THE FINANCIAL CRISIS OF 1772-3: When the Bank of England first responded to systemic risk
- 25 Mar 2015
The 1772-3 credit crisis is historically notable for being one of the earliest purely financial crises, with neither government policy nor European war lying at its root. It also seems to be one of the first times that the Bank of England responded to fears of financial contagion, taking forceful action to deal with the systemically important players whose failure might exacerbate the crisis.
In research to be presented at the Economic History Society’s 2015 annual conference, Paul Kosmetatos describes the breadth of scope, rapidity and size of the Bank of England’s intervention, acting as de facto ‘lender of last resort’ (LLR) to the financial system 30 years before the idea was first articulated.
He begins by quoting Horace Walpole, who wrote on 22 June 1772:
One rascally and extravagant banker has brought Britannia, Queen of the Indies, to the precipice of bankruptcy! It is very true, and Fordyce is the name of the caitiff. He has broken half the bankers.
With the benefit of hindsight, the pronouncement by the Georgian author and politician was overly dramatic, particularly as most people today have never even heard of the Panic of 1772. At the time however, this was a significant shock to British finance, and for a brief moment ‘a universal bankruptcy was expected, and the stoppage of every banker looked for’ (Scots Magazine).
The storm was unleashed by the failure of the Scottish banker Alexander Fordyce in London, and it was in Scotland itself where its effects were most keenly felt, particularly when the big and ambitious Ayr Bank was forced to suspend payments. Aftershocks were felt as far afield as Amsterdam and the North American colonies, the latter then still very much a part of the British Empire.
Though its impact was short-lived, the 1772-3 crisis is historically notable for being one of the earliest purely financial crises, with neither government policy or European war lying at its root. Its rapid and wide geographical spread furthermore raises the question of whether financial contagion was at work. Contemporaries were convinced of this, using the very word on at least one occasion, and identified the systemically important players whose failure might exacerbate the crisis.
The Bank of England appears to have been concerned enough as to intervene actively in the money markets. It provided liquidity by doubling its daily average of bills discounts, and three days after the June 22 bank runs, it discounted nearly as much as it had during the busiest week of the previous financial crisis in 1763.
It furthermore advanced direct short-term credits to selected bankers, and even lent substantial amounts on long-term mortgage security, which contravened its usual policy of only lending against good bills of exchange. A large bailout of the Ayr Bank was also authorised, but was turned down by the Scottish firm for reasons that remain unclear.
This rapid and decisive response has suggested to some that the Bank was acting as de facto LLR to the financial system, some 30 years before the first theoretical articulation of the concept. This view as it applies to Scotland has been challenged from the side of the ‘Free Banking’ theory, which has claimed that in this period the country’s banking system operated wholly free from the interference of a privileged bank, including its role as LLR in a crisis.
This research argues that the record mostly supports the LLR thesis. The evidence of the intervention itself is incontrovertible, as it arises from explicit ledger entries and resolutions by the Bank’s Court of Directors. Unfortunately there survives no documentary evidence, such as correspondence or internal memoranda that directly illustrates the Bank’s decision-making, so we can never be fully confident of its ultimate motivation.
To make up for this deficiency, it is necessary to turn to contemporary discourse in the press and to the correspondence of market insiders. Both were virtually unanimous in identifying the Bank as uniquely able to assume the role of guardian of ‘Public Credit’, and in fact as morally obliged to do just that.
In any event, the breadth of scope, rapidity and size of the Bank’s intervention make it unlikely it was acting ad hoc, or that its sole wish was to accommodate insiders. Specifically for the case of Scotland, the Bank’s support of the bills of exchange network was invaluable, since it preserved a financial instrument that was widely used to construct short-term money market loans for Scottish firms, and even as a monetary surrogate in the prevailing dearth of metal money.
The Bank of England as Lender of Last Resort during the 1772-3 Credit Crisis
Paul Kosmetatos, University of Cambridge