On the Success of ‘Free Banking’ in Sweden (1830-1897)

While the success of the swedish banking system from 1830 until the end of this century is of no dispute, and the banking crises were localized did not result in a general panic, there is a little dispute regarding the degree of freedom of these swedish banks. Erik Lakomaa (2007), provides a large body of evidence that the system was relatively free and that the regulations at that time were not binding. Let’s review some of them :

1. The Development of Free Banking

Notes from private banks seemed to be preferred by the public to the Riksbank notes, as long as the customers had the opportunity to choose. Further evidence of this is that the private bank notes traded at par and that their combined market share was larger than the market share for Riksbank notes. The only advantages the Riksbank notes held as legal tender seem to have been less inconvenience with payment of taxes. Although private notes were generally accepted taxes could only be paid with Riksbank notes. In this regard the effect of the legal tender status was nil. The tax collectors usually accepted private notes for a small fee (fixed or proportional).

Even though the banks were partnerships, the number of partners, in some cases, tended to be large, sometimes up to a thousand (Tunander 1964, p. 50).

The opponents of free banking often emphasized that in Scotland, deposits were a more important money source than note issue, as compared to Sweden (Nilsson 1981, p. 371).

One explanation of this practice were the much stricter usury laws in Sweden, but at the time it was more controversial to abolish these laws and let supply and demand determine interest rates than to allow competing currencies. The usury laws, were therefore not abolished until 1864.

Another explanation for the success of the free banking system in Sweden was that the use of notes was widespread and generally accepted as means of payment (Nilsson 1981, p. 328). Scarcity of specie had accustomed the Swedes to bank notes. As in Scotland, notes were not traded below par during the free banking period, and were generally preferred to coins in business transactions.

The banking laws specified explicitly that private banks were not given any support from the government or the Riksbank (the so-called central bank at that time). It seems however that Riksbank has an advantage against other banks in terms of competitivity.

2. The Legal Framework

In contrast to most free banking systems, the Swedish system had reserve requirements. … The Banking Act of 1874 required the banks to hold 10 percent of their equity capital in specie. … These levels were well below the reserves that were actually held by both the enskilda banks (see figure 1). (note : “enskilda” means “partnership”) Furthermore, Ögren (2003) also notes that “the Enskilda banks never came close to their legal note issuing limits.” The reserves held by the enskilda banks were in every single case higher than the legal minimum today (5 percent).

Free Banking in Sweden 1830-1903 - Experience and Debate (Lakomaa 2007) Figure 1

Why the Riksbank held such high reserves is unclear but one could assume that the historical mismanagement of the Riksbank tainted its reputation and thereby forced the bank to hold higher reserves in order to attract customers.

The decreasing reserve ratios over time was not a unique Swedish phenomenon; the same applied to Scotland … indicating that customers required lower reserves from older, trusted banks.

Furthermore, we can see that the banks, at least during the later part of the free banking regime, were not subject to any legal barriers to entry. The charters were in the 1840s reduced to a mere formality, and after 1851 new banks, provided they were partnerships, only had to register at the Town Hall (Nilsson 1981, pp. 134, 246).

As long as the banks were partnerships and did not threaten the Riksbank’s monopoly on certain obsolete credit services, they were not subject to any other restrictions than the general business law. Nilsson (1984, pp. 395f.) summarizes: “With Stockholms Enskilda Bank as a pilot case, banks were now given full freedom to conduct their business within the framework of general business law.” Or, as Jonung (2000, p. 4) writes:

“The note issue was initially neither controlled by any legal reserve requirements nor by government inspection. The note banks were chartered with the explicit rule that the authorities would “under no circumstances” intervene to support a private bank in financial trouble. Nor could the banks expect to get any help from the Riksbank since this bank was their main competitor.”

In the Banking Act of 1834, it was also stated that private banks were never to be given any governmental support or subsidies (the same already applied to the Riksbank):

The private banks could neither now nor later count on any kind of support from the government and the government may under no circumstances interfere with, support, or bail out, their business more than they do for other kinds of businesses.

… The banks also used the absence of government regulation to create trust. Wallenberg assured the customers of Stockholms Enskilda Bank that the bank would never accept governmental support; this was also stated in the articles of association (Nilsson 1981, p. 319). The bank could in this way signal that it would not assume more risk than the partners could bear. The conclusion is thus that even though the Swedish banks were subject to some restrictions de jure, these restrictions did not restrict the banks de facto, except for limiting their competitiveness in relation to the Riksbank. The most damaging restrictions were the ban on small denomination notes and the special taxes levied on the private banks (Jonung 2000, p. 23).

Regarding this passage, “The decreasing reserve ratios over time … indicating that customers required lower reserves from older, trusted banks”, it is worth noting that it is exactly the same point made by Anders Ögren (2003, pp. 110, 118-119, 125, 156), despite being an anti-free banker.

Now, one can argue that the ban of small notes after 1880 (Hortlund, 2007, p. 24) would have impeded bank competition. This could be true if the Riksbank succeeded to increase its market share after the law was passed. This, of course, was not the case. Lakomaa (2007, pp. 35-36) explains as follows :

When the ban on five rdr notes was proposed, these made up 38 percent of the notes in circulation (Nilsson 1981, pp. 63f.; Jonung 2000, p. 35). […]

Small notes were also deemed to be too profitable for the banks. As they tended to stay in circulation longer than larger notes, a bank could reduce its reserves without risking illiquidity. … It is obvious that the ban strengthened the competitive position of the Riksbank (which was allowed to issue one rdr notes) but despite that the private banks finally were prevented from issuing five and, in 1879, ten rdr notes. The Riksbank did not manage to increase its market share more than marginally. When private bank notes were banned in 1903 the currency stock fell dramatically indicating that the public preferred specie to riksbank notes when they had to exchange their private bank notes (Nilsson 1981, p. 21; Jonung 2000, pp. 13, 15).

Although the swedish banks were not operating under a central banking scheme, the fact that the ban of usury laws in 1864 helps to promote banking competition (Briones & Rockoff, 2005, p. 305) suggests that competition has been constrained before 1864. However, according to Lakomaa, this law was unlikely to impede competition :

Another important factor in the success of the banking system was the abolishing of the usury laws in 1864. The usury laws … had over the years significantly hampered economic development, even though the financial markets early learned how to avoid the most damaging effects: In order to charge higher interest rates than the allowed 6 percent, a part of the interest was called commission or loan fee. The usury laws were nevertheless one of the major reasons why many note issuing banks, but few deposit banks, were founded in Sweden. The note issuing banks could finance their lending at lower cost and they could therefore also offer lower rates than the deposit banks. The interest rate ceiling on lending also kept deposit rates down, making it hard for banks to attract depositors.

… Following the abolishing of the usury laws, deposits increased and banks that did not issue notes were founded. However, most of them never gained any significant market share and the note issuing enskilda banks remained dominant.

Then, Lakomaa (2007) replies to some criticisms of the Swedish banks :

This credit expansion was not only the foundation of the transformation of Sweden from an agricultural to an industrial economy, it also coincided with a period of relatively stable prices (Heckscher 1934).

The foundation for Nilsson’s criticism is that the private banks would not have survived without subsidies from the government. According to Nilsson, subsidies can be given either as loans with interest rates lower than the market rate (as was given to the filial banks) or as the right to issue notes (Nilsson 1989, p. 223; 1981, pp. 14, 334). […]

Several problems can be raised concerning this premise. First, private note issuing banks were founded before the creation of a state monopoly on note issue. Second, if free entry to a market really was a subsidy or a privilege it would also be reasonable to view the right for Volvo to make cars or for Wal-Mart to sell groceries as subsidies from the government, a claim few would agree with. […]

During the entire period, only one bank, Vadstena Enskilda Bank, was closed down. The reason was fraud and theft committed by the manager of the bank, JA Holmberg, but the customers of the bank did not incur any losses when it was closed. […]

Private banks were also blamed for political failures such as the so-called “strangle system,” (Footnote 28 :The strangle system (Swedish: Strypsystemet) was a policy imposed on the Riksbank that said that the bank should contract its lending — instead of raising the interest rates — in case of external currency drains. The result was sharp fluctuations in the volume of credit.) which caused a credit contraction which hit even solvent creditors hard during recessions. However, the strangle system was a result of the usury laws, which prevented banks from adjusting the interest rate to the demand of money (Myhrman 1994). When lending volume could not be adjusted by means of interest rate, the volume of credit was adjusted. The Enskilda banks were heavily criticized for this so called “strangle system,” which in many ways were connected to the regulations for the issuing of notes for the Riksbank and the Enskilda banks, but which most of all had its ground in the usury laws (Segrell 1993, p. 20, Nilsson 1981, p. 14, and Nygren 1981, p. 19). After the usury laws were abolished in 1864, this problem was reduced significantly. Nevertheless, both the private banks and the Riksbank continued to reduce the volume of credit in recessions in order to keep sufficient reserves.

As usual, under free banking system (Vera Smith, 1936, p. 17), the swedish banking freedom has been abolished, not because it was unstable, but because of political motives. Lakomaa writes (2007, p. 42) :

According to Metelius, the main reason for bank monopolization was that private banks were too profitable and were perceived as “stealing” seignorage rents that “rightfully” belonged to the state. This is why the Riksbank then became the Swedish Central Bank (Metelius 1984; Hortlund 2001, p. 75). In the late nineteenth century, several restrictions were put on the enskilda banks. Among them was the previously mentioned ban on small denomination notes and special taxes on note issue. These taxes were increased to .3 percent in 1887, to .5 percent in 1892 and to 1 percent in 1893 (Jonung 2000, chap. 4).

So, according to Lakomaa, the usury laws and the ban on small denomination notes offer very little evidence that these regulations impeded banking competition.

Regarding the performance of swedish banks during the period of “free” banking, Hortlund provides evidence that enskilda banks were able to meet seasonal variation in demand for notes (2007). However, he says (2006) that note stock, after monopolisation, became more upward elastic in times of expansion and more downward elastic in times of recession. He finally shows (2005) that the money cycle becomes smaller after monopolisation while at the same time the credit cycle becomes larger.

Now, the problem is that the swedish banks were not so free as it appears. In some aspects, it was free, in other aspects, it was not. First, Richard S. Grossman in “Unsettled Account : The Evolution of Banking in the Industrialized World since 1800” (2010, p. 208) claimed that : “Like enskilda banks, these limited liability banks were prohibited from either owning or lending against shares or real estate (Allen et al. 1938: 329)”. This, however, is not true. See also Goran B. Nilsson, “Founder: Andre Oscar Wallenberg (1816-1886) Swedish Banker, Politician & Journalist” (2005, p. 218) :

This idea was also fundamental for the young Danish financial comet, C. F. Tietgen, when, in early 1863, he tried to interest Dutch capitalists in investing in a new mortgage bank in Stockholm. This new bank would be owned by stockholders and would devote much of its business to making long-term loans against collateral in real estate, a business that A. O. Wallenberg had systematically avoided.

But the more serious criticisms have been made by Anders Ögren in his lengthy dissertation (2003, 290 pages). He argues that swedish banks were operating under a central banking system because instead of competing the Riksbank the private banks hold a large portion of its notes (along with species) as reserves.

He also claims that Riksbank had the role of a lender of last resort (2003, pp. 235-265). And yet he admitted that the bank has been charged to maintain convertibility but has refused to provide credit during the 1878 banking “crisis” (and had also refused to behave this way, previously, in the 1857/58 banking crisis) because there wasn’t enough money. Besides, Hortlund (2007, pp. 25-26), affirmed that the 1878 was not severe and did not even need an intervention. One obvious problem with the (mis)spelling of these bank “crisis” that sometimes occurred during the free banking episodes (notably that in Scotland) has to do with the fact that none of them turned into a general panic, which is the very definition of a bank crisis.

In 1878–1879 a severe crisis hit the Swedish economy. A boom, fueled by railroad construction and international demand for Swedish iron and timber, turned into a bust when prices fell. The Stockholms Enskilda Bank had invested heavily in railroad bonds. This bank was also more leveraged than other banks – while capital-asset ratios of other banks were around 20 percent, the Stockholms Enskilda Bank was operating on a ratio around 10 percent (Summary of the Bank Reports). When two ironworks that the Stockholms Enskilda Bank was heavily invested in suspended payments, rumours spread that the bank would become insolvent. In December 1878, there was a run on the Stockholms Enskilda Bank. In February 1879, the finance minister Hans Forsell made pronouncements that government support to the banks would relieve capital markets. In May 1879, a special fund called the Railroad Mortgage Fund was created, administered by the National Debt Office, from which banks could borrow on railroad bonds as security (Lindgren 1994).

This incident, it can been argued, shows that the Swedish note banking system was not able to stand on its own without the government intervening and acting as a lender of a last resort. However, this reading is open to debate. It is important to remember that when the government assumes a role as guarantor of the solvency of the banking system, it does not act as a lender of last resort. The classical lender of last resort provides liquidity to all illiquid but solvent banks, in order to quench bank runs and panics. By contrast, the activities of the Swedish government in 1879 was very much about saving one important possibly insolvent bank from bankruptcy, in order to avoid larger damage to the financial system. Apart from the Stockholms Enskilda Bank, banks made marginal use of the fund. (Footnote 2 : From a total of 42 commercial banks, 13 made use of the fund. Of the 7.56 million lent, over half (4 million) was borrowed by the Stockholms Enskilda Bank (Ogren 2003, p. 262).)

The Swedish situation in 1878–1879 was clearly different from the general panics that hit England in 1847, 1857 and 1866, when lender of last resort-response was called for. Apart from limited runs on the Stockholms Enskilda Bank, other banks were not subject to runs or panics. The difficulties of the Stockholms Enskilda Bank did not spill over into a general distrust of the banking system. There is also evidence that bank support for the fund was lukewarm – with the exception of the Stockholms Enskilda Bank, banks did not see themselves in trouble and the fund was therefore not felt to be necessary (Nilsson 1994, p. 288). In sum, it is not clear what contribution the government intervention made to relieve the crisis, and it is conceivable that the banks would have weathered the storm without it.

See also  Hortlund (2006, pp. 221-222). Concerning the 1857 crisis, Ögren (2003, pp. 52-53) himself declares that the central bank at that time was not acting as a lender of last resort :

After the crisis of 1857/58, the support to the banks was administered, not by the Riksbank, but by the authority responsible for the State’s foreign loans, the National Debt Office. It was instead made clear that the Riksbank was to concentrate on maintaining convertibility. Consequently, the Riksbank refused to follow the prescription for acting as lender of last resort.

It is worth recalling that the scottish free banking managed to weather the 1772 crisis, with the collapse of Ayr Bank accompanied by the failure of many other banks, see White’s Free Banking in Britain, 2nd edition (1995). The swedish “free” banking system, Ögren (2006) argues, is similar to a central banking system. This is because Riksbank notes were used as based money. “Swedish law never prevented Enskilda banks from choosing to hold reserves of specie instead of Riksbank notes, and thus to challenge the position of Riksbank notes as base money. … Enskilda banks did not hold specie as reserves until they were forced to by law” (p. 66). Ögren then says that the Riksbank was issuing base money while the Enskilda banks were issuing a form of liquid deposits.

If the Enskilda banks had wanted to out-compete the Riksbank, the Enskilda banks would of course redeem Riksbank notes for specie. In a free banking system, as noted above, there are no incentives for one bank to hold notes issued by competing banks.

And what Ögren (2006, p. 74) says, is of crucial importance : “The law of 1874 dissolved the special status of Riksbank notes by not allowing them to be used as legal backing of Enskilda bank notes, and that law came to embrace all Enskilda banks from 1878”. It follows that only the period after 1878 could be considered as a free banking system, or at least, a near free banking system. In contrast, Briones and Rockoff consider that the period that fits better the free banking scheme begins in 1864 :

In 1824 the monetary monopoly of the Riksbank was abolished, and the first private charter was granted in 1831. Until the 1860s the number of banks remained limited; there were only six chartered banks during the 1840s and eight during the 1850s. The Banking Act of 1864 simplified the procedure for obtaining a charter, and an automatic renewal of charters was allowed. As a result, the number of private note-issuing banks grew rapidly, approaching thirty by the end of that decade. The number then remained stable.

Nevertheless, one problem with Ögren’s assertion is that Riskbank, before the law of 1897, was not really a central bank. Consider what Ögren (2006, p. 70) says here :

The Riksbank is not usually considered as a central bank in the modern sense until the enactment of the banking law of 1897, which gave the Riksbank a monopoly of note issuance. Before 1897, the Riksbank has been described as a State-sponsored commercial bank competing with the Enskilda banks.

But, he rightly points out (p. 78) that a free banking system will not predict that private banks would hold others’ bank notes as base money. If a private bank does not redeem its competitors’ banknotes, it will give them an obvious advantage of market share in notes.

If the Riksbank had been nothing but a State-sponsored commercial bank whose notes were substitutes for Enskilda bank notes, commercial banks would not have utilized them for reserves. The most important fact with the system of the Enskilda banks was that these banks through the entire period had the possibility to be independent of the Riksbank, but chose not to build such a system. The market solution appears to be that the central-banking-based system was viewed as better suited to operate in the growing Swedish economy than its alternatives.

The last sentence is revealing. What he doesn’t seem to realize is that insofar as the Riksbank notes were given a special status, the lack of incentive to out-compete the Riksbank is easily explained. Thus, it is difficult to bluntly accept the very idea that “Enskilda bank system did not work in accordance with free banking theory, but instead functioned as a central-bank-based system” (Ögren, 2006, p. 66). Perhaps the reason why Enskilda lack the incentive to hold gold is due (Jonung, 1984, pp. 370-371) to the banking laws being ineffective to stop them from expanding money supply :

The unused right to issue notes, documented in the monthly bank reports for each enskilda bank, was substantial throughout the prewar gold standard period, constituting about 25 to 60 percent of the actual volume of private notes in circulation (see table 8.4). Consequently, banking laws concerning the maximum size of the private note issue did not effectively restrict the private supply of notes. Because the legal reserves behind private notes included bank assets that did not constitute base money, private banks could, within wide limits, increase their banksedelutgivningsriitt without obtaining base money, that is, gold and Riksbank notes. Private note-issuing banks had thus little need to demand gold for legal reserve requirements against their circulation during the pre-1914 gold standard period.

Recall what Lakomaa has said (2007) : “Although private notes were generally accepted taxes could only be paid with Riksbank notes. In this regard the effect of the legal tender status was nil. The tax collectors usually accepted private notes for a small fee (fixed or proportional)” (p. 30). For a better understanding of the consequences of legal tender laws, see Hülsmann (2008). So, although the Riksbank was a privileged bank, it is not clear that it has the same legal status that a modern central bank would have.

The idea of legal tender status implicitly given to Riksbank is expressed clearly by Briones and Rockoff (2005, p. 306). As noted above, there is disagreement among authors concerning the legal tender status of its notes and the very meager advantage of these notes to be used for paying taxes.

With the move to the gold standard, a law passed in 1874 obliged the Enskilda banks to redeem their notes afterwards into specie only. But in practice, according to empirical evidence reported by Ögren (2003), Enskilda notes continued to be mainly redeemed into Riksbank notes. Indeed, about two-thirds of the Enskilda reserves were held in the form of Riksbank notes. Since Riksbank notes were receivable for paying taxes, they had a legal tender status. The latter meant that there was no difference if Enskilda banks held specie or Riksbank notes. It would appear, therefore, that the supply of Enskilda notes issuance was at least partially dependent on the supply of Riksbank notes, giving the Riksbank some control of the total money supply. The link between the State and the banking system was reinforced in 1869 when the Riksbank began to accept Enskilda banknotes at par.

If we examine the Figure 6 from Ögren (2006), we can see that the Enskilda banks hold a large part of their reserves in Riksbank’s notes, to an extent even larger than species, rather than in other Enskilda banks.

Free or central banking - Liquidity and financial deepening in Sweden, 1834-1913 (Anders Ogren 2006) Figure 6

But that the Riksbank notes were highly valued is in stark contrast with Lakomaa’s statement in that the “Notes from private banks seemed to be preferred by the public to the Riksbank notes, as long as the customers had the opportunity to choose”. But Ögren (2006, p. 83) seems to say that the relatively greater market share in private Enskilda bank notes was due to the less stringent restriction applied to them, as compared to the Riksbank :

Enskilda banks had an advantage in not being subordinated to the specie standard and therefore not having to cover their critical liabilities, such as demand deposits and bank-post bills, to nearly the same extent as the Riksbank. Since the latter’s ultimate responsibility for preserving the specie standard prevented it from holding insufficient reserves, its notes were of a higher quality than the Enskilda bank notes.

… While not as well backed as Riksbank notes, the Enskilda bank notes were of much better quality as a medium of exchange than were other circulating instruments.

We can compare with the evidence presented by Lakomaa (2007, pp. 30, 36) in favor of the idea that private notes were preferred by the customers :

Further evidence of this is that the private bank notes traded at par and that their combined market share was larger than the market share for Riksbank notes. (Footnote 12 : See diagram 2, p. 36. In the countryside the private notes were regarded to be as good as Riksbank notes (Malmberg 1987, p. 37). One objection that the finance committee of 1852 raised against the enskilda banks was that their notes were not accepted by the tax collectors. The committee however didn’t question the legal tender status of Riksbank notes — even though this was the cause of the problem. The public at the time did not hold Riksbank notes unless they had to (Nilsson 1981, p. 15).)

Free Banking in Sweden 1830-1903 - Experience and Debate (Lakomaa 2007) Figure 2

(Footnote 21 : The ratio should not be taken as exact because most enskilda banks held some quantity of Riksbank notes as reserves. Some enskilda banks also held notes from Stockholms Enskilda Bank as reserves. These factors tend to distort the true ratio. The market share for the enskilda banks when it came to day-to-day transactions might well be higher because part of the stock of Riksbank notes were idle.)

Even though the swedish banking system was not as free as his scottish counterpart, it was poorly regulated and was not operating under a central banking scheme.


Briones, I., & Rockoff, H. (2005). Do economists reach a conclusion on free-banking episodes?. Econ Journal Watch, 2(2), 279-324.
Göteborgs Handelskompani (2011). Handelskompaniet history. Source : Göteborgs Historia by Martin Fritz and Bankvärlden årg 1936.
Hortlund, P. (2006). Is the law of reflux valid? Sweden, 1880-1913. Financial History Review, 13(02), 217-234.
Hortlund, P. (2007). The Provision of Liquidity in the Swedish Note Banking System, 1878–1901. Scandinavian Economic History Review, 55(1), 20-40.
Jonung, L. (1984). Swedish experience under the classical gold standard, 1873-1914. In A Retrospective on the Classical Gold Standard, 1821-1931 (pp. 361-404). University of Chicago Press.
Lakomaa, E. (2007). Free Banking in Sweden 1830–1903: Experience and Debate. Quarterly Journal of Austrian Economics, 10(2), 122-141.
Ögren, A. (2003). Empirical Studies in Money, Credit and Banking: The Swedish Credit Market in Transition under the Silver and the Gold Standards, 1834-1913. Institute for Research in Economic History (institutet för ekonomisk historisk forskning vid Handelshögskolan) (EHF).
Ögren, A. (2006). Free or central banking? Liquidity and financial deepening in Sweden, 1834–1913. Explorations in Economic History, 43(1), 64-93.
Smith, V. C. (1936). The rationale of central banking. London: PS King.

This entry was posted in Economics and tagged . Bookmark the permalink.