There was a time when banks acted as custodians of their customers’ money. Indeed, keeping a person’s money and using it as if it belonged to you without their agreement is fraud in common law. A banking license legally exempts banks from charges of criminality in pursuing the normal course of fractional reserve banking business, by making it clear that you, the customer, agree to being a creditor of the bank instead of the bank acting as custodian for your money.
Modern banking has its roots in England’s Bank Charter Act of 1844, which led to the practice of fractional reserve banking. Fractional reserve banking is defined as making loans and taking in customer deposits in quantities that are multiples of the bank’s own capital. Case law in the wake of the 1844 Act, having more regard to the status quo as established precedent than the fundaments of property law, ruled that irregular deposits (deposits for safekeeping) were no different from a loan. Judge Lord Cottenham’s judgment in Foley v. Hill (1848) 2 HLC 28 is a judicial decision relating to the fundamental nature of a bank which held in effect that:
“The money placed in the custody of the banker is to all intents and purposes, the money of the banker, to do with it as he pleases. He is guilty of no breach of trust in employing it. He is not answerable to the principal if he puts it into jeopardy, if he engages in haphazardous speculation…â€i
This was probably the most important legal ruling of the last two centuries. Today, we know of nothing else other than legally confirmed fractional reserve banking. However, sound or honest banking had existed in the centuries before the 1844 Act.
It was probably with sound money and sound banking in mind that Goldmoney recently announced a tie-up with a British-based and regulated peer-to-peer lender, which enables owners of gold and silver bullion to use it as collateral to raise funds.ii The purpose of this article is to explain how honest banking worked before fractional reserve banking was devised. This is the logic behind the recently announced collaboration between Goldmoney and Lend & Borrow Trust Company Ltd. We will start by looking very briefly at the bones of the Goldmoney deal, before going on to explain how banking worked when money was sound, and the serious flaws behind fractional reserve banking.
The Goldmoney – LBT Collaboration
On 23rd May, Goldmoney announced an investment and collaboration in and with the UK-based peer-to-peer lending platform, Lend & Borrow Trust Company Ltd. LBT is unique, being the only peer-to-peer facility in Western financial markets that allows businesses and individuals to use their investment-grade physical bullion as collateral against loans, without the loan obligations and collateral being comingled with other customer business. For example, an individual might have gold stored for him by Goldmoney in an LBMA-recognised vault, and wishes to borrow money against it, utilising it as collateral. LBT’s platform permits lenders and borrowers to agree between themselves – without disclosing their names to each other – the duration and interest rate on loans under an agreement template provided by LBT, which administers the loans. Both the lender and borrower must comply with the terms laid down between them in a standardised LBT agreement.
At no time is LBT a principal in the transaction, so lenders and borrowers can agree an interest rate without having to take LBT’s creditworthiness into account, based solely on physical gold or silver as collateral. Furthermore, LBT is regulated by the Financial Conduct Authority to operate an online electronic system that facilitates peer-to-peer lending.
The logic of a collaboration between Goldmoney and LBT is obvious, in that it enables customers to raise finance using bullion. But there is an underlying sound-money logic as well. Between them, Goldmoney and LBT are the template for sound-money banking as it existed before fractional reserve banking became the standard banking model, after Britain’s Bank Charter Act of 1844.
It should be noted that neither Goldmoney nor LBT operate as banks. Banking licences are granted to banks specifically so they can take customers’ assets onto their balance sheets, exposing them to counterparty risk. In other words, you, the bank customer, become a creditor of the bank. Neither Goldmoney nor LBT have this relationship with their customers, both companies being non-banking regulated financial service providers in their relevant categories and jurisdictions.
