RDP 2001-07: A History of Last-Resort Lending and Other Support for Troubled Financial Institutions in Australia 7. Proposals for Government Note Issue and the Development of a Central Bank

The financial turbulence of the 1840s and 1890s prompted calls for revision of Australia's monetary system. The most significant changes to come from this were the replacement of private bank note issue by the Federal Government note issue in 1910 and the creation of the Commonwealth Bank. While the Commonwealth Bank was established in 1911, it was not until the mid to late 1920s that the bank began to take on a central banking role.

7.1 Government Note Issue

Prior to the establishment of the Federal Government note issue, high-powered money consisted of sterling coin.^[43] This made it difficult for the colonial governments to supply liquidity to the banking system. The declaration of bank notes to be legal tender by the NSW Government in 1893 and the South Australian Government in 1852 was one way around this problem.

Between 1843 and 1896, parliamentary committees in New South Wales, Victoria, Queensland and South Australia recommended the establishment of a government-owned bank and state monopolisation of the note issue. Under these proposals, the government bank would have been empowered to act as lender of last resort (Gollan 1969; Griffiths 1930). However, the proposals were overtaken by debate about federation.

In 1910, the Federal Government's legal-tender note issue was introduced. Initially, it was required that the government's gold reserve cover one-quarter of the value of notes issued up to £7 million. For any note issuance above £7 million, one-for-one backing was required. In 1914, however, the gold reserve provision was relaxed so that the required gold reserve was one-quarter of the value of notes on issue regardless of the size of the total note issue.

7.2 Establishment of the Commonwealth Bank

At its federal conference in July 1908, the Labor Party added the establishment of a Commonwealth Bank to its policy platform. It was proposed that the bank should be one of issue, deposit, exchange and reserve and that the bank should, in times of crisis, sustain credit by rediscounting the securities of other banks (Gollan 1969).

The Act to establish the Commonwealth Bank, passed in 1911, was a compromise between those pressing for a central bank to smooth the operation of a system of private banks and those seeking to nationalise the banking sector. While Prime Minister Andrew Fisher put stress on central banking objectives, the legislation confined itself to the establishment of a government-owned bank with ordinary banking powers. Nevertheless, Denison Miller, the Commonwealth Bank's first Governor, stated the bank ‘should grow so strong that should there be a crisis we will be able to stand behind the other banks and help them’.^[44] During the 1920s, the Commonwealth Bank gradually began to act as the banker to the private banks, providing the means for interbank settlements and occasionally providing loans to other banks to finance short-term liquidity shortfalls. However, the development of the bank's central banking powers was slow.

In 1921, the Commonwealth Bank proposed that the banks settle their interbank payments through accounts with the Commonwealth Bank. The banks were not prepared to keep clearing deposits with the Bank unless they had an assurance that the funds would not be used in competition with them. This assurance was not given, and the banks refused to take up the proposal.

In 1924, legislation was passed which transferred responsibility for note issuance from the Treasury to the Commonwealth Bank and required the banks to settle their exchanges through the Commonwealth Bank.^[45] It was these two reforms that enabled the Commonwealth Bank to become the sole producer of high-powered money. The banks, however, retained their clearing pool reserve separate from the Commonwealth Bank. The reserve served as a guarantee of payment of each bank's settlement obligations (a precaution established during the 1890s). It was not until 1938 that the pool's funds were placed on deposit with the Commonwealth Bank.

During the 1920s, the Commonwealth Bank's lending to the private banks was modest. To assist in financing exports, the Commonwealth Bank offered the banks loans totalling up to £5 million between 1922 and 1925. However, only very small advances were actually made. During the October 1924 liquidity squeeze, the Commonwealth Bank offered to lend the banks up to £15 million; just £2.8 million was lent under this scheme (Giblin 1951).

Footnotes

High-powered money consists of those forms of money that are directly exchangeable for real goods (i.e. commodity money, such as gold coin, and instruments declared to be legal tender). While, up until 1910 the notes issued by banks and backed by gold were also highly liquid, the fact that their widespread acceptance relied on public confidence in the banks that issued those notes indicated that they were one step removed from high-powered money. [43]

Quoted in Coombs (1931, p 35). [44]

The Act also gave the bank full control over the note issue. The Federal note issue was first administered by the Treasury. Between 1920 and 1924 Treasury and the Commonwealth Bank jointly exercised control of the note issue. [45]