Lombard Street

This text will be one of basis for discussion at the FTE/PTA conference in April. Bagehot references Adam Smith in his analysis of the costs and benefits of central banking v competitive or free banking. He writes:

The value of money is settled, like that of all other commodities, by supply and demand, and only the form is essentially different. In other commodities all the large dealers fix their own price; they try to underbid one another, and that keeps down the price; they try to get as much as they can out of the buyer, and that keeps up the price. Between the two what Adam Smith calls the higgling of the market settles it. And this is the most simple and natural mode of doing business, but it is not the only mode.
http://www.econlib.org/library/Bagehot/bagLom5.html#Chapter V, The Mode in Which the Value of Money is Settled in Lombard Street

Bagehot uses Smith's concept of "natural liberty" in his characterization and preference for a system of "natural" banking - a financial system that would be decentralized and competitive, although he realizes that the path dependent nature of emergent systems precludes this system in 19th century England and, presumably contemporary times.

He outlines the system of natural banking:

Under a natural system of banking it would have every facility. Where there were many banks keeping their own reserve, and each most anxious to keep a sufficient reserve, because its own life and credit depended on it, the risk of the Government in keeping a banker would be reduced to a minimum. It would have the choice of many bankers, and would not be restricted to any one.IV.6
http://www.econlib.org/library/Bagehot/bagLom4.html#IV.6

But he recognizes the barriers to this natural system:

But it will be said—What would be better? What other system could there be? We are so accustomed to a system of banking, dependent for its cardinal function on a single bank, that we can hardly conceive of any other. But the natural system—that which would have sprung up if Government had let banking alone—is that of many banks of equal or not altogether unequal size. In all other trades competition brings the traders to a rough approximate equality. In cotton spinning, no single firm far and permanently outstrips the others. There is no tendency to a monarchy in the cotton world; nor, where banking has been left free, is there any tendency to a monarchy in banking either. In Manchester, in Liverpool, and all through England, we have a great number of banks, each with a business more or less good, but we have no single bank with any sort of predominance; nor is there any such bank in Scotland. In the new world of Joint Stock Banks outside the Bank of England, we see much the same phenomenon. One or more get for a time a better business than the others, but no single bank permanently obtains an unquestioned predominance. None of them gets so much before the others that the others voluntarily place their reserves in its keeping. A republic with many competitors of a size or sizes suitable to the business, is the constitution of every trade if left to itself, and of banking as much as any other. A monarchy in any trade is a sign of some anomalous advantage, and of some intervention from without.

http://www.econlib.org/library/Bagehot/bagLom2.html#II.63

II.65
On this account, I do not suggest that we should return to a natural or many-reserve system of banking. I should only incur useless ridicule if I did suggest it. Nor can I propose that we should adopt the simple and straightforward expedient by which the French have extricated themselves from the same difficulty. In France all banking rests on the Bank of France, even more than in England all rests on the Bank of England.

http://www.econlib.org/library/Bagehot/bagLom2.html#II.65