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Banks and limited liability

William Rees-Mogg has a nice, rather wistful account of the days of when bank managers actually knew their clients, knew their economic circumstances and were not in the business of lending money to folk with little or no credit history. Mr Rees-Mogg is a devotee of the gold standard. However, in talking about the changing nature of banks and the quality of their staff, he does not touch on an issue which struck me the other day: limited liability.

Under limited liability laws and with central bankers acting as lenders of last resort, there is an element of moral hazard. Some free marketeers like Sean Gabb – whom I mention below – think limited liability laws are a statist curse on the capitalist system, since they would not arise without active state adjustments of corporate law. I am not sure about whether limited liability would exist in a world of pure laissez faire. It might, I guess. Also, not everyone buys the idea that LL is a distortion of the market or would not exist without state action.

However, there are still some nooks and crannies of the banking world where unlimited liability still exists and works successfully. The Swiss private bank Pictet, founded in 1805 in that memorable Napoleonic battle year of Austerlitz and Trafalgar, operates a partnership system where the bank partners face unlimited liability. As a result, Pictet operates a very conservative lending and investment policy. During the fat years of the ‘Noughties, Pictet may have seen some of its more aggressive competitors steal a march, but now the bank is attracting inflows from investors who appreciate the structure of the firm. At a time when Swiss banks have sometimes attracted bad headlines due to massive losses undertaken by over-confident people, the example of Pictet is an interesting contrast.

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12 comments to Banks and limited liability

  • I think there are two aspects to LL:

    Limits on liability for torts, where the other party has not entered a contract with the corporation, cannot legitimately be justified.

    Limits on contractual liabilities could conceivably be arrived at even without official LL status, by putting a clause in the contract to that effect, so they aren’t such a problem.

    The real problem with banks is the lender of last resort provisions and depositor guarantees, which externalise the risks within the business.

    If banks operated like other LL corporations, then, if they were unable to meet their obligations, they would go into administration and the administrators would pay out the creditors as far as possible.

    That might result in some savers losing out, but, if they knew that in advance, they’d be a lot more careful where they put their money and they’d start to view saving with an interest paying bank for what it is; an investment in a risk taking business.

  • RRS


    How does any form of enforcable liability arise other than through the coercive powers of a “legal system” derived through a political (or social) structure?

    Thus the limitations are really restrictions on those coercive powers to enforce obligations as laibilities.


    What is a “Tort?” Does it require the existence of a duty?

    Has the concept evolved to a determination of how harm is to be repaired?

    Consider: Absolute liability without fault.

  • RRS

    It might be of interest to those considering the liabilities of banks to look at the historical past when shareholders in banks could be assessed for shortfalls.

  • RRS: and not just banks, but any company, I presume?

  • Adrian

    Well yes, Pitcet remains a partnership and the partners do have unlimited liability but it is really a custody and investment advisory business, not a fully fledged bank in the borrow-and-loan sense. It also remains wholly owned by the founding family. I would see it as a throwback to an earlier era and it occupies a lucrative niche but it isn’t a useful precedent on which to build a reform of the general banking business model.

  • Lee Moore

    Not sure whether I’m making the same point as RRS, as I found his/hers a bit cryptic. It’s all very well being prudent and conservative in your business dealings, and accepting unlimited liability because you’re happy to stand by your prudent business practices. But if the courts make a habit of making giant unjustified awards against businesses, based on political rather than legal considerations (as they do) then the prudent business is operating in a world of state jackals, and needs whatever legal protection it can get.

  • I generally support the idea of unlimited liability. LL is a state created and protected distortion. Hoiwever I’m not sure it would be the first thing the Emperor Jock would change. And here’s why…

    Spooner’s four great monopolies, if addressed, would leave the current less well off with more money and an expectation that they would be able more to provide for themselves by using that to build up a portfolio of productive assets wherever possible (obviously not land since land value would have gone).

    Until this new economy settles down and systemic changes are reflected in the way people do business, the main thing they’d have to invest in, largely, would be companies and during that period of adjustment (not all businesses would survive that change and new formms would come to the fore) I don’t think it would be right to encourage people to invest in something only to find themselves wiped out.

    One could steadily “wind back the clock” on limited liability however, and expect companies to make shares partly paid perhaps stepping up the portion of their liabilities that are covered by the unpaid part of shares. So there would be a specific, known liability for shareholders – it would be more than their investment, but they’d know how much and could plan for, or even insure against it being called in.

    Would that work? Eventually I suspect companies would look somewhat different in terms of exposure and so on and one could then remove limited liability.

  • lucklucky

    The whole issue is the always: There are not free launches.
    If we want faster growth we need to make more bets(lending,investing)and eventually more risky bets(lending,investing) in technology, people etc. If an important part of them fail then we will have trouble, how much trouble depends also in our the reaction to failure. So what is the best? How can we determine that it is the right time to invest in X technology or people? We can’t.

    Now better schools and knowledge would improve the odds of more of us being nearer right time.

  • RRS


    The provision for assessment on bank shareholders was statutory (in the NBA).

    That was distinct from the share contract between shareholders and the corporation, which did permits shares to be fully paid and non-assessable, which banks at one time could not do.

    The power of statutory assessment created a right of subrogation in bank creditors (depositors et al.). Naturally this limited capital resources available to banks to those who could “take the hit.”

    However, in most other (non-bank) corporations (U.S.) the assessment would have been limited to wiping out the shareholders interest to the extent the assessment was not met, whereas in banking, the exposure was extended further by statute.

    In all this “issue” (LL) is a microcosm of the effects of political overlay upon institutions (establishments) generated in or by inter-personal human relationships.

    Hope that is not too pedantic – just to explain the choice of banks as a topic. Even the Venetians had problems there.

  • Not pedantic at all. I asked a specific question, and got an appropriate (and interesting) answer. Thanks:-)

  • Paul Marks

    Gold “standard” – please take Paul Marks screams of rage as read (I am bit tired to type out my usual rant).

    Limited liability – fine as long as everyone knowns they are dealing with a limited liabilty concern and CHOOSE to do so, it is called freedom of contract (and was NOT created by 19th century statutes).

    “Lender of last resort” – evil, evil, evil, scream, curse, throw stuff round the room (and so on).

    Of course the basic problem is lending out money that does not exist (in various complex ways) – hence the gap beteen the Monetary Base (notes and coins – MB)and M3 (Monetary Base plus bank credit – in reality if money is lent out the lender, and the depositor, do not have the money anymore till when and IF it is repaid, one should not base new loans on I.O.U.s and so on).

    Still this is disputed – and just getting rid of all government help for the banks would be enough, as if I am wrong fine. And if I am right then the credit bubble banks would go bankrupt – and better banks would grow up in their place.

    Of course there would be a massive bust in the “real economy” – but that is going to happen anyway.

    Last point.

    I may not hold that limited liability is wrong (I hold that it may be fine if people choose that) – but I like the sound of the Swiss private bank you mention.

    There has been far too much “modernization” of Swiss banking – the old ways may have been wrong (by my rigid dogmatic standards), but they were vastly less insane than the modern ways.

    If there are credit bubbles at least keep them small – as the old banking ways did in Switzerland (and in England at one time).

  • RRS: “Liability: How does any form of enforcable liability arise other than through the coercive powers of a “legal system” derived through a political (or social) structure? Thus the limitations are really restrictions on those coercive powers to enforce obligations as laibilities.”

    The alternative is no rule of law, so all contracts become legally unenforceable, rape and murder are no longer crimes, etc. Fine if you want a full fledged anarchist society, but I don’t think it’s especially desirable.

    “Torts: What is a “Tort?” Does it require the existence of a duty? Has the concept evolved to a determination of how harm is to be repaired? Consider: Absolute liability without fault.”

    For the purposes of this discussion, it isn’t relevant. The key question is, under the law, as an individual, what harm am I forbidden to do to another without their consent? The same should apply equally to somebody operating through a corporation.

    The issue is so much what the liabilities are, but whether or not you are able to reduce them by operating through a particular state created structure.