working man Thomas Newcomen of Devon developed his steam engine only with help from an earlier inventor Captain Thomas Savery, who had Court connections and had taken out a patent in 1698. As a result, Newcomen never got rich and his engine, although widely used, was not developed further until James Watt’s improvements after 1769. Country banking revolutionized the innovation process and made finance available to the 99% as well as to the high-aristocracy-or-London-wealthy 1%.

Some of the economic justifications for country banks no longer exist. It no longer takes four days to get from Newcastle to London, so finance-seekers in Kansas can logistically get on a plane to New York, San Francisco or even London and meet with a potential financier within a day. In addition, the general lubrication of finance is much better than it was in 1790; a vast array of debt, equity and derivative products can be designed and sold by anyone competent in the business.

However, the other advantages of country banks are replicated much less well than they should be. A finance-seeker in Kansas is likely to find that nobody local, who he knows, has any capability to provide him with finance beyond a credit card. Even the regional banks and brokers that existed 50 years ago have to a large extent disappeared, so that both commercial banks and investment banks are almost entirely national in scope, concentrated on the two coasts. Of course, they have branches in Kansas, but the financing decision is unlikely to be made by the local branch, by people who know you.

There is an exception to this, and that is the network of people who have graduated from perhaps a dozen top colleges, many of whom then move to the large investment banks and venture capital funds, and of course are readily available to any ex-classmate they knew well, and at least marginally receptive to approaches from fellow alumni. However, that is the exact equivalent of the “Whig Supremacy” financial system before 1760, with no country banks. There was never much difficulty getting financing for an Earl, and not much for even a Baronet, provided he had good London connections. For those today without those connections, or a degree from a top college, financial availability for a new business is as limited outside Silicon Valley as it was in provincial England in 1740. The economic effect of this is worse than in 1740; we have the “woke” Alinskyite admissions departments of the Ivy League selecting the leaders of tomorrow, with less and less emphasis on actual merit.

There is another problem, and it is even more insidious. There were at the peak around 800 country banks, all of them pretty well completely independent of each other (though correspondent banking networks existed). That was a product of the 1797 “suspension of debt payments” which made country bank notes the only means of payment available in many transactions, since Bank of England notes were scarce and coins fled the country to take advantage of the bullion premium available in foreign markets such as Amsterdam.

Nevertheless, even with the full Gold Standard, before 1797 and after 1821, and knocking out the fly-by-night operations, there were at least a couple of hundred solid country banks, all run independently by different partner groups. Since there was no centralized credit training, each country bank did business in its own way, with its own specialties – Stuckeys of Langport, Somerset was very good at agricultural finance, for example. However, provided you were not so eccentric as to set up your business where there was absolutely no local expertise, there were probably half a dozen country banks you might talk to within a day’s horse ride, each of them doing business differently. Even as a working man, you could probably get an introduction to one of them, or more if you needed it – as I said above, these people were not very grand.

The result was that, in the country banking system, many entrepreneurs got finance, and a vast range of small businesses were at least able to discount their receivables, which was what most of them needed. No “groupthink” was possible, no fashionable ideas quelled the eccentrics – the bankers were not fashionable, even if well dressed by say Derby standards. If an idea could work, and could be begun on a modest scale, the chances were that it could be financed.

I do not think we can say the same about today’s financial system. We need a reform that atomizes the system, breaks it down into smaller components, and sends those components to communities across the country, where they can interact primarily with local entrepreneurs without fancy degrees. The big deals are not a problem; if the banks are small they can syndicate deals to 1,000 other banks – any fool can do big deals, as those who have interacted with our leading investment bankers can attest. Little deals are more difficult; they require a country banking system.

(The Bear’s Lair is a weekly column that is intended to appear each Monday, an appropriately gloomy day of the week. Its rationale is that the proportion of “sell” recommendations put out by Wall Street houses remains far below that of “buy” recommendations. Accordingly, investors have an excess of positive information and very little negative information. The column thus takes the ursine view of life and the market, in the hope that it may be usefully different from what investors see elsewhere.)