3: How Lombard Street Came to Exist
The author expresses a distaste of "conjectural history" in which a theorist constructs, in the absence of recorded facts, a plausible narrative to explain the possible origin of things, but yet, such narratives gain popular acceptance.
In the case of banking, it is supposed that it evolves as a community gains wealth, and the citizens seek to avoid the risk of keeping money at home, and so store their wealth in banks. However, the author scoffs at this notion, its primary foible being the assumption that many people would entrust a single institution with the custody of their wealth. This is entirely the case in other nations, such as France, where many people store their money in a vault in their own homes and prefer to keep it so - it has been quite impossible to convince a sufficient number of Frenchmen to agree to place their money in a bank, and the incidence of check-books and credit money is virtually unknown.
The "real history" of banking is very different from this conjectural history, and began not from any surplus of wealth, but by the want of it. This is, entrepreneurs and merchants needed a loan of cash in order to fund operations that would return that amount and an additional profit, and those who had money (wealthy noblemen, whose fortunes were frittered away over time) were willing to lend their capital to such an operation in return for a share of the profit.
(EN: I suspect this "real" history is based on just as much conjecture and scant bits of evidence as the one the author dismisses - and that there is no singular "truth" to the origins of the banking industry, but that both factors came into play - there can be no loan without something to loan, and whether the funds loaned out were the fortunes of the nobility or the pooled meager resources of the emerging middle class in wealthy towns is ultimately of little consequence.)
The bank was more or less an accounting service among the lenders and borrowers of money, keeping the ledgers straight, redeeming notes, collecting amounts owed, and so on. It was not until some centuries later than the notion of banking gained any popularity with anyone other than the borrowers and lenders of significant sums of money.
The author quotes Adam Smith's theory on the growth of merchant banking - in effect, that when business was conducted among merchants of a given bank, there was no need for one to withdraw cash to provide to the other, who would then deposit it - the bank could merely transfer the money between accounts. The same sort of ledger-based transactions are done when money is borrowed or repaid between creditor and debtor at the same bank: the money stays put, and ownership of it is reassigned.
The incidence of forgery and debasement also made banking attractive to the owners of money: when accepting payment in coin, the payee assumes the risk that the money given them represents a certain amount of metal. If the particular coins tendered have been debased by the mint, or shaved by those who have handled them, he is effectively robbed of value: a bank transaction for an ounce of gold is guaranteed by the bank to represent an ounce of gold, and no less. This is what made banking attractive to the smaller customer, and bank notes more attractive than coinage in daily transactions.
It was the emergence of paper currency and ledger-based transactions that solidified the need for a banking industry. Loans and payments could well have been maid in coin, and should the banks fail at any time, the paper money they have issued will become worthless, but trade itself will perpetuate by means of commodity money. It would certainly slow the economic growth of a nation to do so, and make financial transactions inconvenient, but the collapse of banking would not mean the utter collapse of an economy - only the loss of a convenience - and the only wealth destroyed would be that which exists in the form of paper money, bills or ledger balances.
The emergence of central banking extends this convenience: while transfer of funds can be made in the legers of a bank when the payer and payee are both customers of that bank, there is considerable traffic among banks to redeem notes - a web of interconnection where a bank must seek to redeem or exchange a quantity notes with multiple other banks. A central bank facilitates such transactions, by creating a market in which money can be traded among banks. And this is the evolution of banking in all major European nations: England, France, Germany, Italy, etc.
However, the nations on the European continent have in recent times suffered much strife, in the form of invasions and revolutions. In such circumstances, each person seeks to have certainty of the preservation of his wealth, and little faith in a local bank to maintain it for him in times of conflict. The constancy of strife in continental Europe has thus made England safe harbor for European wealth, by virtue of its isolation ad stability.
While banks continue to profit from the business of loans, a significant proportion of their business is in the creation and maintenance of paper money. But because paper money is a bearer instrument, it is no more secure than coin - an individual who amasses "a great heap of banknotes" will eventually be struck by the idea that he is just as vulnerable to robbery as if he were hoarding coin, and weighs the risk he undertakes by maintaining his own cache of funds versus the risk of storing the value at a bank (specifically, the failure of the bank will eradicate his funds). This assessment is made subjectively, by the consideration of the individual who holds wealth, in paper or in coin, which is the reason that "uneducated minds" tend to hoard cash rather than deposit it in banks.
(EN: I would dispute this assertion, as it is less a matter of education than of trust. Even an educated person will prefer cash in hand if he has reason to distrust the stability of the banking industry, and it may at times be an entirely rational and intelligent to prefer cash. But since it is a subjective decision based on an assessment of risk, men will differ in whether they think it foolish or wise to hold cash or trust in banks, and each will aver that his own choice is the most intelligent and anyone who chooses otherwise is deficient.)
Another factor that leads to central banking is the lack of wealth in places where it can be best managed, and the consolidation of wealth in places where it cannot.
That is, a banker in a remote district has a significant advantage over those in larger banks in urban areas: they know their customers. Such a banker has lived in the area he serves, knows the people there, knows the history of the local economy, and can leverage this knowledge to decide whether to extend credit. The manager in a urban bank cannot as readily do so: he does not know the people who ask to borrow money of him, and faces greater uncertainty. In effect, his is easily deceived, by virtue of his own ignorance, and finds himself sought after by "the worst people."
This, too, is the value of a central banking system, in that the bankers best equipped to assess the creditworthiness of a prospective borrower have the least funds to loan, and the bankers who have the greatest capital have the least knowledge of borrowers. Hence a system by which a banker who knows his clientele can access the financial resources of a larger organization enables the greatest issue of capital at the least risk.
Another factor in the development of a privately-managed central bank is the history of political mismanagement of funds. Some detail is given of the reign of Charles II, who so completely betrayed the public trust as to bring the credit of the English state to its lowest possible point: in essence, the money of the time was issued on gold in the custody of the state, and the state simply refused to return it. A series of misdeeds led to the establishment of a private bank to obtain credit for the government and, when stability returned, the general attitude of the people was to trust in the same institution as maintained their government's financial holdings to maintain their own.
The tendency toward relying upon the BE was formalized by an act of Parliament in 1742, which gave BE the exclusive right to issue currency for the state. This was entirely a formality: the BE already had a practical monopoly on the issue of notes, and this merely made it a legal monopoly, with a sense of permanence, inasmuch as any act of legislation is regarded as reliable rather than subject to be changed at a whim.
As such, "it is quite natural" that the BE became the primary bank in London, and that all other bankers would be drawn to use it as a common and central repository for their own reserves.