Incentives Matter in Banking Too
By David Henderson
Do you have any idea what the balance sheets of your bank(s) look like? I don’t. I don’t know whom they lend to.
I don’t have to. And the reason is deposit insurance. Even when my checking account hits 5 digits, the amount in it is well under the $250,000 limit that is covered by deposit insurance. So no matter how risky the loans my bank makes, I don’t have to worry.
In Canada in the 1870s, by contrast, there was no deposit insurance. Indeed, deposit insurance was not introduced to Canada until 1967. In “Stability in the absence of deposit insurance: The Canadian banking system, 1890-1966, Journal of Money, Credit, and Banking, November 1995, Vol. 2, No. 4, University of Toronto economists Jack Carr and Frank Mathewson and Victoria University (in Wellington, New Zealand) economist Neil Quigley write:
The Canadian Bank Act, 1871, was explicitly designed to prevent the public from thinking that the government was responsible for either the commercial administration of the banks or the ability of individual institutions to pay their creditors. It required banks to make monthly returns to the Department of Finance, but envisaged the self-interests of the shareholders and mandatory double liability as sufficient protection for the creditors.
The related footnote states: “In this period, the banks undertook extensive advertising of their balance sheets in the press. In addition, newspapers reproduced the monthly financial statements that the banks provided to the government.
Incentives matter. Depositors cared about how safe their deposits were and banks and newspapers responded to this concern by reporting balance sheets.
Note: You might wonder what double liability is. Elsewhere in the article, Carr, Mathewson, and Quigley explain it: “Double liability of the shareholders meant that creditors of the bank were secured by both the value of the equity and retained earnings in the bank and a claim against the personal wealth of shareholders equivalent to the subscribed capital.”