1.1.2 The Bank of England and the growth of banking
In 1694, the Bank of England was established. This resulted from the need of the government of King William III to raise funds to finance the war with France.
With no single goldsmith prepared to shoulder the risk, a group of partners agreed to share the business between them, lending the King £1.2 million at an interest rate of 8 per cent per annum. Additionally, the group of goldsmiths extracted the right, via a charter, to form a company to carry on banking operations in London under the name of ‘The Governor and Company of the Bank of England’. In subsequent years, the government borrowed additional sums from the bank, and when its charter was renewed in 1708 an Act of Parliament was passed prohibiting any other bank with more than six partners from issuing bank notes. This effectively gave the Bank of England the monopoly in note-issuing among the large banks in England.
The eighteenth century witnessed the development of country banks to provide banking services outside London, and the establishment of specialist, private banks in London. There were 68 banks in London at the end of the eighteenth century and around 400 in the provinces – and with most having no more than six partners, a high proportion of these were able to issue their own bank notes!
However, the years from 1775 to 1825 did turn out to be calamitous for the embryonic banking industry as it struggled during a prolonged period of weakness in the economy, with certain assets (particularly land) falling in value. The Bank of England itself came under pressure, with its cash reserves being depleted, largely due to the extensive borrowing by the government to finance the war with France. There was a succession of bank failures, with events culminating in 1825 with the collapse of 63 country banks. These failures emphasised that the main weakness in the banking system was that the restriction on the right to issue notes if there were more than six partners meant that most banks were, inevitably, small. Consequently, many were always going to be vulnerable at times of weakness in the economy, and especially during localised weaknesses – with the result that many were unable to meet their obligations to their depositors.
The nineteenth century consequently saw a period of reform in the banking industry. In 1826, permission was granted to banks with more than six partners to issue notes, provided they had no branches within 65 miles of London. The additional power this gave to the provincial banks was counterbalanced by the Act also granting the Bank of England the right to set up branches in the provinces – a right it understandably took advantage of.
The year 1833 saw the right of the provincial banks to open branches in London, albeit without note-issuing rights. The first to do so was the London and Westminster Bank in 1834. The emergence of these new banks in London, operating without note-issuing rights, was effectively the birth of the banking system we are familiar with today.
The 1844 Bank Charter Act further constrained the right to issue notes by preventing any additional banks, from that point, from acquiring note-issuing rights. Furthermore, banks with the prior note-issuing rights that changed their corporate status (i.e. their ownership structure) or merged with another bank would lose their right to continue issuing notes. In effect, the 1844 Act paved the way for the Bank of England to become the sole issuer of bank notes in England.
You will recall that it was the power to issue notes (for those banks with no more than six partners) that provided the capacity to create credit through the issuance of notes with a value in excess of the value of the deposits of bullion held. Now, with the capacity to create credit through note-issuing denied to them, the banks had to turn to a new means of supporting their lending activities. This led to the emergence of the cheque system, and with it the evolution of the modern banking industry.