ADMS 1010 Chapter Notes -Free Banking, Potash, Lower Canada

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Published on 12 Apr 2013
School
York University
Department
Administrative Studies
Course
ADMS 1010
Professor
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CASE 1
Origins of Financial Stability in Canada: The Bank Act of 1871
Issues faced by Sir John A. MacDonald (PM):
need for a more comprehensive act that would replace the existing bank charters in the 4 provinces since
they would expire in 1871
ensure a national currency and coinage - national unity would be greatly enhanced by having a medium
of exchange which was universally accepted and trusted throughout the Dominion
The political goal was financial stability, and the managerial challenge was to create the institutional and
regulatory framework to carry it out
Banking in Early Canada: 17591817
1759 to 1763
- no financial system
- large supply of paper currency in circulation in Lower Canada, issued by the French government but not
regarded as a safe store of value by the Canadiens
- thrifty and prudent farmers kept their savings in ‘specie,’ which consisted of gold and silver coins
- paper money became worthless after the fall of Quebec in 1759
1770
- lack of money to carry on the ordinary business of life
- reliable form of money either for a means of payment or to store value, or even to help governments
with their own finances did not exist
- two values existed for the pound in the same marketplace, resulting in ordinary citizens being short-
changed when dealing with merchants who had the advantage of understanding the relative value of
various coins
- cost of transporting gold and silver coins, the risk of theft, and the long overseas shipping route without
news all implied high risk, resulting in shortage of specie which led to various improvisations of paper
money
- lack of large-denomination money hampered foreign trade
1810
- merchants of Montreal had great difficulty in financing their exports of flour, potash, lumber, and fur to
Britain, while paying for imports of clothing, sugar, salt, and farm tools
- market developed in bills of exchange but a great distance and a time lapse of six months to two years
between the transaction and the final payment meant neither side met their financial obligations
- one of the chief functions of banks in providing credit to facilitate trade was to buy the bill of exchange
at a discount
First Bank of the US
- opened in Philadelphia in 1791
- forerunner to and model for the Canadian banking system
- charter authored by Alexander Hamilton, first secretary of the treasury during the First Congress in
Philadelphia
- modelled on the Bank of England, founded in 1694, with regards to providing 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
- charter killed in Congress upon renewal in 1811 because a) it had been doing its job so well and b) much
of the public issue of stock had been acquired by British investors, and war with Britain was imminent
- charter revived in 1816 but allowed to lapse by Congress in 1836 for the same reasons as in 1811
- US never enjoyed a national banking system again
Free banking
- emerged in the United States after the demise of the Second Bank of the United States
- licensing of banks fell back into the hands of the states
- anyone with enough capital could open a local bank with no branches, causing numerous bank failures
and a flood of fraudulent paper money
The Earliest Banks in Canada
Bank of New Brunswick
- first bank to receive a provincial charter in 1820
- max voting rights of 10 shares
- heavily influenced by the Massachusetts banking system
- ‘double liability’ clause (shareholders of the bank were required to take up an amount of stock equal to
what they already owned in the event of failure) to encourage prudent behaviour by the directors and
shareholders in issuing bank notes
Bank of Nova Scotia
- first joint-stock bank
- heavily influenced by the Massachusetts banking system
Bank of Montreal
- articles of association adopted in 1817
- commenced operations in 1818
- received provincial charter and royal assent in 1822
- authorized capital was £250,000 or $1 million Canadian
- serious restrictions on share ownership and on voting rights (max voting rights of 20 shares to restrict
wealthy families in New York and Boston who provided most of the capital to supplement the scarce
supply in Montreal)
- liabilities of the bank could not exceed three times its paid-in capital, and the paid-in capital had to be in
specie gold or silver
- charter was limited to ten years to monitor the consequences of its chartering activities
- charter forbade it from engaging in any other trade or business, and prevented the extension of credit for
the purchase of real property (preserved the Dominion of Canada’s small economy from the acquisition
by the banks of our manufactures and railways, and also from the land speculation excesses which we
have observed south of the border)
- exclusive banker to the government in Quebec City: sole depository for government monies, the fiscal
agent for the colony with the Treasury in London, and the overseer of the note issue of other banks as
well as of its own notes
The Bank of Upper Canada
- obtained royal assent after a bizarre political battle with Kingston, not least because nine of the bank’s
fifteen directors were also members of Upper Canada’s Executive Council, the governing body of the
colony
- authorized capital was £200,000 - but only £20,000 had to be paid in
- constraint on the bank’s note issue not observed, so that the note circulation exceeded the legal
requirement
- engaged in ‘specie war’ with Bank of Montreal
- escalated battle with Bank of Montreal when government at York passed an act preventing out- of-
province banks from operating in Upper Canada unless their notes were redeemable at York
- management caused it to become increasingly overextended in its loans to the rapidly growing business
of canals and railways
- failed in 1866
Bank Act of 1871
- uniform federal act, replacing all provincial charters
o minimum capital of $500,000, of which 10 per cent to be paid up
o power to issue notes in denominations of $4 or more, not to exceed paid-up capital and secured
by gold or Dominion notes
o double liability on shareholders, to be paid before realizing on the assets of a failed bank
o total bank liabilities not to exceed three times capital
o mandatory decennial revision by Parliament
o one vote per share
o prohibition against extending credit on real property
o maintain 6 per cent interest ceiling
- charter of the Bank of Montreal as standard
- encourage the banks to have multiple branches, rather than pursue the American model of single banks
with no branches
Suggested Questions
1. What were the issues faced by businesses in the 1800s in Canada as a result of operating in a multiple-
currency environment? Had the banking system changed for the better by 1867? How? What were the
lessons for the establishment of a sound currency?
2. What were the differences between the Bank Act proposed by John Rose and the version proposed by
Sir Francis Hincks? Which of the versions would have been best for the Canadian economy? For
business enterprises?
John Rose wants to copy the American free banking system; opposed to large banks having branches;
accede transfer of note-issuing power to the Dominion
3. Why were the proposals of Sir Francis Hincks acceptable and those of John Rose not?
4. Do you think the provision for a decennial revision of the Bank Act was a wise decision, and if so, why?