RDP 2001-07: A History of Last-Resort Lending and Other Support for Troubled Financial Institutions in Australia 4. The 1840s Depression

During the 1830s, the expansion of the pastoral industry and whaling, the spread of land settlement and capital inflows from Britain fuelled rapid growth. In this environment, the existing banks expanded their activities, British banks entered the Australian market and a number of new colonial banks were established.

Economic conditions began to turn in 1840. The wool industry had reached the bounds of profitable expansion onto new land. Severe drought in 1838–1840 necessitated wheat imports and payment for this drained liquidity from the colonies. The British financial crisis of 1839 heightened British investors' sensitivity to declining returns in the colonies, which in turn slowed capital inflow. A slump in land sales, falling prices and incomes culminated in an upsurge of insolvencies that substantially weakened the banks.

The depression of the early 1840s precipitated the first wave of bank failures seen in Australia. Although six banks failed (and one merchant company abandoned its banking operations), they were relatively small, and in most cases depositors fully recouped their funds. In line with the prevailing philosophy that the government should not intervene in banks' operations, there was no official intervention in these failures. The government, however, was more ready (on social rather than economic grounds) to intervene to protect depositors who had placed funds with the colonies' savings banks.

4.1 Trading Bank Failures

Throughout the nineteenth century, Australian trading banks operated in a largely unregulated environment. The charters and acts under which the banks were established imposed a range of restrictions on banks, including limitations on the types of lending, particularly against real property, that could be undertaken. The 1840 Colonial Bank Regulations stipulated simple capital adequacy requirements, some restrictions on bank lending and that all bank notes were to be payable on demand in coin (Baster 1929).^[11] These constraints were widely evaded and progressively relaxed by legislative changes.^[12]

The largest bank to fail in 1843 was the Bank of Australia. It was particularly affected by the failure of one large borrower – a milling and merchant firm. Two banks jointly provided a loan to the Bank of Australia enabling it to repay all creditors other than the banks. In the wind-up of the bank, shareholders lost twice the value of their shareholding (requiring shareholders to pay-in funds on top of the loss of their initial capital investment) offset by a portion of the real estate held by the bank (Sykes 1988). Auctions of the bank's assets allowed it to settle its debts and finally close in July 1851.

The other well-established bank to fail was the Derwent Bank. During the 1830s, it had expanded by offering mortgage finance, attracting borrowers who were refused finance elsewhere (Butlin 1953). The bank continued in operation until 1849 by borrowing from other banks. In 1849, the banks refused to continue to extend finance and the bank's shareholders resolved to wind-up the bank. Most outstanding notes and deposits were repaid within a few months.

Three small domestic banks, established at the peak of the expansion in 1839 and 1840, failed in 1843. Loan defaults and heavy borrowing by the bank's own directors saw the Port Phillip Bank fail in January 1843. In April 1843, investigations of the accounts of the Sydney Banking Company unearthed management fraud, leading shareholders to close the bank. The Colonial Bank's losses in the first half of 1842 led proprietors to question whether to wind-up the bank. This triggered a run that cut the bank's note circulation by half and deposits by a third. In an environment where the shareholders themselves were pressed for cash, they opted to cut their losses and close the bank. In each of these cases, note holders and depositors were quickly repaid.

Of the two other banking failures during the 1840s, one involved the withdrawal from banking by Archers Gilles and Company. The company acted mainly as a merchant and trader. The Union Bank's bailout of the company was conditional on the transfer of its banking business to the Union Bank. This involved no loss to depositors or note holders. The second failure involved the fraudulent operation of the Royal Bank of Australia. While the bulk of the bank's deposit liabilities and shareholders were based in Britain, most of its assets were in Australia. The bank, formed in 1839, never carried out more than cursory banking operations. Instead, its funds were fraudulently used to finance Benjamin Boyd's pastoral, shipping and whaling activities in Australia (Sykes 1988). In 1846, the bank's directors in London discovered Benjamin Boyd's deception. Liquidation of the bank imposed heavy losses on both depositors (few of whom were Australian) and British shareholders.

Throughout the whole period, the few deposit runs that did occur did not spread much beyond the troubled institutions. With the exception of the Royal Bank, note holders and depositors lost almost no money. Given shareholders' preferences to cut losses and close their banks, there was little scope for government intervention. The banks themselves, in their submissions to the NSW Select Committee on Monetary Confusion (sic) held in August 1843, argued that the ‘natural course of events’ should be allowed to run.

In NSW, two legislative initiatives did help banks and borrowers withstand the depression. In December 1841, legislation was passed relaxing the treatment of insolvents, permitting debtors with real prospect of ultimately paying to retain and use their property. This gave banks greater scope to restructure non-performing loans. The introduction of wool liens and stock mortgages in 1843 expanded the range of assets banks could take as collateral. This made it easier for squatters, who had no fixed property assets, to obtain finance.^[13] The volume of such loans did not offset the overall decline in bank loans, but helped sound squatters withstand the depression (Butlin 1986).

4.2 Savings Banks

The first savings bank in Australia, the New South Wales Savings Bank, was established in 1819 as a private initiative, although with the Governor's patronage.^[14] The bank struggled to attract funds and, in 1832, the Savings Bank of NSW was established in its place.^[15] The colonial administration took a more active role in running the new bank. The Governor was president of the bank, while management was vested in trustees appointed by the Governor.

In May 1843, a run on the Savings Bank of NSW occurred as a result of rumours that the Governor, after examining the bank's securities, had declared them to be worthless. There were also concerns that the trustees had lost money in the failure of the Bank of Australia. The bank met deposit withdrawals by rediscounting bills with other banks. A Board of Inquiry, appointed by Governor Gipps, found that the savings bank was solvent. In response to the run, the government undertook to guarantee trustees' borrowings, if taken out to meet the bank's repayments, of up to £50,000. Larger loans could also be guaranteed with the consent of the Governor-in-Council. These arrangements were put in place for fear of the social consequences that might follow if depositors were unable to access their funds.

Between 1835 and 1865, savings banks were established in each of the other colonies either as government-owned and controlled entities or under the management of a board of trustees over whose appointment governments usually exercised some control. In Queensland, South Australia and Western Australia, private initiatives to establish savings banks were ultimately supplanted by government-owned institutions.

Footnotes

Up until 1910, individual banks were permitted to issue their own bank notes. While bank deposits were not transferable, bank notes circulated widely in the colonies as a means of payment. Although note holders were afforded greater protection than depositors, it was not until the 1880s that bank notes became a first charge on bank assets, ranking ahead of deposits in the event of the wind-up of a bank. [11]

For example, several banks were able to operate for a number of years before legislation governing their incorporation was passed (Teare 1925). [12]

Squatters were farmers who settled on Crown land to run stock, especially sheep, initially without government permission, but later under a lease or licence arrangement. [13]

Savings banks were distinguished from trading banks by their focus on small deposits and constraints on their lending that saw them invest mostly in government securities, and later (after the 1910s) in residential mortgages. [14]

The savings bank was quite separate from the Bank of NSW. [15]