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Canadian versus US Banking

Summary:
I’ll be discussion leader at a colloquium the weekend after next whose topic is Canadian banking. The readings are so much fun because I’m learning so much history, mainly about banking but partly about politics, in the country I grew up in. Here’s a great passage from Charles W. Calomiris and Stephen H. Haber, Fragile by Design: The Political Origins of Banking Crises and Scarce Credit, Princeton University Press, 2014. The Bank of Montreal, however, did not always step in: it allowed smaller banks to fail. This was an important attribute of the system: unless depositors knew that they could suffer losses, they would have no incentive to monitor the behavior of the bankers. When a bank that was large enough to threaten the entire system failed, however, the

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Canadian versus US Banking

I’ll be discussion leader at a colloquium the weekend after next whose topic is Canadian banking. The readings are so much fun because I’m learning so much history, mainly about banking but partly about politics, in the country I grew up in.

Here’s a great passage from Charles W. Calomiris and Stephen H. Haber, Fragile by Design: The Political Origins of Banking Crises and Scarce Credit, Princeton University Press, 2014.

The Bank of Montreal, however, did not always step in: it allowed smaller banks to fail. This was an important attribute of the system: unless depositors knew that they could suffer losses, they would have no incentive to monitor the behavior of the bankers. When a bank that was large enough to threaten the entire system failed, however, the Bank of Montreal stepped in to coordinate a response by other banks. This happened in 1906, when the Bank of Ontario failed, and again in 1908, when the Sovereign Bank of Canada failed. In these cases, the Bank of Montreal orchestrated takeovers of the insolvent banks. In the case of the Bank of Ontario, the process was so seamless that the failed banks’ depositors were not even aware that there was anything to be concerned about.

Calomiris and Haber go on to quote from a book written in 1910:

On the evening of October 12 [1906] the bankers in Toronto and Montreal heard with surprise that the Bank of Ontario had got beyond its depth and would not open its doors the next morning. Its capital was $1,500,000 and its deposits $1,200,000. The leading bankers in the dominion [DRH note: Canada was officially the Dominion of Canada in those days] dreaded the effect which the failure of such a bank might have. The Bank of Montreal agreed to take over the assets and pay all the liabilities, provided a number of other banks would agree to share with it any losses. Its offer was accepted and a representative of the Bank of Montreal took the night train for Toronto . . . . [T]he bank opened for business the next day with the following notice over its door: “This is the Bank of Montreal.”

Calomiris and Haber then write:

The contrast between this method of dealing with bank failures and that of the United States could not be more striking. In the United States, the ability of banks to coordinate their responses to crises was confined to collective action of particular cities’ clearinghouses, branching banks in the South, or other localized bank networks. When shocks associated with recessions raised significant liquidity problems for U.S. banks, nationwide banking panics resulted (in 1857, 1873, 1884, 1890, 1893, 1896, and 1907), even though (with the exception of the panic of 1857) these were not times of severe loss to banks or widespread bank failure. Four of those recessionary shocks (1857, 1873, 1893, and 1907) resulted in widespread suspensions of convertibility: that is, banks refused to redeem their own deposits.

Because of restrictions on branch banking in the United States, the United States had a fairly primitive banking system until the 1980s.

David Henderson
David R. Henderson (born November 21, 1950) is a Canadian-born American economist and author who moved to the United States in 1972 and became a U.S. citizen in 1986, serving on President Ronald Reagan's Council of Economic Advisers from 1982 to 1984.[1] A research fellow at Stanford University's Hoover Institution[2] since 1990, he took a teaching position with the Naval Postgraduate School in Monterey, California in 1984, and is now a full professor of economics.[3]

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