Lesson from history of Rothschilds and US free banking

Lars Rhode, Governor of Denmark Central bank in this speech speaks on trust in financial services (what else to talk!).

My topic is trust and transparency in the financial system.

In recent years, the topic has surfaced again following a number of unfortunate issues that have accumulated since the financial crisis. For a long time we may have thought that this was primarily a problem that existed outside Denmark’s borders. But then cases emerged in Denmark too. There have been money laundering cases, there have been deliveries of very large banknotes to bureaux de change, and incorrect advice has been provided in connection with investment  products. The financial sector has been involved in transactions that have drained the government  coffers of many billions of kroner in dividend tax. And I am sure we could find more examples.

What these examples have in common is that they contributed to undermining trust in the financial system. Trust is low at the global level. That  has been documented by the Edelman Trust Barometer. In fact, one of the key messages in the Edelman analysis is that the financial sector is the sector that people trust the least. Danish surveys also point to low trust in the financial sector.

He picks examples from Rothschild and US free banking:

How can we learn more about the present and about how to shape the future? One way is to look back and learn from history. So I would like to start with two examples from the past.

I will begin in the 18th century. More specifically with the Rothschild family dynasty. It was founded by Mayer Amschel Rothschild. He was the head
of a poor family comprising his wife and 10 children. The family lived in Frankfurt in the late 18th century. Good ideas combined with unusual
willpower gave Mayer Rothschild a point of departure for forging business relationships with powerful men in the area. He also dispersed his
sons across Europe. The sons established their separate trading firms and were successful. Especially the son in London was doing well. He
soon became so rich that he could lend money to the Duke of Wellington. In 1814, this son became the British government’s secret banker for funding the Napoleonic wars.

My other retrospective example relates to a period of around 30 years in mid-19th century USA. Before this period, every single bank in the USA
had to have a charter through special legislation for that specific bank.  However, this changed when many states began to introduce state charters describing the general requirements to be met by banks that wanted a licence to operate. This period has been called the “free banking” era .because anyone meeting the relevant state’s banking requirements could establish a bank. 

Lessons:

What can we learn from these two historical examples? Firstly, I note that the people involved also took on the risk – they all had something at  stake. It was their own money – or their close business partners’ money – that was lent. That gave them an incentive for sound risk management. They were focused on behaving in such a way that their good names and reputations and their wealth were not jeopardised. That is no longer the case.

Today’s banks are so large that no individual or small group of people can own and operate a big bank. This means that there is no longer a close link between those bearing the risk, the owners, and the day-to-day management. When shares are as widely dispersed as they are in most Danish banks, everyone is responsible, which ultimately means that no-one takes on the responsibility. Being owned by everyone is the same as being owned by no-one.

Secondly, I note that the market plays an important role. It is good if clients vote with their feet.

You might ask whether things had been different today if we had learnt more from history.

Banking clearly has swung from one extreme to another. In earlier days it was common for banks to fail with minimal protection and markets voting with their feet. Now even bad banks do not fail..

 

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