In England, from 1694 to 1825, the Bank of England was the only bank that was allowed to take the joint-stock corporate form; all other banks had to be organized as partnerships, and were legally constrained to have no more than six partners, which meant that they could not grow to a sizable scale. Banks were also subject to usury laws, which discouraged them from expanding their circle of borrowers(if a bank cannot charge a new client a higher interest rate to compensate for the fact it does not know much about him, it will not lend to that client at all). The English government exempted itself from these usury laws, thereby channeling credit to itself, rather than the private sector.
England’s repressed banking system had adverse consequences for the private sector, but it served the State well by providing a captive source of savings to fund the sovereign’s war needs. England industrialized in spite of the fact that the government had quite consciously constrained the growth of the banking system in order to favor itself through its exclusive partnership with the Bank of England. This constrained capital accumulation by the private sector during the early years of the industrial revolution, as investment was financed out the pockets of tinkerers and manufacturers, not through bank lending.
Not only did repressive policies limit bank credit, they also made the English banking system unusually unstable. Prior to 1870 England had one of the most crisis-prone banking systems in the world. The instability of English banking reflected the limits on the size, branching and diversification of banks. The limited private access to credit and unstable structure of English banking produced public complaints, which prompted the government to pursue risk-subsidizing policies in support of the brokered bills market (administered through government pressures on the Bank of England) to make private credit cheaper. The moral-hazard consequences of these policies encouraged excessive risk taking by small banks and bill brokers, which further contributed to banking instability.Note well those latter characteristics were present in the United States too; unit banking and the Real Bills Doctrine. However, some of England's former colonies fared better. The Happy Six being, Australia, Canada, Hong Kong, Malta, New Zealand, and Singapore. Why?
The crux of the problem is that all governments face inherent conflicts of interest when it comes to the operation of the banking system, but some types of government—most particularly democracies whose political institutions limit the influence of populist coalitions—are better able to mitigate those conflicts of interest than others.
These inherent conflicts of interest are of three basic types: 1) Governments simultaneously supervise and regulate banks, and look to them as a source of government finance; 2) Governments enforce the credit contracts that discipline debtors on behalf of banks (and in the process assist in the seizing of debtor collateral), but they rely on those same debtors for political support; and 3) Governments allocate losses among creditors in the event of bank failures, but they may simultaneously look to the most numerically significant group of those creditors—bank depositors—for political support.
The implication, we hope, is inescapable: the property rights system that structures banking is not a passive response to some efficiency criterion, but rather it is the product of political deals that determine which laws are passed, which groups of people have licenses to contract with whom, for what, and on what terms. These deals are guided by the logic of politics, not the logic of the market.The Six are happy because they've largely avoided allowing the logic of politics to set the rules for their banking sectors.