This archived content originally appeared at, the predecessor site to, and does not carry the sponsorship of the Cato Institute.

Reserve requirements and free banking

“The Banks are required to have reserve of specie equal to one-third of the amount of Bank Notes in circulation. The declared average Monthly Circulation of Notes by the Banks has been about £285,459; and the Treasurer [the government official in charge of bank regulation] has always found the reserve considerably to exceed the required one-third.” (Ceylon Blue Book for the Year 1870, page 485. Colombo: William Skeen, Government Printer, Ceylon)

The passage above points to three aspects of free banking regulation. One is that reserve requirements existed.

The second is that they were not necessarily binding. That banks’ actual reserves always considerably exceeded their minimum legally required reserves suggests that at the time, the note-issuing banks in Ceylon (today Sri Lanka) would have held the reserves even without any legal requirement, purely out of business considerations.

The third aspect is that, though not binding in 1870, the requirement could have become binding later. The spread of the telegraph and of new techniques of financial management across branch networks connected by quick communication were among the factors that led to a general decline in bank reserve ratios during the late 19th century.

Free banking is a system of competitive issue of money and credit. The more competitive it is the freer it is. Trying to decide in particular cases when a banking system was nearer or farther from the fully competitive pole involves knowing about the historical details. In one of my first papers on free banking, a survey of all the then known episodes (in The Experience of Free Banking, edited by Kevin Dowd; not legally available online), I summarized the major regulations I knew of for each episode. Ignacio Briones (who wrote a dissertation in French about Chile’s free banking period) and Hugh Rockoff (whose re-examination of U.S. so-called “free banking” influenced those of us who have written about the more truly free banking that existed in other countries) wrote a worthwhile article almost a decade ago with a taxonomy of regulations and their effect on bank freedom. It would in principle be possible to devise an index of bank freedom based on their taxonomy or another one. Currently we are still far from the level of detail we need to know to make such precise, or apparently precise, comparisons across many countries.

  • joe bongiovanni

    Against what?
    A false monetary-economic construct?
    Lending that which you do not have?

    Why not have banks issue money and credit to accord with their capital, gained from investors and depositors?
    Why give any bankers a privilege to lend out money and credit against anything but what they own?
    Isn’t that the true conservative construct?

    Why promote financial and economic instability and the deeper pro-cyclicality of any ‘fractional’ reserve banking model?
    What we need is a banking system that can stand on its own, without endangering the real economy where the real people live and work.
    Regardless of the reserve fraction, why allow any group of private individuals (corporate) to engage in what should be an illegal activity…..lending something they have not yet earned?

    Having a more democratic credit structure is laudable. Ensuring that greed be not the mover of economic activity requires that bankers only lend the money(equivalents) of their liabilities and equities.

    Banks should do all the credit and the lending. But creating and issuing the national currency should revert to the government.

    • Warren

      Wow, way to ignore history. 150 years of a stable banking in Scotland with gold reserves sometimes being as low as half a percent. Yet despite a few bank failures there were no runs, no crises and over all depositor losses so low as to be inconsequential.

      You do realize that the currency was backed with gold AND securities AND collateral AND The personal assets of the partners AND the willingness of the other banks to buy up the any leftover notes at par?

      So yeah, the money was totally backed. Just not with the useless and costly chests of gold that 100% reservists insist is the only way to run a bank.

      You all are free to run that sort of bank but it’s a bad business model and will fail.