Lombard Street: A Description of the Money Market

by Walter Bagehot

The amount of the present business of private banks is perfectly unknown. Their balance sheets are effective secrets—rigidly guarded. But none of them, except a few of the largest, are believed at all to gain business. The common repute of Lombard Street might be wrong in a particular case, but upon the general doctrine it is almost sure to be right. There are a few well-known exceptions, but according to universal belief the deposits of most private bankers in London tend rather to diminish than to increase.

As to the smaller banks, this naturally would be so. A large bank always tends to become larger, and a small one tends to become smaller. People naturally choose for their banker the banker who has most present credit, and the one who has most money in hand is the one who possesses such credit. This is what is meant by saying that a long established and rich bank has a 'privileged opportunity'; it is in a better position to do its business than any one else is; it has a great advantage over old competitors and an overwhelming superiority over new comers. New people coming into Lombard Street judge by results; they give to those who have: they take their money to the biggest bank because it is the biggest. I confess I cannot, looking far forward into the future, expect that the smaller private banks will maintain their ground. Their old connections will not leave them; there will be no fatal ruin, no sudden mortality. But the tide will gently ebb, and the course of business will be carried elsewhere.

Sooner or later, appearances indicate, and principle suggests, that the business of Lombard Street will be divided between the joint stock banks and a few large private banks. And then we have to ask ourselves the question, can those large private banks be permanent? I am sure I should be very sorry to say that they certainly cannot, but at the same time I cannot be blind to the grave difficulties which they must surmount.

In the first place, an hereditary business of great magnitude is dangerous. The management of such a business needs more than common industry and more than common ability. But there is no security at all that these will be regularly continued in each generation. The case of Overend, Gurney and Co., the model instance of all evil in business, is a most alarming example of this evil. No cleverer men of business probably (cleverer I mean for the purposes of their particular calling) could well be found than the founders and first managers of that house. But in a very few years the rule in it passed to a generation whose folly surpassed the usual limit of imaginable incapacity. In a short time they substituted ruin for prosperity and changed opulence into insolvency. Such great folly is happily rare; and the business of a bank is not nearly as difficult as the business of a discount company. Still much folly is common, and the business of a great bank requires a great deal of ability, and an even rarer degree of trained and sober judgment. That which happened so marvelously in the green tree may happen also in the dry. A great private bank might easily become very rotten by a change from discretion to foolishness in those who conduct it.

We have had as yet in London, happily, no example of this; indeed, we have hardly as yet had the opportunity. Till now private banks have been small; small as we now reckon banks. For their exigencies a moderate degree of ability and an anxious caution will suffice. But if the size of the banks is augmented and greater ability is required, the constant difficulty of an hereditary government will begin to be felt. 'The father had great brains and created the business: but the son had less brains and lost or lessened it.' This is the history of all great monarchies, and it may be the history of great private banks. The peculiarity in the case of Overend, Gurney and Co. at least, one peculiarity is that the evil was soon discovered. The richest partners had least concern in the management; and when they found that incredible losses were ruining them, they stopped the concern and turned it into a company. But they had done nothing; if at least they had only prevented farther losses, the firm might have been in existence and in the highest credit now. It was the publicity of their losses which ruined them. But if they had continued to be a private partnership they need not have disclosed those losses: they might have written them off quietly out of the immense profits they could have accumulated. They had some ten millions of other people's money in their hands which no one thought of disturbing. The perturbation through the country which their failure caused in the end, shows how diffused and how unimpaired their popular reputation was. No one in the rural districts (as I know by experience) would ever believe a word against them, say what you might. The catastrophe came because at the change the partners in the old private firm—the Gurney family especially—had guaranteed the new company against the previous losses: those losses turned out to be much greater than was expected. To pay what was necessary the 'Gurneys' had to sell their estates, and their visible ruin destroyed the credit of the concern. But if there had been no such guarantee, and no sale of estates, if the great losses had slept a quiet sleep in a hidden ledger, no one would have been alarmed, and the credit and the business of 'Overends' might have existed till now, and their name still continued to be one of our first names. The difficulty of propagating a good management by inheritance for generations is greatest in private banks and discount firms because of their essential secrecy.

The danger may indeed be surmounted by the continual infusion of new and able partners. The deterioration of the old blood may be compensated by the excellent quality of the fresh blood. But to this again there is an objection, of little value perhaps in seeming, but of much real influence in practice. The infusion of new partners requires from the old partners a considerable sacrifice of income; the old must give up that which the new receive, and the old will not like this. The effectual remedy is so painful that I fear it often may be postponed too long.

I cannot, therefore, expect with certainty the continuance of our system of private banking. I am sure that the days of small banks will before many years come to an end, and that the difficulties of large private banks are very important. In the mean time it is very important that large private banks should be well managed. And the present state of banking makes this peculiarly difficult. The detail of the business is augmenting with an overwhelming rapidity. More cheques are drawn year by year; not only more absolutely, but more by each person, and more in proportion to his income. The payments in, and payments out of a common account are very much more numerous than they formerly were. And this causes an enormous growth of detail. And besides, bankers have of late begun almost a new business. They now not only keep people's money, but also collect their incomes for them. Many persons live entirely on the income of shares, or debentures, or foreign bonds, which is paid in coupons, and these are handed in for the bank to collect. Often enough the debenture, or the certificate, or the bond is in the custody of the banker, and he is expected to see when the coupon is due, and to cut it off and transmit it for payment. And the detail of all this is incredible, and it needs a special machinery to cope with it.

A large joint stock bank, if well-worked, has that machinery. It has at the head of the executive a general manager who was tried in the detail of banking, who is devoted to it, and who is content to live almost wholly in it. He thinks of little else, and ought to think of little else. One of his first duties is to form a hierarchy of inferior officers, whose respective duties are defined, and to see that they can perform and do perform those duties. But a private bank of the type usual in London has no such officer. It is managed by the partners; now these are generally rich men, are seldom able to grapple with great business of detail, and are not disposed to spend their whole lives and devote their entire minds to it if they were able. A person with the accumulated wealth, the education and the social place of a great London banker would be a 'fool so to devote himself. He would sacrifice a suitable and a pleasant life for an unpleasant and an unsuitable life. But still the detail must be well done; and some one must be specially chosen to watch it and to preside over it, or it will not be well done. Until now, or until lately, this difficulty has not been fully felt. The detail of the business of a small private bank was moderate enough to be superintended effectually by the partners. But, as has been said, the detail of banking—the proportion of detail to the size of the bank—is everywhere increasing. The size of the private banks will have to augment if private banks are not to cease; and therefore the necessity of a good organisation for detail is urgent. If the bank grows, and simultaneously the detail grows in proportion to the bank, a frightful confusion is near unless care be taken.

The only organisation which I can imagine to be effectual is that which exists in the antagonistic establishments. The great private banks will have, I believe, to appoint in some form or other, and under some name or other, some species of general manager who will watch, contrive, and arrange the detail for them. The precise shape of the organisation is immaterial; each bank may have its own shape, but the man must be there. The true business of the private partners in such a bank is much that of the directors in a joint stock bank. They should form a permanent committee to consult with their general manager, to watch him, and to attend to large loans and points of principle. They should not themselves be responsible for detail; if they do there will be two evils at once: the detail will be done badly, and the minds of those who ought to decide principal things will be distracted from those principal things. There will be a continual worry in the bank, and in a worry bad loans are apt to be made and money is apt to be lost.

A subsidiary advantage of this organisation is that it would render the transition from private banking to joint stock banking easier, if that transition should be necessary. The one might merge in the other as convenience suggested and as events required. There is nothing intrusive in discussing this subject. The organisation of the private is just like that of the joint stock banks; all the public are interested that it should be good. The want of a good organisation may cause the failure of one or more of these banks; and such failure of such banks may intensify a panic, even if it should not cause one.