Notes on free banking in Canada in the 1830s Ronald A Shearer Vancouver 1994 Adam Shortt referred to the mid to late 1830s as "one of the most exciting and abnormal periods in Canadian political and financial history." (Shortt, 1986, 830). It may also have been decisive in setting the course of Canadian banking policy for decades. There were several important developments: the chartering of new banks and increases in the capital of existing chartered banks; attempts to obtain charters for new banks on different principles than those of the existing institutions; the establishment of non-chartered banks with a substantial presence in the banking system; and deliberate measures taken by the provincial legislatures and the Imperial government to suppress significant banking innovations including non-chartered banks. These notes are an attempt to assemble the historical record on one of these developments. We review and consolidate the available evidence concerning non-chartered banks, including evidence on their quantitative importance. The literature on the non-chartered banks of this period is scanty. The most extensive discussion, largely anecdotal, is by Adam Shortt (Shortt, 1986,295-337). By contrast, Breckenridge's exposition is very brief (Breckenridge, 1910, 36), and they are given but passing mention in the two standard modern histories (McIvor, 37-38; Neufeld, 39-40). Although the non-chartered banks had a short existence, they had quantitative importance and the fact that they represented a plausible alternative form of banking organization that has been much touted in recent years suggests that they merit more careful attention (White, 1984; Selgin, 1988). Unfortunately, there is little evidence; they left more shadows than records. I. The private banks of Upper Canada Upper Canada was a much more fertile ground for banking experiments than Lower Canada, although few of the attempted innovations were long lasting. At the time that the first non-chartered bank was established, banking in Upper Canada was divided between two chartered banks. The "Old Lady," the Bank of Upper Canada established in 1822, accounted for 73% of the reported bank assets of the Province, and the relatively new Commercial Bank of the Midland District, established in 1832, held the remaining 27%. A. The Agricultural Bank. Undoubtedly there were earlier private banking ventures, but the first important non-chartered bank in Upper Canada, and the first one for which there is some documentation, was the firm of Truscott, Green & Co., commonly called the Agricultural Bank. It opened in Toronto in June 1834,1 allegedly to operate "on the Scottish system" -- a proposition that one editorial writer pronounced "good news indeed if it be true."2 1. Scottish Banking The "Scottish system" of banking is a vaguely defined concept that had an almost mystical attraction for Canadian banking reformers of the period.3 It was alleged to provide safe, stable banks (in contrast to those of England and the United States) and a stable currency while vigorously promoting economic progress and prosperity. Conceptually, the system had three separable but interrelated components, of which the second two received particular but varying emphasis by Canadian reformers. First, the banks were to be free to open branches and agencies throughout the province. This is not emphasized by Canadian reformers, perhaps because in the Canadian context it was a privilege that was taken for granted. The chartered banks already operated on this principle. Second, it implied competitive banking with freedom of entry and minimal regulation.4 Freedom of entry required banks operating without legislative charters and hence with unlimited liability of partners or shareholders, which was thought to ensure responsibility in management and enhanced security for note holders and depositors.5 The prospects of strong competition for the entrenched chartered banks, and 1 Truscott (1838). Shortt states both "in May, 1834" (311) and "shortly after the middle of June" (832). It was certainly open on June 17, the date on which the Common Council of Toronto applied to it for (and was granted) a œ1000 loan.(Grady, 1834a). The Correspondent noted the arrival of "three gentlemen" (probably only Captain Truscott and Mr. Green) who were about to establish a "new banking house" in its issue for May 24, 1834, and the Patriot reported the plans to establish the new bank in its June 6 issue. In a petition to the Legislative Assembly in 1835 Truscott and Green stated that the bank opened in May 1834 (Truscott 1835b). 2 Hallowell, 1834. 3 For example, one of the questions asked by an 1835 Legislative Committee investigating a proposal for a provincial bank with joint private and government ownership was "Do you understand the Scotch system of Banking." (followed by whether the witness was in favour of requiring banks to pay interest on deposits) [Upper Canada, 1835c]. Another 1835 enquiry into the state of the currency of Upper Canada reported being strongly impressed with the merits of the banking system of Scotland, although its review of the system was very incomplete [Upper Canada, 1835b]. A succinct contemporary account of the Scottish system from Chambers' Edinburgh Journal, received some circulation in Canada, reprinted in the Quebec Mercury and the Kingston Chronicle. This article contains a clear statement of the nature and benefits of the Scottish system, arguing that the banking system was almost solely responsible for the superior performance of the Scottish economy. The same notions are echoed in other contemporary Canadian commentaries. See for example, Upper Canada, 1835b; Anon., 1837; Young, 1837. While more cautious in his claims, Adam Smith provided strong authority for the proposition that "... the banks have contributed a good deal to ... [the very considerable increase of] ... the trade and industry of Scotland." (Smith, 1776, p 262). For a recent statement to the same effect see White, 1984. 4 An editorial writer stated: ... we wish to see Banking free to all, under proper regulations and restrictions. ... (L)et any five individuals who may wish, commence Banking, and issue their notes, provided that such notes never extend more than a certain fixed amount beyond that capital which they have invested (Hallowell, 1834). The restriction to five partners is not a Scottish principle. Indeed, the opposite is true. What distinguished early Scottish banking organization was the dominance of unchartered joint stock banks with many shareholders. Apart from this and the (unspecified) linkage of the note issue to capital, the editor did not specify the "proper regulations and restrictions." 5 Thus, one editor:..." Private Bankers are answerable to the Public to the whole extent of their fortunes, and are therefore more trustworthy that the United States institutions, which are legalized not to pay their debts in case of failure ...." [Hallowell, 1834] An 1835 legislative committee on the currency (which included the radical reformer W.L. MacKenzie) strongly endorsed the joint stock principle for banking in the province. The report included a sketchy proposal for a joint stock bank, an almost literal copy of the prospectus for the Plymouth and Devonport Banking Company which, along with material on several other British joint stock banks. This was probably provided to the committee by George Truscott. He appears in the documentation attached to the report as chairman of a June, 1831 meeting in Exeter of "Gentlemen favourable to the principle of Joint Stock Companies" for the purpose of selecting a provisional committee for the creation of a joint stock bank for the County of Devon. This was probably the Plymouth and Devonport Bank whose prospectus was issued in October (Upper Canada, 1835b). particularly the Bank of Upper Canada, was one of the powerful attractions of Scottish banking to Canadian reformers. Third, it implied adoption of the Scottish practices of paying interest on deposits and lending on cash accounts instead of discounting bills for fixed periods.6 While these practices were apparently invented in Scotland, by the early 1830s they had been widely adopted, with variations, in England (Watt, 1836). A cash account involved a line of credit that could be drawn upon at any time without the explicit discounting of a note. The size and timing of loans could be tailored to the needs of the borrower. It also meant that outstanding loans could be repaid, in whole or in part, at any time and not just on scheduled repayment dates or on maturity of the bill.7 The payment of interest on deposits meant that excess funds would be deposited in the bank, not hoarded as banknotes. This, it was argued, discouraged excess borrowing and limited the danger of excess note issues, adapting the note issue to the actual needs of the economy (Hallowell, 1834). Canadian reformers were particularly concerned about finance for agriculture and the attraction of the cash loan system for farmers is obvious. Funds could be made available at the beginning of the agricultural season before there was any saleable output to secure a discountable bill and the advances repaid as the crop was sold. The farmer would no longer be dependent upon a merchant for credit. Surplus funds, to be used over the winter, could be lodged in the presumed safety of an interest bearing account, reducing the risk of holding banknotes and providing a source of income not available from normal bank deposits. The crucial issue, however, was security for the line of credit. The "Scottish principle" seems to have required either the surety of other people of known wealth8or the collateral of other assets, perhaps financial assets, perhaps real property.9 For a frontier farmer to find two wealthy persons to stand surety 6 The clearest contrast between the "Scottish" practice and then conventional bank lending is in Young (1838). See also Smith, 269-70.