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History of Banking in Scotland
Chapter XVI - The Small-Note Scare of 1826

IN consequence of the severe financial crisis which darkened the close of the year 1825, the Government resolved on radical alterations in the banking legislation of the United Kingdom. In the King's Speech on the meeting of Parliament on 2nd February 1826, the principal place was occupied by references to the embarrassments which had occurred in the pecuniary transactions of the country since the close of the last session. His Majesty also advised the devising of "such measures as may tend to protect both public and private interests against the like sudden and violent fluctuations, by placing on a more firm foundation the currency and circulating credit of the country." The crisis was almost entirely confined to England; but the Government contemplated a movement towards the assimilation of the paper currency of the three kingdoms. Their first task was to introduce changes in the banking system of England. An almost insuperable obstacle, however, presented itself in the shape of the special privileges of the Bank of England. As far as the public were concerned, the worst of these privileges was the prohibition of any other company or partnership consisting of more than six persons carrying on the business of banking in England. This provision was enacted by a clause in an Act passed in the reign of Queen Anne, 1708. As then understood, the business of banking involved the issue of notes; and this was always considered, until 1844, as a distinctive characteristic of bankers. Technically, the prohibition was directed only against the issue of notes payable on demand, or for any time less than six months; but in the then existing circumstances of banking, it effectually precluded the establishment of joint-stock banks other than the Bank of England. The effect of this had been most pernicious, as it checked the growth of strong banks, and encouraged the formation of a multiplicity of weak ones.

The Government entered into negotiations with the Bank of England for a relaxation of this prohibition, and eventually obtained their reluctant consent to an arrangement whereby joint-stock banks, consisting of any number of partners, might be formed, with power to issue notes as bankers outside a radius of sixty-five miles from London. This provision was availed of to some extent; but it was not until the re-enacting and explanatory Act of 1833 that full advantage was taken of the power granted. The branch system of the Bank of England was also an outcome of the proceedings of this time, special powers having been conferred by Parliament on the bank directors to delegate their powers of management to agents. Another important change effected was the suppression of bank-notes under the value of £5. The Government appear to have been convinced that note-issuing was essentially connected with the late crisis. As we have already shown, there was not sufficient reason for this belief. We do not mean to assert that the provincial note issuers were sufficiently trustworthy; but it appears from the state of the paper currency at the time, that there had been no overissue of notes. The Earl of Liverpool, indeed, on behalf of the Government, stated that, as estimated by the returns of stamps used, the issues had been increasing to a great extent; but the statistics compiled of the actual notes in circulation showed a considerable decrease in all the years to which he referred, with the exception of 1825. In that year, however, the amount was but little above the point at which it stood several years before. It was the weakness of the banks, as prescribed by Parliament in favour of the Bank of England, combined with injudicious banking advances, that led to the numerous failures of provincial bankers in England. The enlargement of the powers of banking, without the suppression of small notes, would have been not only sufficient in itself, but would have been more effectual in building up the shattered fabric of the deformed system of banking with which Parliament had afflicted the English nation; for banks would have been enabled to extend their operations into quarters where, without the use of small notes, banking would be unprofitable.

The Government, however, decreed the abolition of bank-notes under £5. Before the English Act - limiting, and, after a certain time, prohibiting, such issues—was actually passed, Lord Liverpool announced that it was intended to introduce a similar measure with regard to Scotland and Ireland. In this, however, the Government were reckoning without their host. When the intelligence reached Scotland, the Nemo me impune lacessit spirit was at once aroused. The proposal was almost universally denounced as an infringement of the rights of the nation, and as injurious to its interests. Sir Walter Scott's magic pen was enlisted in the cause. His celebrated letters, under the nom de plume of "Malachi Malagrowther," although taking too roseate a view of Scottish banking experience, gave point to the national excitement, and undoubtedly tended greatly to focus the opposition. At the same time, they excited the most extraordinary criticism in Parliament and elsewhere, as calculated to foster rebellion. The agitation was carried on warmly at county meetings, where speeches in favour of the bank-note issues were made, and resolutions unanimously passed disapproving of the proposed change.

As showing the thoroughly convertible nature of the notes, Mr. Gibson-Craig stated, at a meeting of the county of Edinburgh, that "It was only the other day that Mr. Maberly's house here had collected £30,000 of Edinburgh bank-notes, and presented them for payment, when gold was tendered in exchange. He said this was not what he wanted, but bills on London; but he was told that the promise on the face of their notes was to pay gold, which they would pay, and nothing else." [Edinburgh Magazine, March 1826.] He also referred to the bank failures which had occurred, and showed that the note issues were in no way connected therewith, and that the country had suffered no loss. The position of the Scottish banks was also warmly defended in a number of pamphlets which appeared at the time of this attack on one of their most vital characteristics. Indeed, the excitement produced by the well-meant but misdirected attentions of the Government was the means of producing in Scotland, for the first time, anything which could be called financial literature. The Scottish newspaper press, with a few exceptions, strongly advocated the retention of the small-note issues. The Scotch and Irish members strenuously opposed the intended legislation, and successfully insisted on the appointment of a committee of each House of Parliament to inquire into the utility of small notes in Scotland and Ireland. The committees examined a number of witnesses, and reported against the proposed change. On the 8th of May, the Government confessed that they had been convinced of the advisability of leaving the note issues of Scotland and Ireland on their present footing.

In looking back on this episode, while one may smile at the intensity of the excitement, and especially at its peculiarly Scottish national character, as seeing, in an honest endeavour of the Government to improve the currency system, an instance of Southern treachery, one cannot but recognise the fact that the people were right, and that it was well for Scotland that the intended change was prevented. The paper currency of Scotland had been of the greatest service in furthering the industries of the country. The total amount of loss by the note issues of defaulting banks had been surprisingly small. In point of fact, the banking system of Scotland had worked remarkably well, and there was positively no occasion to make any legislative alteration in it, as far as the nation itself was concerned. At least, any changes which might have been advantageously introduced had no connection with the system pursued, or with the state of the paper currency. The object of the proposed measure was to secure uniformity in the currency of the three kingdoms. This was a desirable enough object, if it could have been attained without undue sacrifice. The price the Scotch and Irish people were asked to pay was, however, too much, seeing they were called on to sacrifice an essential portion of their existing system without obtaining any benefit in return.

At the present day the circumstances of the case are somewhat altered. Even as late as 1826, the use of a paper currency, which had been originally the great instrument in vitalising the industrial energies of Scotland in its poverty-stricken condition, still conferred some of its old benefits, although the nation had become comparatively wealthy. With still further increase in wealth, and with the restrictions imposed on note-issuing by the Acts of 1844 and 1845, the direct benefits of a bank-note currency have well nigh vanished. Statesmen appear to be very ignorant on this point; for, even at the present time, they speak as if the mere fact of retaining an issue of £1 notes would satisfy the necessities of Scotland. It is not the fact that Scotland possesses a paper currency of the denominations of £1 and upward that confers a special benefit on the nation. It is the fact that the banks are permitted to issue such a currency that forms the advantage. Without this right, the character of banking in Scotland would be greatly altered; —the banks would be forced to contract the extent of their operations; banking facilities would be withdrawn from a great number of localities presently in the enjoyment of them; and the customers of banks would probably have to pay increased charges. The reason of this is that, by means of their right to issue, the banks can profitably conduct business at a much cheaper rate than if they had to use coin of the realm, or—what would be substantially the same, as far as the present argument is concerned—Government or Bank of England notes, for which they would have to - give full value. This is the great point involved at the present time in the question of Scottish bank-note issues, and it deserves very full consideration by members of Parliament. But, in 1826, this indirect advantage was not alone in operation; the direct benefits conferred on a comparatively poor country by an efficient paper currency were also active. So popular were the notes of the Scottish banks—not only in Scotland, but also in the northern counties of England—that, during the height of the crisis, large quantities of them were forwarded to these districts, where, it is said, "they are equally as valuable as the paper of the Bank of England." As to Scotland, the writer adds, "So general is the feeling of security in this country, that even the most ignorant people have scarcely ventured to consider it possible that the distress at present existing in the English capital could extend to this side of the Tweed." [Scots Times (Glasgow), 24th December 1825. See also Maberly Phillip's Banks, Bankers, and Banking, London, 1894, pp. 100-1, and Boase.] It was well, therefore, that the banks in Scotland were allowed to continue their long-established and well-appreciated custom of issuing £1 notes.

So conspicuously was the superiority of the constitution of the Scottish banking system over that of England shown to be by the experience of this crisis, that, as we have seen, the Government tried, as far as possible, to extend its principles to the sister kingdom, by encouraging the formation of large joint-stock banks. The attempt proved highly successful, despite the difficulties presented by the consequences of previous banking legislation. Several banks, which have since become very powerful institutions, were soon afterwards formed. In this connection, a writer, [Principles and Practice of Banking, T. Joplin, London, 1826. The author founded, and was the first secretary of, the Provincial. Bank of Ireland.] who was himself a practical and successful banker, and took an active part in the projection of joint-stock banks in London, very clearly showed the advantages which were derivable from adopting Scottish principles, by contrasting the experience of the systems of banking pursued in Scotland and England respectively. He further showed, what has never been fully appreciated by English statesmen, that paper currency, payable in gold on demand, cannot be issued at pleasure; and that the freedom of Scottish banking, by permitting the growth of a system of large joint-stock banks, had preserved the northern kingdom from the disastrous experience which had attended banking in England. On the other hand, he made the curious statement, that privacy was the cause of the success of the Edinburgh banks. By this he means that they were enabled to amass large profits by speculation in the public funds. This was undoubtedly the case; but the success of the system cannot, of course, be used as an argument against the publicity which is now rightly desiderated.

Another English banker, [The Scotch Banker, Thomas Attwood, London, 1828. Mr. Attwood was a banker in Birmingham. He writes fiercely against the Scottish banks, styling them "monopolising and engrossing," and ascribes their comparative immunity from disaster to their not being pressed. But why were they not pressed?] who, however, is by no means so complimentary to the Scottish bankers, denounced the past course of banking legislation with much vehemence, but with, perhaps, less discretion. The following quotation, from a more pleasing writer, [Credit Currency, G. Poulett Scrope, London, 1830.] is interesting as an appreciative contemporary statement of the advantages of a paper currency:—"It has been proved that all the parties who make use of money for purposes of interchange, buyers as well as sellers, share in the great advantages derived from the substitution of paper for metallic money. Consequently, there can be no doubt that, by universal consent, the former will be used in preference to the latter, whenever the security offered for the convertibility of notes on demand is such as to ensure the public confidence. Thus it has been ascertained from experience, that gold and paper money of the same denominations will not circulate together. 'The paper drives out the gold.' This has been, somewhat absurdly, made a matter of regret by those who fail in perceiving that it only takes place in consequence of the vast benefit which a paper currency confers on all producers, by enabling them to retain and employ that part of their capital which would otherwise be locked up in a metallic currency. So far from being a defect, it is the great merit of a paper currency, without which, indeed, it could neither be introduced into circulation, nor of any service were it introduced."

As the bogey of over-issuing is still raised against the Scottish banks from time to time, it may be well to point out that, under a system in which the notes are payable in legal tender on demand, with regular and frequent exchanges among a plurality of banks, widespread over the country, such as exists in Scotland, over-issuing is practically impossible. Any bank attempting to issue beyond the natural demand of the public, would find its notes coming back on it so rapidly that it would be forced at once to cease such action. The notes would not stay out; and the other banks would soon bring their erring brother to book.

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