RDP 2001-07: A History of Last-Resort Lending and Other Support for Troubled Financial Institutions in Australia 3. The 1820s

Bryan Fitz-Gibbon and Marianne Gizycki

October 2001

The Australian history of official support for troubled financial institutions began just under forty years after the formation of the New South Wales (NSW) colony. The first bank to operate in Australia, the Bank of New South Wales, was established with the active support of the colony's Governor in 1816. Within the first 11 years of the bank's operation it was struck by liquidity crises three times. While the bank was able to withstand the first in 1821 without outside support, it sought assistance from the colonial administration in 1826 and again in 1828. In both cases, loans were granted by the NSW Governor out of concern for the potential effect of the bank's failure on the colony's economy. Although a penalty rate of interest was not charged, the loans were subject to caveats that restricted the bank's ability to take on new risks, required the bank to increase its capital reserves and strengthened the colonial administration's oversight of the bank.

3.1 The Establishment of Australia's First Bank

The NSW colony's recurrent shortages of currency and the inefficiency and scope for fraud in the private issuance of promissory notes led Governor Lachlan Macquarie to favour the establishment of a colonial bank. In late 1816, the Bank of NSW was established as a privately owned bank. Macquarie granted the bank the privilege of limited liability, usually obtainable only by Royal Charter. If the proprietors had been prepared to establish the bank as a partnership with unlimited liability – the usual form of corporate structure at the time – no special charter would have been required. Macquarie believed that the proprietors would not risk subscribing to the bank without some guarantee against losing more than their subscribed capital if the bank were to fail (Holder 1970).

Macquarie, in fact, had no specific power to approve such a charter. The British administration instructed Macquarie to refrain from providing any implicit support for the bank and to inform the bank's shareholders that the bank would have to trade as an ordinary partnership.[5] Macquarie delayed responding to this direction. And while questions about the validity of the charter arose from time to time, the bank continued its business.

Macquarie's patronage helped the bank to establish itself within the colony. The bank's notes were specified as the medium of payment for customs duties and for various properties sold by the government. Macquarie, however, stopped short of making the Bank of NSW the banker to the colonial administration (Butlin 1953).

The bank experienced its first serious difficulties in late 1820 when its cashier defrauded it of £6,000 (equivalent to 10 per cent of the bank's assets). In January 1821, word of the fraud became public, sparking a brief deposit run. The run was stemmed by the bank's president, in his capacity as Provost-Marshal, undertaking to accept the bank's notes in official payments, and by some 20 merchants (most of them shareholders) advertising their willingness to take the bank's notes. The bank itself promised that all notes presented would be met in government bills or coin.

3.2 The Liquidity Crisis of 1826

The early 1820s saw a boom in the colony's economy. The boom was marked by rapid population growth, pastoral expansion, and sharp rises in the prices of agricultural stock. Against this background, the Bank of NSW expanded its lending at a rapid rate. Its total loans grew from £23,577 in 1820 to peak at £95,408 in May 1826 (Butlin 1953). By 1826, however, the bank found itself in extreme difficulties. These arose from two main sources: increased competition, and an acute shortage of currency throughout the colony. Mismanagement of the bank compounded its problems.

The first source of competition came from the Waterloo Company. While the company began as a flourmill, as a sideline it also accepted deposits and issued its own notes. More significantly, a second bank – the Bank of Australia – opened in the colony in July 1826. Payment of capital subscriptions to the new bank drew cash and deposits away from the Bank of NSW.

The April 1826 foreign exchange crisis created a serious drain on the colony's liquidity. An import boom resulted in large currency outflows. In addition, the colonial administration moved the colony to the sterling standard.[6] This precipitated large exports of Spanish dollars, which were more rapid than offsetting imports of sterling, leading to a generalised shortage of coin.

In May 1826, the Bank of NSW found itself unable to discount bills denominated in Spanish dollars. Although the bank's cash reserves were almost exhausted, the bank was solvent (Sykes 1988). The bank applied to the government for a loan of £20,000. Liquidation of the bank's assets risked triggering widespread bankruptcy in the colony.[7]

Governor Ralph Darling commissioned a Board of Inquiry to assess the bank's affairs. The Inquiry attributed the Bank of NSW's difficulties to the import boom. While it did not find that there had been any fraud, the Inquiry recommended that any support should be subject to the condition that ‘… the management of the Bank should be conducted with more circumspection than appears to have been lately observed’.[8]

Governor Darling agreed to support the bank. The conditions attached to the loan included:

  • the appointment of three directors (to be added to the existing board of seven) acceptable to the Governor;
  • the reduction of the bank's weekly lending by a quarter for the remainder of 1826; and
  • the full payment of capital that had been subscribed, but not fully paid, by the end of the year, with no dividend to be paid to shareholders in that time.

The announcement of the provision of support was sufficient to shore up public confidence (deposits exceeded withdrawals by the end of May). Although the bank sharply curtailed its lending, in August it was forced to draw on the government loan. It was able to repay the loan by January 1827.

3.3 Further Runs on the Bank of New South Wales, 1828

In late 1827 and early 1828, divisions among the management and shareholders of the Bank of NSW further undermined the bank and public confidence in it. In its weakened state, the Bank of NSW was poorly placed to withstand the colony's slide into depression in late 1827 (Butlin 1953).

A run on the bank developed in the closing weeks of 1828, and the bank again applied for government assistance. Concern about the consequences of the Bank of NSW calling-in its loans at a time of economic distress saw the government agree to offer support.[9] A number of witnesses to the colonial administration's inquiry, called to consider the bank's request, suggested that suspension of the Bank of NSW could trigger a general panic and a run on the Bank of Australia.[10] Governor Darling was also mindful of the benefits of having two banks operating in competition and the need to avoid the perception of using his position for personal gain (his family were shareholders in the Bank of Australia).

This time the support was subject to more stringent conditions:

  1. the wind-up of the bank within a year;
  2. a progressive reduction in lending;
  3. no dividend payments until repayment of the loan;
  4. a government-appointed director and the submission of weekly statements of accounts to the Governor; and
  5. bills from the bank selected by officers of the government were to be taken as security against the loan.

Again, the government's support succeeded in quelling public anxiety.

In response, the bank strengthened its efforts to collect overdue loans and improved its liquidity sufficiently to repay the government loan in May 1829. The bank then defied the government's order to wind-up its affairs. In the face of the substantial improvement in the bank's condition, the Governor relented and allowed the bank to continue trading.

Footnotes

Earl Bathurst to Governor Macquarie, 29 October 1818, Historical Records of Australia, 1, IX, pp 840–841. [5]

Up until 1826, the colony had no official currency. Coin circulating in the colony came from a variety of countries, although the Spanish dollar was the most prevalent currency, as was the case in most British colonies. [6]

Earl Bathurst to Governor Darling, 1 December 1826, Historical Records of Australia, 1, XII, p 703. [7]

Quoted in Sykes (1988, p 14). [8]

Governor Darling to Sir George Murray, 29 December 1828, Historical Records of Australia, 1, XIV, p 549. [9]

Extract from the Proceedings of the Executive Council, Minute No 14, Historical Records of Australia, 1, XIV, pp 551–555. [10]