Free banking is unregulated banking in which those who operate the bank can provide any business system that they wish to offer. If the market accepts the system, then their enterprise will prosper; if not, their enterprise will fail.
Free-banking systems may be based on a gold standard, a gold and silver standard or even a fractional reserve standard. The only standard is what the market will accept. In practice, many free-banking systems have apparently practiced a form of private fractional reserve banking that included the ability to issue promissory notes payable in gold or silver (or both) to the bearer.
Such systems often seem to have remained stable even when more notes were issued than gold and/or silver in the warehouses. This is because absent state-created economic catastrophes, people did not show up all at once to collect their precious metals. Free banking usually has flourished in environments where the state has little control over the larger financial environment and thus economic catastrophes are not common. Additionally, free-banking clearinghouses are usually available to provide banks with additional gold and silver in case where the banks are not able to provide sufficient money metals at a given time.
Vera Smith defines free banking as "A régime where note-issuing banks are allowed to set up in the same way as any other type of business enterprise, so long as they comply with the general company law. The requirement for their establishment is not special conditional authorization from a Government authority, but the ability to raise sufficient capital, and public confidence, to gain acceptance for their notes and ensure the profitability of the undertaking." (The Rationale of Central Banking and the Free Banking Alternative, Minneapolis, MN: Liberty Fund, pp. 169–70)
According to Wikipedia some examples of free banking include:
1. 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.
2. 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.
3. Scotland. Scottish free banking existed 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, wherein both banks agreed to accept rival banks' notes in the ordinary course of business.
4. United States. Although the period from 1837 to 1864 in the US is often referred to as the Free Banking Era, the term is something of a misnomer, for it refers not to a general system of "free" banking in the literal sense described previously, but rather to various state banking systems based on so-called "free banking" laws. These laws made it unnecessary for new entrants to secure charters (each of which was subject to a vote by the state legislature), but nonetheless restricted their undertakings in important ways. From 1863 to 1913, [during a period] known as the National Banks Era, state-chartered banks were still operating under a free banking system. Some scholars have found that the system was mostly stable.
5. Sweden. Sweden had two periods of free banking: 1830–60 and 1860-1902. Following a bank crisis in 1857, there was a rise in popular support for private banks and private money issuers (especially Stockholm's Enskilda Bank, founded in 1856). A new bank law was adopted by parliament in 1864, deregulating the interest rate. The following decades marked the height of the Swedish free banking era.
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