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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.