Current Views on the Nature and Origins of Central Banks

Chapter 1 first restates the present dominant view on the nature and origin of central banking, which can be summarized as follows: (1) Defining central banking is ‘by no means straightforward’; (2) the Riksens Ständers Bank and the Bank of England would have been the first sort-of central banks; (3) early central banks did not have a policy mandate and the orientation towards public objectives would go back only to the nineteenth century; (4) there has been no concept of central banking before 1800; (5) early central banking developed out of the largest commercial banks; (6) the lender of last resort (LOLR) would have developed only in the second half of the nineteenth century or even later. Second, the chapter reviews a recent literature which started again to question this view. It is explained how this book will take up the challenge to correct the myth about the origins of central banking.

Introduction and Overview

The Introduction describes the main themes and objectives of the book and provides an overview of its content. First, the current dominant view on the origins of central banking is recalled and challenged, and it is outlined what alternative view this book will propose, namely that central banking dates back to before 1800 and that a number of European continental institutions played a major role in its development. Then an overview of the chapters of the book is provided: Chapter 1 restating the currently dominant view on the origins of central banking; Chapter 2 on money issuance; Chapter 3 on the relation with the government; Chapter 4 on lending to the private sector; Chapter 5 on the lender-of-last resort; Chapter 6 on the overall balance sheet of early central banks; and Chapter 7 restating the rehabilitation of early central banking; The annex schematically reviews a total of 25 central banks operating before 1800.

Early Central Banks’ Economics and Balance Sheets

This chapter summarizes the roles of the various central bank operations in the pre-1800 world, what one can conclude on the overall economics and business model of early central banking, and what this implies in terms of overall balance sheet and risk management approach. The ‘alchemical quest’ of early central banking included in particular the universal challenge of bank balance sheet management to achieve significant liquidity, maturity, and credit transformation while preserving bank funding stability also in future stress situations at a high level of confidence. Section 6.1 reviews again in one context the key balance sheet positions of early central banks and the associated economic functions and market operations. Section 6.2 systematically compares the operations of the major early central banks and reviews their balance sheet structures and relative sizes.

Lending to Private Borrowers and Other Private Assets

This chapter recalls the economic rationale of central bank lending to private borrowers (Section 4.1) and argues that the recent literature has often underestimated the importance of such lending by early central banks, without this implying that central banks were really competing with ‘commercial’ banks (Section 4.2). Finally, it illustrates pre-eighteenth-century awareness of the subject by reviewing the literature of the time (Section 4.3). Lending of central banks to private borrowers had a number of advantages relevant as of the first centuries of central banking: (1) providing an option for granular asset diversification and expansion, allowing thereby also to increase the monetary base; (2) generating income with limited risks; (3) improving the availability and pricing of loans for private debtors; (4) anchorizing the central bank in society. Lending to private borrowers took in particular the form of Lombard and discount operations.

Annex

The annex presents, with a common template, a catalogue of 25 pre-1800 central banks. While it benefits considerably from previous surveys, it has a narrower focus on central bank operations and balance sheets, and on the genealogy of central banking. It also includes some banks which are not contained in the previous surveys of Roberds and Velde (the Bank of Scotland, the Banco di Santo Spirito di Roma, the American settlers’ land bank projects, the central bank projects of Leipzig and Cologne, the Copenhagen bank, the Russian Assignation Banks, the Banco Nacional de San Carlo, the Bank of North America, and the Bank of the United States). Not all institutions completely fulfil the definition of a central bank, and particularly not for the entire lifetime of its existence. However, all banks included had, at least in the way they were conceived, important elements of central banking, and thereby at least illustrate the challenges that central bank design faced pre-1800.

Issuing Financial Money of Ultimate Quality

The essence of central banking is the issuance of central bank money—being itself defined as dominant financial money used at a large scale for payments and being of the highest possible credit and liquidity quality amongst all financial assets, such that payment through it is accepted as settlement of any other financial claim. This chapter elaborates on the nature of central bank money and reviews the pre-1800 theory and practice of central bank money issuance. It is shown that the nature of central bank money and its benefits were well understood by early authors. Moreover, the 25 central banks that issued (or at least aimed at) issuing central bank money before 1800 are introduced. The types of central bank money (deposits, banknotes, certificates of deposits) are briefly reviewed.

Rehabilitation

This chapter returns to the question who invented what in central banking. The review confirms broader and earlier origins of central banking, with particularly the early banks in Barcelona, Genoa, Naples, Venice, Amsterdam, and Hamburg having all made major contributions and actually having developed all central bank operations that would prevail until the early twentieth century (except discounting trade bills). The Bank of England invented the private ownership model based on a joint stock company, which became the template for most central bank creations in the eighteenth and nineteenth centuries, but has been considered outdated since the mid twentieth century. Moreover, it had the largest balance sheet amongst all central banks in the eighteenth century. The chapter ends with a list of 15 major current central bank topics which all can be traced back to before 1800, showing how relevant the study of early central banking remains.

Lender of Last Resort

The recent central banking literature often argues that the LOLR function would be the key feature defining a ‘modern’ central bank. This chapter argues that this view may appear too radical (despite the enormous benefits of the LOLR) as the appearance of the LOLR does not change the nature of central banking (which is primarily associated with the issuance of central bank money). After providing an overview of the roles of central banks for financial stability, the chapter focuses on one early LOLR episode, namely the measures of the Hamburger Bank, Bank of Amsterdam and Bank of England in the European debt crisis of 1763. It is shown that in particular the Hamburger Bank acted as systemic lender of last resort, comparable to what modern central banks did in 2008.

Lending to, and Relation with the Government

This chapter discusses pre-1800 relations between central banks and governments, including central bank lending to the government. The latter is interpreted both from the monetary perspective in Section 3.1 (need for secure and liquid assets to leverage the precious metal reserves) and from the state financing perspective in Section 3.2 (reliable and elastic additional source of government funding). Both may be beneficial for society, but from the perspective of central banking, the first is sufficient. Section 3.3 reviews the pre-1800 risks of problematic recourse of the government to the central bank. Section 3.4 reviews the tools that have been designed to reduce the risks of government exploitation of central banks. Section 3.5 discusses why all pre-1800 central banks were created through an exclusive public charter. Finally, Section 3.6 provides examples of pre-1800 government guarantees and public capital injections.