I’ll be discussion leader at a colloquium the weekend after next whose topic is Canadian banking. The readings are so much fun because I’m learning so much history, mainly about banking but partly about politics, in the country I grew up in.
Here’s a great passage from Charles W. Calomiris and Stephen H. Haber, Fragile by Design: The Political Origins of Banking Crises and Scarce Credit, Princeton University Press, 2014.
The Bank of Montreal, however, did not always step in: it allowed smaller banks to fail. This was an important attribute of the system: unless depositors knew that they could suffer losses, they would have no incentive to monitor the behavior of the bankers. When a bank that was large enough to threaten the entire system failed, however, the Bank of Montreal stepped in to coordinate a response by other banks. This happened in 1906, when the Bank of Ontario failed, and again in 1908, when the Sovereign Bank of Canada failed. In these cases, the Bank of Montreal orchestrated takeovers of the insolvent banks. In the case of the Bank of Ontario, the process was so seamless that the failed banks’ depositors were not even aware that there was anything to be concerned about.
Calomiris and Haber go on to quote from a book written in 1910:
On the evening of October 12 [1906] the bankers in Toronto and Montreal heard with surprise that the Bank of Ontario had got beyond its depth and would not open its doors the next morning. Its capital was $1,500,000 and its deposits $1,200,000. The leading bankers in the dominion [DRH note: Canada was officially the Dominion of Canada in those days] dreaded the effect which the failure of such a bank might have. The Bank of Montreal agreed to take over the assets and pay all the liabilities, provided a number of other banks would agree to share with it any losses. Its offer was accepted and a representative of the Bank of Montreal took the night train for Toronto . . . . [T]he bank opened for business the next day with the following notice over its door: “This is the Bank of Montreal.”
Calomiris and Haber then write:
The contrast between this method of dealing with bank failures and that of the United States could not be more striking. In the United States, the ability of banks to coordinate their responses to crises was confined to collective action of particular cities’ clearinghouses, branching banks in the South, or other localized bank networks. When shocks associated with recessions raised significant liquidity problems for U.S. banks, nationwide banking panics resulted (in 1857, 1873, 1884, 1890, 1893, 1896, and 1907), even though (with the exception of the panic of 1857) these were not times of severe loss to banks or widespread bank failure. Four of those recessionary shocks (1857, 1873, 1893, and 1907) resulted in widespread suspensions of convertibility: that is, banks refused to redeem their own deposits.
Because of restrictions on branch banking in the United States, the United States had a fairly primitive banking system until the 1980s.
READER COMMENTS
Art K
Apr 15 2021 at 6:08pm
“n the United States, the ability of banks to coordinate their responses to crises was confined to collective action of particular cities’ clearinghouses, branching banks in the South, or other localized bank networks. ”
Because of the population of Canada, one could argue this was the same thing. Canada’s population today is about the same as California.
KevinDC
Apr 16 2021 at 10:13am
There’s an important difference you’re overlooking here. It’s not so much about the population within a country (or state) that makes the difference, the key factor here is the degree of legally mandated fragmentation of the banking system within that country (or state). California and Canada have comparable populations, but with unit banking laws in the US, the banking system within the state of California was far more fragmented and undiversified than within the country of Canada. These laws didn’t just limit the ability of banks to operate across state lines – they also restricted the ability of banks to branch out within states as well. If the local economy in Calgary took a big hit, the banks in Calgary were part of banking networks that extended throughout the entire country, which made them far more robust to local shocks. But if the local economy of Bakersfield took a big hit, the banks within Bakersfield had no such network to help absorb shocks, and were almost guaranteed to go down.
Think of it with this analogy. Imagine, for whatever reason, California passed a law saying that anyone who invests in the stock market can only invest in one company. You can invest in Facebook, or Tesla, or Krispy Kreme donuts, etc, but you legally must put all your investment eggs in one basket. Meanwhile, no such laws exist in Canada, and people are free to have stock portfolios which are as diversified as they wish. It’s pretty obvious that in this scenario investments will be much more volatile in California than in Canada, regardless of their similar populations. And, imagine if after California investors experience all this volatility and droves of people losing their entire savings after a single company’s stock declines, people responded by saying “Well, that just shows how unstable investing is when you leave it up to the unregulated free market – we need to pass more laws and regulations to protect people’s investments.” This would be an utterly bizarre reaction to have, especially when you have Canada right there to give you a counterpoint – but that’s basically how many people reacted to the volatility of US banking when unit banking laws were in effect.
Comments are closed.