The Online Library of Liberty

A project of Liberty Fund, Inc.

• Banking In the Latin Nations.
• Part I.: Banking In France.
• Chapter I.: Its Status Before the Revolution.
• Chapter II.: The Bank and “system” of Law.
• Chapter III.: The Discount Bank—la Caisse D’escompte.
• Chapter IV.: Assignats—the Basis of Their Issue.
• Chapter V.: The Bank of France.
• Chapter VI.: Banks and Bankers After the Revolution.
• Chapter VII.: Banking In the French Colonies.
• Part II.: Banking In Italy.
• Chapter I.: Primitive Banks.
• Chapter II.: Banking Under the Unification of the Kingdom.
• Chapter III.: Italian Co-operative Banks.
• Chapter IV.: The Bankers of Florence.
• Chapter V.: Banks and Bankers In Sicily.
• Part III.: Banking In Spain.
• Chapter I.: The Earliest Banks.
• Chapter II.: The Bank of Spain.
• Part IV.: Banking In Belgium.
• Part V.: Banking In Switzerland.
• Part VI.: Banking In Portugal, 1750 to 1891.
• Chapter I.: The First Great Banks.
• Chapter II.: The Bank of Portugal.
• Part VII.: National Bank of Roumania.
• Part VIII.: The Latin Monetary Union.
• Part IX.: Dynamics of Circulation.
• Part X.: The Banks of Alsace-lorraine After the Annexation. *
• Banking In Canada.
• Author’s Preface.
• Chapter I.: Currency Expedients.
• Chapter II.: 1817-1841. Banking Under Joint-stock Charters.
• Chapter III.: 1841-1867. Banking In Old Canada.
• Chapter IV.: Banking Under the Dominion.
• Chapter V.: Scope of Existing Laws.
• Chapter VI.: Land Banks—loan Companies.

CHAPTER III.

1841-1867. BANKING IN OLD CANADA.

STEPS TOWARD UNIFORM REGULATION OF BANKING.

THE first Governor-General of the new province was Lord Sydenham, who held the same currency views as Lord Overstone, and the time was that in which the controversies were being carried on which resulted in England in the Bank Act of 1844. Lord Sydenham favored for Canada a provincial bank of issue, and he outlined a scheme under which he proposed to cancel the right of issue by the chartered banks, remunerating them therefor; and by giving it to this institution, which was not to do a general banking business, he hoped to make a large profit for the Government. He proposed a gold reserve of one-fourth of the issue, to which a maximum was fixed, with Government bonds for the balance, and he claimed that such a system would ensure ready convertibility. But the Canadian people were intelligent enough to see the defects of such a system, and, apart from other faults, the lack of elasticity alone condemned it. It was opposed, of course, by the banks, but also on many grounds by the general public, and did not become law. The Legislature, however, took advantage of the opportunity to impose a tax on bank notes of one per cent. per annum on the average in circulation.

The union of the two provinces emphasized the importance of uniformity in banking, and a committee on banking and currency, after considering the recommendations of the Home Government, contained in the dispatch of Lord Russell of May 4, 1840, already referred to, reported in favor of the following restrictions:

In the renewal by the new province of Canada of the charters granted by the old provinces of Lower and Upper Canada, these restrictions, in addition to most of the provisions to protect the public already mentioned, were observed, and thus the provision for the double liability of shareholders in the event of failure was imposed for the first time on the banks of Lower Canada.

Once more, by a dispatch dated 30th May, 1846, the home authorities furnished “Revised Regulations to be Observed in Incorporating Banking Companies in the Colonies.” In this dispatch, after ineffectually urging, as in 1840, the abolition of the notes of smaller denominations than £1, twenty new regulations were proposed. Although eventually the banking system conformed to most of these regulations, they were not of sufficient importance to be noticed here.

We have now ascertained the principles at the base of banking in the old province of Canada, and which eventually made the foundation of the banking legislation of the confederation of the British North American provinces brought about in 1867. There were, however, two aberrations from sound principles to which I must refer, one of which was of short duration, while the other still exists as the one serious blot on our currency system.

“FREE BANKING ACT OF 1850.”

The first of these aberrations was the so-called “Free Banking Act of 1850.” Anyone having the opportunity to examine the correspondence of a Canadian bank at this time would at once realize how close were the trading and financial relations of Upper Canada and New York State, relations relatively much more important than now. The leading bankers of many of the large cities of the State were well known individually to leading bankers in Upper Canada, and, apart from the mere routine of business, an extensive correspondence was carried on. In Canada, the experiment was being tried of banks specially chartered, with large capital, and branches, and with a circulation not specially secured. The banks had come through the trying times of 1847-48 without suspension or failure, but they did not open branches fast enough to satisfy the most enterprising of the business community; the Provincial Government was straitened financially, and the people had the common delusion that there was not enough money in circulation. In New York State, the opposite policy of banks with small capital, no branches, and a specially secured circulation was on trial; but the people of that State were so much more prosperous than the people of Canada, that it is not strange that many desired to try the banking system which had apparently contributed toward such good results. In consequence, a measure was passed entitled “An Act to Establish Freedom of Banking in this Province, etc,” having for its object the creation, under a general act and not by special charter, of small banks without branches, with a circulation based upon the securities of the province. It was hoped that this would have the effect of creating a market for such securities. Such privileges as still existed under which in Lower Canada private bankers might issue notes were repealed, and any existing chartered bank might, in part or as a whole, surrender circulation under the unsecured system and issue under the secured system, thus escaping the tax of one per cent. per annum from which the secured notes were exempt. Indeed, by subsequent amendments stronger inducements were offered. Of the chartered banks, the Bank of British North America alone made use of the new act, and only because of a special disability under which it labored. Being established by royal charter, and the British authorities having been at all times opposed to notes of smaller denominations than £1 currency ($4), it had not, in common with the other banks whose charters were Canadian in origin, the right to issue notes of as low a denomination as five shillings currency ($1). It was accordingly benefited by taking advantage of the new act to the extent of the notes of small denominations required in its business. Altogether, only five banks with these limited privileges came into existence under this act. The minimum capital required was £25,000 currency ($100,000), and at the highest point the circulation in notes of small denominations by the Bank of British North America was greater than the entire circulation of the five free banks, while the total was only a little over £300,000 currency. In ten years, the system had practically come to an end, the only bank continuing to issue notes being the Bank of British North America, which, because of the disability already mentioned, issued its small notes under the free banking act until 1870, when the Dominion Government took from all banks the right to issue notes of less denomination then $4, and subsequently all smaller than $5, reserving the privilege for its own issues. Of the five banks thus created, two retired their notes and other obligations and went out of business, and three obtained charters, and were thus enabled to issue notes not specially secured. No attempt is here made to explain in detail the free banking system, because in Canada it left practically no enduring result of its former existence, and the reader can study it to better advantage in its origin and development in the United States. A very full account of the Canadian experiment will be found, however, in the first volume, page 154, of the “Journal of the Canadian Bankers’ Association, 1893-94.”

INCREASE OF BANK CAPITAL AUTHORIZED.

Although the free banking experiment did not actually end until some years later, its failure, as early as 1854, was clearly apparent and the demand for increased banking capital had not been satisfied. The Legislature therefore, relaxing somewhat the conditions hitherto imposed, granted permission to six existing banks to increase capital in the aggregate to the extent of about £2,000,000 currency, requiring them, however, to invest one-tenth of the paid-up capital in securities of the province. From this time there has, indeed, always been a disposition, although not to a serious extent, to make the banks, in exchange for their franchise, carry a portion of the public debt. In the same year the treaty for reciprocal relations in trade between Canada and the United States was passed, and the great impetus given thereby to business was naturally accompanied by the granting of several new bank charters. From 1855 to 1866, inclusive, more than twenty-five charters were granted, including the three free banks, which had decided to come under the ordinary system, and of these about fifteen banks actually came into existence. Two or three of them failed or were wound up voluntarily within a few years, and one was absorbed by amalgamation, but the remaining institutions, with two exceptions, are in existence at the present time.

The few years preceding 1857 had been in Canada as elsewhere years of great expansion in trade, while the building of Government-aided railroads and speculation in real estate were carried on at a pace of feverish excitement hitherto unknown in this country of moderate development. The Bank of Upper Canada was still the leading bank in that western portion of the province of Canada which before the Union had been known as Upper Canada. Down to 1857 it had paid large dividends and had apparently enjoyed great prosperity. Through the financial trouble of 1857 the Canadian banks were successful in preserving the strong credit which had always characterized them—they did not suspend specie payments—but the seeds had been sown for trouble of a more momentous nature than any previous experience, or any which Canadian banks have been called upon to suffer since that period. The area served by the Bank of Upper Canada and its branches was the most daring in its enterprise of any portion of Canada. There the railroad-building assumed greatest proportions and land speculation reached its craziest extremes. The Bank of Upper Canada had too freely aided new enterprises and had built up a capital of over $3,000,000,* on which even in 1858 it paid a dividend of eight per cent. By 1861 some of its errors had been realized and there was a change of administration in the Bank, in consequence of which the capital was cut down to $1,900,000. At this time the business of the Government, which it had for many years enjoyed, was transferred to the Bank of Montreal. After these events the Bank of Upper Canada enjoyed still a large measure of respect because of its past history, but maintained only a waning existence. In 1866 it failed. The failure was not only disastrous, but the winding up of the Bank was involved to a certain extent in mystery. The Government, for reasons not very apparent, did not press the collection of the double liability from the shareholders and paid off creditors at seventy-five cents on the dollar, losing, it is believed, all of its own claim of over a million of dollars. But although the winding up of the Bank was conducted in a manner which would be impossible now, the rude shock to the confidence of the public in banks was sufficiently effective; and this first great disaster was not an unmixed evil.

A GOVERNMENT BANK OF ISSUE PROPOSED.

We now come to the second aberration from the path of virtue in finance to which reference has been made. In 1859, the Minister of Finance, professing concern regarding the security for bank note issues and the general conduct of banking, but perhaps having quite as much in mind his own difficulties in carrying on provincial finances, instituted an inquiry through a committee on banking and currency, and followed this up by proposing in 1860 the establishment of a provincial bank of issue not unlike that proposed by Lord Sydenham. The issue by the Government of legal-tender notes would create a currency the prompt payment of which on demand, it was pretended, would be more assured than if issued by the banks. He was, however, unsuccessful, his proposal not being acceptable to the Legislature. But in 1866 the needs of the province were of such a nature that a somewhat similar proposal was brought forward, and this time with at least partial success. The Minister did not dare to press strongly for the entire separation of noteissuing from the other functions of banking and the assumption of this particular function by the Government through a mere bank of issue, because it was evident the people were not prepared for such a change. The Government had a floating debt, however, of about $5,000,000, nearly half of which was owed to its Canadian banker, the Bank of Montreal. The balance, doubtless, was largely due in England and might have to be provided from Canada. Its debentures were at a discount of about fifteen per cent. and it could not afford to consider the principles of finance too closely. The Minister, in language often heard before and since, talked of resuming some of the privileges hitherto deputed to others and of paying the debts of the country with the currency which it had the right to issue, etc., but the condition of the provincial finances was the strongest argument. As a result, power was obtained to issue notes payable in specie at Montreal and Toronto which should be a legal tender. The amount was to be fixed from time to time by authority of the Governor-in-Council, but the maximum was not to exceed $8,000,000.

Instead of directly forcing the banks to retire their notes in circulation, inducements were offered to cover the period until their charters expired, the intention being to take away the privilege when charters were renewed. To any bank voluntarily resigning its right to circulate notes, the Government offered to pay five per cent. per annum on the amount of its notes outstanding on April 30, 1866, until the date of the expiry of its charter, and the bank was to be allowed until January 1, 1868, to complete the withdrawal of its notes. For the issue and redemption of the Government notes which these banks would use in place of their own, the Government agreed to pay one-quarter of one per cent. every three months on the average amount kept in circulation. Finally, banks giving up their privilege of circulating notes were to be relieved from the requirement, already referred to, of investing ten per cent. of their capital in provincial bonds, and were at liberty to exchange them for the new provincial notes. The reserve to be held by the Government for its outstanding note issues was as follows: Until the issues exceeded $5,000,000, twenty per cent. in specie, and the balance in bonds of the province. For circulation in excess of $5,000,000, the specie reserve to be twenty-five per cent., with a corresponding reduction in the provincial bonds held for the remainder.

The total circulation of all Canadian banks at this time was about $10,000,000, of which the Bank of Montreal enjoyed over thirty per cent. As we have already stated, the Government was in debt to the Bank for over $2,000,000 at this time, and the Bank was by law required to hold ten per cent. of its capital in provincial bonds, so that it must have owned at least $600,000 in these bonds, its capital being at this time $6,000,000. Had it been practicable for the remaining Canadian banks, and had they been willing, to retire their circulation and accept the commuted profit, the effect upon the finances and trade of the country of the withdrawal of so much capital could only have been general bankruptcy. But the Bank of Montreal was in a position to retire its circulation without disturbing its advances to the public, inasmuch as it would receive from the Government, in exchange for the debt due the Bank, and for the provincial bonds it held, an amount of the new provincial currency in excess of any possible contraction of its own issues for some years to come. It therefore readily accepted the new conditions, while the other banks did not. The Bank of Montreal, already the bankers and now the note-issuing agency of the Government, was thus almost placed in the position of a State bank, and, rightly or wrongly, there was apparently a division of interest between it and the other banks which led to unfortunate results. The country was again experiencing a period of inflation, the circulation of the banks, in consequence, rapidly expanding; and it must have been a source of irritation to the Government and the Bank of Montreal that the aggregate of circulation in 1867 by the remaining banks was about $1,700,000 higher than in 1866, while that of the Government in actual circulation, added to such notes of the Bank of Montreal as were yet unredeemed, made a total considerably less than the circulation of the Bank of Montreal before the change. On the other hand, the banks circulating their own notes were at a disadvantage at the various points where settlements had to be made with the Bank of Montreal. The former would generally be the debtors, because of the volume of their notes falling into the hands of the Bank of Montreal, and not offset by similar notes of that bank coming into their hands. The Bank of Montreal could demand payment in gold or in the new legal tenders instead of the ordinary method of settlement by draft on some commercial centre. To get over this difficulty the various banks appear to have agreed with the Bank of Montreal to hold at the minimum a certain amount of the new legal tenders, the aggregate of the minima of all the banks being $1,000,000.

To add to other causes of irritation between the Bank of Montreal and its weaker brethren, a financial panic was brought about by the suspension of one of the most important banks in the western part of Canada, caused by large advances to a railroad company. The bank eventually was amalgamated with another, the shareholders saving a portion of their investment; but, owing to differences of interest and opinion between the Bank of Montreal and the others as to the assistance to be rendered to the institution in trouble, delay and doubt caused runs upon other western banks. The bank which suspended had a capital of $4,000,000, and being undoubtedly solvent, should not have been allowed to suspend if it had been at all possible, by harmonious action, to have liquidated its debts with open doors. The failure of the Bank of Upper Canada had caused the public to be extremely sensitive, and had there been unanimity of interest, the suspension of a second large bank, followed by a panic regarding other institutions, would doubtless have been averted.

Without entering into the question of the extent to which the unsound legislation contained in the Provincial Note Act contributed to the disasters of 1867, its passage certainly darkened the general cloud which hung over the history of Canadian finances at this moment. On July 1, 1867, a few months before the suspension of the bank which caused the panic, the Provincial Government of Canada came to an end, merging into that of the present Dominion of Canada.

Note.—The history of joint-stock banking in the provinces previous to confederation contained in chapters 2 and 3 has been compressed as much as possible, not only because the space at the command of the writer is limited, but because the present sketch purports to be a history of development and principles rather than of the incidents of Canadian banking. In the chapter to follow, the writer deals with what has happened in his own time and experience, but for the facts dealt with in chapters 2 and 3 he is almost entirely indebted to the very comprehensive history by Dr. Breckenridge, entitled “The Canadian Banking System,” and published in the second volume of the “Journal of the Canadian Bankers’ Association, 1894-95.” The reader who desires ampler information is referred to that excellent work.

[* ] In 1857 the decimal currency was adopted in Canada, and hereafter sums of Canadian money are expressed in dollars.