Free banking

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Free banking is a theory of banking which invokes only market forces, with a conspicuous absence of central banks and any banking regulations, with only the general commercial laws applicable. Free banking includes no restrictions on the formation of banks, the issue of bank notes, the acceptance of demand and term deposits, and the provision of loans, advances and other forms of credit. Banks would also be free to engage in non-banking businesses such as insurance, and non-banks would be free to engage in the business of banking. Banks would set their own credit, capital and reserve policies.

[edit] Theory of Free Banking

Free banking theorists consider that free banking is characterised by:

Competitive issue of redeemable currency. Historically this meant bank notes but cryptography and modern communications technology mean that it can now take the form of electronic tokens.
Mutual acceptance of notes at par, and clearing of notes through note exchanges.
In the same way competitive provision of current account services, and clearing of inter-bank payments between such accounts through clearing houses and settlement banks.
Development of short term credit markets to allow banks with excess reserves to invest them at interest, and banks in need of reserves to borrow funds short term.
Development of, and bank investment in, marketable debt securities, providing investment opportunities that can be liquidated at short notice, and acting as collateral for short term inter-bank borrowing and lending.
Generally, financial intermediation between borrowers and lenders.
Absence of legal tender laws.

[edit] History of Free Banking

Banking has been more regulated in some times and places than others, and some times and places it has hardly been regulated at all, giving some experiences of more or less free banking.

Australia. In the late 19th Century, banking in Australia was subject to little regulation. There were four large banks with over 100 branches each, that together had about half of the banking business, and branch banking and deposit banking were much more advanced than other more regulated countries such as the UK and USA. Banks accepted each other's notes at par. Interest margins were about 4% p.a. In the 1890s a land price crash caused the failure of many smaller banks and building societies. Bankruptcy legislation put in place at the time gave bank debtors generous terms they could restructure under, and most of the banks used this as a means to restructure their debts in their favour, even though they didn't really need to. The results was a spate of bank 'failures' that provides a blemish to an otherwise favourable record for free banking.
Switzerland. In the 19th Century several Swiss cantons deregulated banking, allowing free entry and issue of notes. Cantons retained jurisdiction over banking until the enactment of the Federal Banking Law of 1881.
Scottish Free Banking. This period lasted between 1716 and 1845. The Bank of Scotland, the original Scottish bank charter and The Royal Bank of Scotland, chartered by England, issued competitive currencies. This resulted in a "currency war" in 1727. The result was a cooperative equilibrium, where both banks agreed to redeem. This area of study has been developed further by Lawrence H. White, in books such as Free Banking in Britain: Theory, Experience and Debate 1800-1845.

There is speculation that with electronic currencies free banking can evolve into Anonymous internet banking. The implications of this for the monetary system are unknown, and much of the area of rigorous theory in this area has been abandoned for a wait and see attitude.