Case 1 The Bank Act.pdf

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Administrative Studies
ADMS 1010
Barry O' Brien

Case 1: Origins of Financial Stability in Canada: The Bank Act of 1871 Pages 20 – 37  The stability of financial institutions is something which the business community and general public has taken for granted  After the Second World War, economic reconstruction was marked by the creation of the International Monetary Fund and the World Bank  The domestic regulation of banking systems in most countries was gradually being modified  It was extended to cover the growing complexity of the economy, with the emergence of consumer credit and home ownership  The enormous growth in global trade and investment also required the expansion of government oversight and international cooperation on financial governance  The global financial system has come close to collapse in the last two years  Many steps have been required by governments to rescue their banks from default  There is a growing realization that financial innovation has outrun effective regulation  The Canadian banking system has been perceived as surviving the huge stress better than any other systems in the world  The relative stability of the banks can be traced back to the very origins of banking law and th regulation in the 19 century  The authors of the first Bank Act in 1871 had to understand the nature of the market economy and what was required to facilitate its growth  Trust and confidence in the financial system had to be one of the most fundamental building blocks  This case study sets out the business problem that the Fathers of Confederation had to deal with and shows how they handled it  It begins with a fictional conversation that take place in 1969 between Sir John A. Macdonald and the prime minister Sir Francis Hincks  They are discussing the unsatisfactory state of affairs in Canadian banking  It concludes with Hinck’s recommendations for converting the banking laws of the four provinces into a contemporary national banking act  The most critical feature of the new Bank Act had already been determined in the British North America Act of 1867  This was the decision to allocate to the new Dominion government exclusive authority over banking, currency, interest and related matters  The existing bank charters in the four provinces became valid throughout the new Dominion, they would expire in 1871  A related challenge was to ensure a national currency and coinage  In 1869 Nova Scotia still clung to sterling instead of dollars  The question of having government-issued paper currency alongside paper notes issued by a variety of chartered banks was very much unsettled  Macdonald and Hincks both recognized that national unity would greatly enhanced by having a medium of exchange which was universally accepted and trusted throughout the Dominion  MacDonald was then preoccupied with extending the Dominion from sea to sea  He already purchased Rupert’s Land from the Hudson’s Bay Company and Manitoba came into existence in 1870  He was planning to bring PEI into Confederation  For this expanding country’s banking needs, there was a branch of the Bank of British North America and also a locally owned bank of Bank of British Columbia  These two colonial banks had been chartered by the British government directly and were now to be brought under the control of the Dominion government and when British Columbia joined Confederation  The political goal was financial stability and the managerial challenge was to create the institutional regulatory framework to carry it out Foundations of banking and currency in Canada Banking in Early Canada 1759-1817  There was no financial system in Canada before the passing of power in Canada from France to Britain in 1759-1763  There was a large supply of paper currency in circulation in Lower Canada issued by the French government  This was not regarded as a safe store of value by the Canadians  Farmers kept their savings in “specie”, which consisted of gold and silver coins  After the fall of Quebec in 1759, paper money became worthless  The British military governors of Quebec from 1759-1820 held the same lack of interest in trade and finance as did those who remained in Lower Canada  They too came from landed gentry and shared the values of the small core of impoverished landowners to whom they turned for advice  Both were contemptuous of merchants and traders  As a result there was no thought of financial legislation, this meant that domestic trade and the financing of exports and imports were severely hampered until the 19 century  By 1770 there were about 70,000 people in Lower Canada, 5000 were English-speaking civilians  An observer noticed that the farmers were hoarding their money and didn’t spend it  The lack of money to carry on the ordinary business of life continues to plague the economy from then till now 1870  A reliable form of money either for a means of payment or to store value or to even help governments with their own finances did not exist  The most common used currencies were a jumble of gold and silver coins  English and French coins were both legal tender in Lower Canada  In Upper Canada accounts were kept in “York currency”  Two values exist for the pound in the same market place did not work out very well  Ordinary citizens were often short-changed when dealing with merchants who had the advantage of understanding the relative value of various coins  The cost of transporting gold and silver coins, the risk of theft and the long overseas shipping route without news all implied high risk  The shortage of specie led to various improvisations of paper money  Some merchants and manufacturers issued small promissory notes called “bon-pours”  The British army began issuing its own paper money to buy provisions  These were put into general circulation as “army bills”  The lack of large-denomination money hampered foreign trade  In 1810 the population of Montreal was 10,000  The merchants had great difficulty in financing their exports of flour, potash, lumber and fur to Britain  A market developed in bills of exchange, which were orders on the buyer issued by the seller and payable to a third party  There was a great distance and a time lapse of 6 months to 2 years between the transaction and the final payment  Buyers of produce were not necessarily honest of capable of meeting their obligations  The role of a financial intermediary was to buy the bill of exchange at a discount  This became one of the chief functions of banks in providing credit to facilitate trade First Bank of the United States  These same frustrating problems in financing overseas applied equally to the US through  Through which a growing proportion of Canada’s import-export business was directed  In 1791 the Frist Bank of the US opened in Philadelphia  The significance of this first national bank in the US was that it became the forerunner to and model for the Canadian banking system  The first attempts to define a bank charter in Canada was copied almost word for word from the charter of the Frist Bank of the US  The author of this pioneering American act was Alexander Hamilton  He was the forceful champion of the view that a sound national banking system was required as “a major element for raising a powerful and prosperous nation”  By 1791 there were already five state-charted banks in existence in five US cities  The constitution of 1787 was silent on the critical issue as to whether banking was a federal or state matter  This became a fundamental dividing point between the American banking system and our own as set out in the British North America Act  The US constitution did specifically assign the power to issue and regulate coinage to the federal government and defined gold and silver as the only legal tender  The states were prohibited from issuing paper money  Agrarian forces from the southern states were against Hamilton  Bankers in NY and Boston resented the proposed location of the First Bank in Philadelphia  The First Bank of the US was endorsed by Congress with the support of Washington  The government managed to put up its share with some highly creative accounting  As well as creating a national institution, the act incorporating the First Bank of the US also provided a vehicle which the government could use as a safe depository for taxes  And to provide loans to itself and keep the state-chartered banks in line  The First Bank of the US was in fact modelled after the Bank of England founded in 1694  The Bank of England was not only a commercial bank but the chosen instrument of government in effect a sort of central bank  The key to exercising control over state-charted banks was the requirement that every issuer of bank notes was required to convert its own notes, on demand into gold or silver  The Frist Bank of the US could and did accumulate the notes of banks which is considered unsound  Then presented them all at once for redemption in gold or silver  This would effectively kill any bank that had overextended itself by too much leverage of tis own issue of bank notes on its reserves of gold and silver  The charter of the First Bank of the US was limited to 20 years  When the charter came up for renewal in 1811, it was killed by its many enemies in Congress  Because it had been doing its job so well  Another factor was that much of the public issue of stock had been acquired by British investors and war with Britain was imminent  During the war years 1812-1814 the requirement that specie would be the only legal tender was suspended  The country was flooded with paper money issued by banks of uncertain credentials  In 1816 the charter of the First Bank of the US was revived as the Second Bank of the US with another 20 year charter  In 1836 once again the charter was allowed to collapse by Congress much as the same reasons in 1811  The US would never enjoy a national banking system with branches of banks across all states The Earliest Banks in Canada  Merchant companies took careful note of the First Bank of the US  There had been a wave of migration from NY and NE  About 30,000 immigrants from the US who became identified in 1789 as “United Empire Loyalists”  The requirements of commerce made little impression on the Colonial Office of the British Treasury  From 1793-1815 both English and Scottish banking systems were very unstable  In 1797, the Bank of England suspended cash payment and did not resume it until 1821  It was mainly through the example of the National Bank of Scotland started in 1824  The transition was gradually made to be present system of a few large banks with numerous branches  The Bank of Montreal was already a reality  Its articles of association had been adopted in 1817 and the bank commenced operating in 1818  It did not receive a provincial charter and royal assent until 1822  An earlier attempt to incorporate a Bank of Lower Canada had been made as early as 1792  The proposed charter of this earlier bank copied the articles of association of the Frist Bank of the US  Another attempt to establish a Bank of Quebec in 1808 failed  The Bank of Montreal’s articles were also similar to those in the earlier aborted cases  There was no market in the shares because the bank was not yet charted as a joint-stock company  There were serious restrictions on share ownership and on voting rights  This was aimed at the wealthy families in NY and Boston who provided most of the capital to supplement the scare supply in Montreal  An even more restrictive limit of ten shares was included in the articles of the Bank of New Brunswick which was the first bank to receive a provincial charter in 1820  The first joint-stock bank was the Bank of Nova Scotia incorporated in 1832  Both Maritime banks were influenced by the Massachusetts banking system  The most critical regulation in the Bank
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