RDP 2001-07: A History of Last-Resort Lending and Other Support for Troubled Financial Institutions in Australia 5. Intermittent Failures and Runs, 1850–1890

While overall conditions remained comparatively calm between the depressions of the 1840s and the 1890s, economic and political fluctuations, peppered with fraud, triggered isolated liquidity crises and bank failures in South Australia (in 1852 and 1885), Queensland (in 1866) and Victoria (in 1879). While the difficulties experienced in South Australia and Queensland prompted responses from the public sector, depositor runs in Victoria marked the first mutual support provided by the banking industry, which was coordinated by the Associated Banks of Victoria.

5.1 South Australia

Gold rushes in NSW and Victoria in 1851 triggered an exodus of both people and cash from South Australia. This led the South Australian Government to introduce a package of measures to shore-up banks' liquidity and the liquidity of the colony more broadly. Under the Bullion Act of 1852, banks were required to accept gold ingots as deposits. The notes issued by banks in exchange for the ingots were declared legal tender for a year. This gave banks time to ship coin from London. As well as easing the general liquidity shortage, it is likely that the government's actions saved the Bank of South Australia from suspending payment (Butlin 1961a). The bank had been particularly hard hit by the liquidity squeeze since it accounted for around half of the colony's banking business.

Drought in 1885, combined with falls in the world price of copper, weakened South Australia's main agricultural and mining businesses, creating bad debt problems for the banks. In February 1886, fraud on top of bad debts brought down the Commercial Bank of South Australia (which accounted for 9 per cent of deposits in South Australia). In the weeks before the bank's closure, it sought assistance from the Associated Banks in Melbourne (an alliance of the strongest Victorian banks). After examining the bank's books, the Associated Banks declined to take over the bank's business (Sykes 1988). While legal complications delayed the liquidation of the bank, by 1893 all depositors had been repaid.

5.2 Queensland

As a result of the Queensland colony's heavy dependence on foreign borrowings for the development of road and rail infrastructure, the Queensland Government was caught up in the financial turmoil in England in May 1866. The failure of the government's agent for the sale of its debt in London led it to seek other avenues for emergency borrowing. The government proposed an issue of inconvertible, legal tender notes. Queensland's Governor, however, withheld assent. The ensuing political crisis triggered a change of government. The new government adopted the note issue plan, although the notes issued were convertible into gold and were not legal tender. A large circulation was never achieved (between 1866 and 1869, the government notes averaged at most 17 per cent of total note issue in Queensland) and the notes were withdrawn in 1869 (Butlin 1986).

When news of the British crisis reached Brisbane in July 1866, there were generalised runs on banks, particularly the government-backed savings banks.^[16] The Colonial Treasurer's statement that all demands for payment would be ‘faithfully met’ eased the position of the savings banks.

The deposit runs precipitated the closure of the Bank of Queensland (which had been formed in London in 1863). By 1866, the bank was the fourth largest in the colony, accounting for 15 per cent of bank deposits (Sykes 1988). Although the bank was solvent, it did incur a loss in 1866 as drought in Queensland in the mid 1860s impaired the pastoral industry's ability to meet its debts. In the face of Queensland's political turmoil, the London shareholders chose to liquidate the bank, rather than inject fresh capital. By July 1867, all depositors were repaid in full (Butlin 1986).

5.3 Victoria

Melbourne had become Australia's main financial centre following the Victorian gold rushes in the 1850s. In the absence of a central bank, and with the government unwilling to intervene to assist troubled banks (other than the savings banks), the trading banks began to take collective action to provide limited last-resort support through their industry association. The Associated Banks of Victoria was formally constituted in 1877 by those banks that conducted the government's banking business in Victoria.^[17] It therefore represented the largest and strongest banks operating within Victoria.^[18]

Three banks, the Provincial and Suburban Bank, the Australian and European Bank and the City of Melbourne Bank, sought assistance from the Associated Banks in 1879. Each of these banks was small.^[19] The first of these was deemed to be too weak to warrant support. The second received limited support, while the third, which was the soundest of the three, received strong public support from the Association. The differential treatment afforded to the troubled banks reflected both the Associated Banks' concern to protect their own viability (by only lending to sound institutions) and moral hazard concerns (refusing to support banks that had been managed recklessly). Debate within the Associated Banks concerning the public's ability to discriminate between notes issued by different banks saw the banks grapple with the systemic consequences of bank failure, albeit in a limited way.

The Provincial and Suburban Bank made losses in all seven years of its operation (which were masked by misstating the bank's accounts). Following its closure in May 1879, the Associated Banks' investigation of its operations confirmed that the bank had been ‘founded, reared, and ended in fraud’.^[20] Some banks within the Association argued that the public did not discriminate between notes issued by sound and weak banks, and therefore other banks should honour the Provincial and Suburban's notes. The prevailing view, however, was that the Provincial and Suburban was widely known to be unsound, and no support was provided.^[21] In the liquidation of the bank, note holders received just 10 per cent of their notes' value, depositors received a little over 40 per cent of their funds, while shareholders lost all of their capital investment (Sykes 1988). This marked the last time in Australia's history that bank notes were not fully paid (Polden 1977).

Underlying bad debts led to the suspension of payment by the Australian and European Bank in June 1879. The Associated Banks agreed to cash Australian and European's notes and advance the bank £50,000. The Associated Banks' support combined with payments of uncalled capital by shareholders and the extension of the maturities of a number of large deposits enabled the bank to re-open a fortnight after its closure (Wood 1990). A more generous offer by the Associated Banks, accompanied by harsher conditions (the Associated Banks offered to meet all of the bank's obligations if it went into liquidation at once), was refused by the bank's directors (Blainey 1958). Not long afterwards, in August 1879, the Australian and European Bank was taken over by the Commercial Bank of Australia, and all creditors were eventually repaid.

The suspension by Australian and European sparked a run on the City of Melbourne Bank (which was the only other bank of issue that was not a member of the Associated Banks). The Associated Banks inspected the bank's securities and found the bank to be in a sound condition. The Associated Banks resolved that they were prepared to lend £40,000 if necessary, and issued a statement indicating they were prepared to offer the bank ‘whatever assistance may be required to meet their engagements in the present emergency’.^[22] The deposit run quickly subsided and no financial assistance was required. A similar, but less severe, run on the Commercial Bank of Australia also stopped. Depositors most likely believed that the Associated Banks would also support one of their own members (Butlin 1961a).

While the Victorian Government stood aside from the banking difficulties of 1879, pressure in the late 1880s led to legislation strengthening the protection of holders of bank notes. Problems from the Oriental Bank's Asian and African operations led it to suspend payment in May 1884. The Victorian Government insisted on priority for debts owed to it, at the expense of note holders and depositors. This prompted proposals for banking reform to protect note holders.^[23] On the recommendation of the 1887 Royal Commission on Banking, legislation was passed which made notes the first charge on each bank's Victorian assets (Butlin 1961a).^[24] Most of the witnesses to the Commission's inquiry argued that bank notes should be afforded particular protection as they were widely accepted without question, whereas customers could exercise their own choice over the placement of their deposits.

Footnotes

Runs by British depositors also affected Australian banks. The National Bank of Australasia found itself unable to meet its obligations in London. It obtained a last-resort loan from the Bank of England until funds could be shipped from Australia (Blainey 1958). [16]

No such industry organisation was established in any of the other colonies, although the Australian banks in London formed an association in 1875 (Butlin 1961b). [17]

The Association consisted of the four Anglo-Australian banks whose main Australian office was in Melbourne (the Bank of Australasia, the Union Bank, the London Chartered Bank, the English, Scottish and Australian Chartered Bank) and six colonial banks based in Melbourne (the National Bank of Australasia, the Commercial Bank of Australia, the Bank of Victoria, the Colonial Bank, the City of Melbourne Bank and the Federal Bank). [18]

The Provincial and Suburban accounted for just 0.3 per cent of all Victorian deposits, the Australian and European Bank 1.8 per cent and the City of Melbourne Bank 1.4 per cent. [19]

ES Parkes (Superintendent of the Bank of Australasia) quoted in Butlin (1961a, p 233). [20]

The Australian Insurance and Banking Record reported that the closure of the Provincial and Suburban Bank ‘caused no astonishment in banking circles’ and ‘produced no effect whatever up on the price of other bank shares’ (9 June 1879, Vol 3, p 163). [21]

Text reproduced in the Australian Insurance and Banking Record, 9 June 1879, Vol 3, p 158. [22]

Amendments to the Colonial Bank Regulations in 1846 had limited banks' note issue to the amount of paid-up capital. In addition, by the late 1860s, most colonies required shareholders to bear unlimited liability for banks' note issues. (In most cases, bank shareholders were liable for twice the value of shares subscribed to repay creditors in the wind-up of a bank.) [23]

Similar concerns saw the South Australian Banks Notes Security Act make bank notes a first charge on banks' assets in 1889. [24]