Lombard Street: A Description of the Money Market

by Walter Bagehot

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 anyone 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 which 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 that 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 anyone 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.