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L’Encyclopédie de l’histoire du Québec / The Quebec History Encyclopedia
History of the Banking system of Canada[to 1948]
[This text was written by C. A. CURTISS in 1948. For the precise citation, see the end of the document.] The history and structure of the Canadian banking system can best be understood and interpreted in terms of Adam Shortt's three main evolutionary influences. These influences were (1) the actual experience of operating under Canadian conditions, (2) the experience of the neighbouring states, and (3) in the earlier period, the views of the British Treasury as expressed through the colonial office in various ways - minutes, memoranda, circulars, letters, and the disallowance of bills. With these factors in view, the development of the Canadian banking system becomes a more easily understood social process, and the various innovations and retreats merely reflect the temporary dominance of some influence. Because of its close relationships with the United States and Great Britain, Canada has shown a great deal of ingenuity in selecting from the legislation of both countries, and this process of combining cannot be seen better than in the field of banking.
The Peace of Paris in 1783 left only the northern half of the continent under British control, and from that date until Confederation the British provinces in North America were separate, independent colonies, each in direct communication with the British government. Thus the early history of banking in Canada is the combined history - of all the provinces, although the greater economic importance of the central provinces gave them much greater weight in the ultimate development of the banking system. Accordingly, a brief history of the early banking developments in each of the provinces will be set out.
One of the earliest references to banks in the central area - Upper and Lower Canada, later the United Province, and now Ontario and Quebec - was in 1792, when some gentlemen of Montreal decided to establish a bank under the name of the Canada Banking Company. Only a private bank of deposit, however, resulted from this effort. In 1808, another attempt at establishing a bank was made in the city of Quebec, when a charter was asked from the legislature, but was not granted. During the War of 1812, army bills - a form of hand-to-hand promissory notes - were issued by the government, but by 1816 the amount outstanding was very small, and in 1820 the office of issue was closed. The elimination of the army bills revived the matter of more currency-the point from which most early banks started; and in 1817 the Bank of Montreal was organized and started under articles of association. A charter was asked for in 1818, but was not finally approved until 1822.
The Bank of Montreal is generally regarded as the first bank of discount, deposit, and issue to be established in what is now the Dominion of Canada. In 1818, the Quebec Bank was started, as well as an institution called the Bank of Canada, which should not be confused with a later bank of the same name or with the present central bank. These two banks applied for charters and received them about the same time as the Bank of Montreal. Then, as now, each bank required a separate Act of incorporation, but then there was no general banking code, and the charter was the source of the bank's legal capacities.
As the early charters indicate the path on which the Canadian banking system eras starting, their main points may be set out briefly. All the charters were alike and, therefore, the Bank of Montreal charter may be taken as typical. A study of this charter shows clearly that it was taken directly from that of the first Bank of the United States , which had been planned by Alexander Hamilton, the first secretary of the Treasury of the United States . Thus the Canadian banking system is a direct descendant - the only surviving one of the first Bank of the United States. Here is one line of influence at a critical point in the development of the system. The Bank of Montreal charter had the following provisions:
There were other provisions, but these are the more important. Although the origins of the Canadian banking system are thus evident, the tremendous difference between the provisions of the bank charter of 1822 and that of 1934 indicates the great distance travelled in the century of development.
In Upper Canada the first bank charter was granted in 1819 to the Bank of Kingston, and the second in 1821 to the Bank of Upper Canada. The latter is of peculiar interest because one-quarter of the capital was subscribed by the government, and also because the bank was largely under the control of the Family Compact. Through the collapse of the private Bank of Upper Canada at Kingston and the inability of the Bank of Kingston to get going within the period of its charter, the Bank of Upper Canada obtained a monopoly of banking within the province and hoped to keep it. With its control of the Legislative Council it could have thwarted all efforts to obtain new charters, but a financial crisis in 1821-2 made it necessary for the bank to apply to the legislature for a reduction in its capital and for other considerations. This gave the Assembly an opportunity to protest the monopoly, but it was not until 1832, however, that another charter - that of the Commercial Bank of the Midland District - was granted to the financial interests of Kingston whose first charter had lapsed. The Bank of Upper Canada had its charter extended in the same year. In 1830 the British government had issued instructions to the colonies as to what was desirable in bank charters, but these instructions were not followed.
Some dispute arose over these Acts, in which the British government threatened .to disallow them. Strong representations were made from Canada, however, and the Acts were finally allowed. But the British government stated that they would allow no further Acts (a resolution not strictly adhered to), unless they conformed to the set of instructions sent out in 1833, which contained the following provisions:
These provisions have been set out in some detail to show the influence of the British government on Canadian banking development. The third, fourth, and eighth provisions were already in operation, and the first practically so; the others were gradually inserted in the charters after this time, although it was not until after 1841 that all were included. Thus, while there was a local tendency towards better banking laws, the influence of the British government hastened and secured these sound developments.
In both Upper and Lower Canada many new charters were granted in the period before the union of the provinces, and a study of these charters shows how the Canadian banking structure developed as experience showed what was desirable and what was not. An interesting development occurred in 1834, when an unchartered bank in Upper Canada started paying interest on deposits, and this practice was soon followed by the other banks.
In 1841 the Bank of Montreal charter was amended, and a change was made in the form of the monthly return to the government. This return was greatly amplified and remained practically unchanged until Confederation. Another point in the amended charter limited the circulation of the bank to its paid-up capital. Even at this date the circulation of the banks was approximately half of their total debts to the public, while at the present time it is only about one-twentieth; this shows the importance of this banking function in the early period.
The union of the provinces had very definite effects upon the banking structure, for banking legislation became broader and gave recognition to the interprovincial commercial relationships which were already in existence. It also had important effects through the political side. Lord Sydenham, who was governor at this time, had very definite views on currency and banking, and was very closely allied with the "currency school" group in England. He desired to see these views put into effect in Canada, and in 1841 a bill was introduced which was to establish one bank of issue, under government control; the other banks were to lose the right of note issue and obtain their notes from the government bank by depositing public securities. The bank was to perform no banking functions other than rote issue. The plan was supported by some because of the exigencies of public finance, and the proposed bank plan promised a possible source of funds for the public works of the government. Francis Hincks, who was chairman of the select committee of the Legislative Assembly on banking and currency which considered the plan, was strongly in favour and despite many strong reasons against the scheme it was reported on favourably by the committee. The Assembly, however, owing to the influence of the banks and to political divisions, refused to pass the bill, and the plan was killed. Sydenham's death occurred shortly afterwards, and the bill was not revived.
The final report of the committee was in favour of adopting some uniform banking system in the province, and it made a series of recommendations - most of which had been suggested in a circular from the British government in 1840 - which, it was deemed advisable, should be followed in granting charters in the future. These recommendations cannot be given here, but they provided the basis for practically all charters granted from this date to Confederation, and indeed beyond that time. They must, in fact, have been very much in mind in the drafting of the first effective Bank Act of the Dominion, for Hincks, the chairman of the committee of 1841, was in 1871 the minister of Finance responsible for this legislation.
The next important move was in 1850, when the Free Banking Act was passed. The provisions of this Act were taken mainly from the United States, where they later served as the basis of the national banking system. For the immediate purpose the main provisions of the Act were the secured note issue - each bank depositing public securities and receiving notes in exchange - and the introduction of unit banking. Despite the sympathy of the government, again because of reasons of public finance, the plan was not effective, in part owing to defects in the Act and in part to the opposition of the chartered banks. Only a few small banks came under the Act, and it was soon demonstrated to be of little significance, but it was not completely repealed until 1880.
This Act, however, did have three points of permanent interest. In the first place, it was the first general Act which applied to all banks, a point to be accepted later in the Canadian system. Secondly, it associated the government for the first time with the note issue, another feature which was later to become a part of the Canadian system. Thirdly, it made bank notes a first charge on the assets, which was also to be accepted later.
In 1854, the Bank of Montreal charter was amended, and the new provisions were made to extend to other banks also - a move towards a general Act. One of the changes required a monthly return to the government as under the Free Banking Act. It may be noted in passing that, in 1858, another Bank of Canada was chartered, but its name was later changed to the Canadian Bank of Commerce.
In 1859, a very important Act from the viewpoint of banking practice was passed. This had to do with what are now the "pledge" sections (86 to 88) of the Bank Act. In brief, the legal position of warehouse receipts, etc., and bills of lading had not been satisfactory to lenders on such security, and the new Act provided that these documents could now be taken as a pledge for a loan, at the time the loan was made, and the creditor would in effect have legal title to the goods in case of default. To show the way the law developed (this is a case of local influence) it was at first intended that the law should apply to the warehouse, carriers, etc., as bailees; that is, they had to be third parties, and they could not give receipts for their own goods so held. Then the law was extended so that a warehouse could give a receipt for goods owned by a borrower in the warehouse, thus developing the principle of a borrower remaining in possession of the security for a loan. Then later the principle was extended so that certain specified groups, such as farmers, lumbermen, and fabricators of raw material, could give as security goods in their own possession. It became in effect a sort of chattel mortgage and allowed the banks to make loans which they otherwise would not have made. The original Act did not give the banks alone permission to act under it, but extended its provisions to individuals; only later did it become a part of the Bank Act. Originally, it was an attempt to meet a need which was felt by the whole community, and was not a special privilege to the banks.
Although the province of Nova Scotia had kept provincial notes in circulation from the War of 1812 to Confederation, similar plans had never been accepted in the central provinces . In 1866, however, the proponents of a government currency were successful in getting enacted the Provincial Notes Act of that year. A T. Galt, the minister of Finance, admitted that the primary financial need of the government was the deciding factor. Under the Act not more than $8,000,000 of provincial notes, redeemable in specie on demand in Montreal or Toronto , were to be issued; a reserve of 20 per cent. was to be held for the issue under $5,000,000, and 25 per cent. for the excess over this amount. The Act, however, did not stop at being a simple government note issue, but made provisions for and offered inducements to the chartered banks to surrender voluntarily their note issues. Thus the scheme came back to something like the earlier proposals. The Bank of Montreal, under E. H. King, because of its peculiar relationships with the government, accepted the plan and retired its notes; this was profitable for it, but not for the other banks, which did not accept the plan. The Act was barely in operation when Confederation took place, and these notes, with the other provincial notes, were turned into the Dominion note issue, which became a simple government issue and did not actively attempt to supplant the issue of the chartered banks.
Although there were changes made in bank charters from 1860 to Confederation none was of great significance, and the other provinces may be considered next. The Bank of New Brunswick received its charter in 1820 and was the first bank in the Maritimes. The provisions of its charter were very similar to those of central Canada ; where there were minor differences the New Brunswick bank tended to follow New England models. In 1834 the Central Bank of New Brunswick was incorporated, and its charter embodied the British government's proposals of 1830 and 1833. Other charters were granted from time to time, and in general there was little variation from the central Canada pattern. Although a bank had been mooted in Nova Scotia for many years, the Bank of Nova Scotia, incorporated in 1832, was the first chartered bank in that province. This bank was also the first in British North America to have the double liability clause in its charter. Other charters were granted in Nova Scotia, and all were similar to those in New Brunswick and central Canada .
One of the functions given to the new federal government by the British, North America Act was control of banking and currency. Thus one of the first duties of the newly-established parliament was to meet this new banking situation. This was done by a temporary Act, which was to expire in 1870. By it the provincial charters were made, in effect, Dominion charters, and any bank could now operate in any part or all parts of the territory of the new Dominion; the Maritime banks were made subject to the same taxation as those in the central provinces . As the other provinces - Manitoba , British Columbia , and Prince Edward Island - came into the federation, the scope of the Dominion Bank Act was extended to these territories, and such banks as existed came under it. The Bank of British Columbia operated under royal charter until taken over in 1901 by the Canadian Bank of Commerce. Other provisions in the Act simply re-enacted the province of Canada's general legislation affecting banks, including the law regarding the taking of security under warehouse receipts, etc. In 1869, a statute was passed extending, until 1870, some charters which were about to expire. These Acts provided time for more comprehensive legislation to be considered. There were at Confederation 18 banks operating under Province of Canada charters, 4 under New Brunswick charters, and 5 under Nova Scotia. In addition, there was the Bank of British America operating under royal charter. Thus there were 28 banks in all to be affected by any new enactments. There were in addition 3 unused charters in the province of Canada , 5 in New Brunswick, and 2 in Nova Scotia, all capable of being used.
The discussion of banking matters had been greatly stimulated by the failure in 1866 of the Bank of Upper Canada and in 1867 of the Commercial Bank, and thus the new banking law was awaited with great interest. E. H. King, the manager of the Bank of Montreal, had come out in favour of a bond-secured currency, and when Sir John Rose, the minister of Finance, made his resolutions known in the Canadian House of Commons, it was clear that he was in agreement with this view and that his proposed Act would be very similar to the recently adopted National Banking Act in the United States. In 1867-8, a Senate committee had approved of the American plan, and in 1868-9 a House committee was struck to study the concrete proposals of Sir John Rose. After some debate had taken place upon the proposals, it became clear that the government would have difficulty in proceeding with them. The opposition objected vigorously to the plan, and several government supporters also took exception to it. Later, it became evident that the cabinet was not unanimous either. Before the time came to proceed with the legislation Sir John Rose announced its withdrawal, but he indicated that it would be re-introduced at the next session. He resigned, however, from the cabinet a few months later, and the measure was not revived.
The merits of the controversy cannot be detailed here, but the opinion might be advanced that the decision to adhere to the. existing system was a sound one. The government had some interest in a bond-secured currency, because it assisted, so it was believed, the market for government securities. The Bank of Montreal was in favour of the plan, because it was the government bank, had already retired its circulation, and was in a position to gain from the new system. The other banks, however, were strongly opposed to losing the right of note issue, which they felt was vital to their profitable operation. In view of the economic structure of Canada at that time, it was doubtless of genuine advantage to the country to have the banks in such a position that they could create a note liability with the same ease as a deposit liability. More notes were used then, relatively, than cheques. Thus the decision, in 1869 and 1870, to leave the right of issue was regarded as sound.
Sir Francis Hincks succeeded Sir John Rose as minister of Finance, and in 1870 he introduced the resolutions covering his new Act. Despite his early sympathy with Sydenham's bank of issue project, he threw over the whole idea of a bond-secured currency, reversed the government's policy, and presented a Bank Act which was, in effect, the codification, with such changes as time had shown necessary, of the then existing bank charters. He was at first in favour of a fixed minimum reserve ratio for the banks, but this too was dropped. The Act passed at this session, required the banks to be incorporated by letters patent rather than by parliamentary charters, which had been the practice up to this time.
For some reason or other, the banks were strongly in favour of incorporation by parliamentary charter, and only one bank actually used the Act of 1870. Because of this, Sir Francis Hincks, in 1871, presented another measure which provided for parliamentary charters and dropped the letters patent procedure. This statute was practically the same as that of 1870, but there was one slight change with respect to capital requirements. As this was the first general Bank Act of the Dominion under which banks actually operated, its main provisions may be set out briefly.
The capital required was large: $500,000 was to be subscribed, of which $100,000 was to be aid during the first year and another 100,000 during the second year. The note issue was limited to the amount of the paid-up capital; the denomination of the notes was to be not less than $4, and notes were redeemable at certain designated places, but not at all branches. Shares were subject to the double liability, and suspension of payment by the bank for 90 days forfeited the charter. Lending on the bank's stock was prohibited, and provision was made for limiting dividend payments until a certain reserve fund had been accumulated. The banks were required to hold one-third of their cash reserve in Dominion notes - another case of the ever-present needs of the government. The return to the government was amplified greatly, and the charters of the banks were extended until 1881. Thus began the practice of having a definite and equal period for all charters, which in turn led to the "decennial revision" of the Bank Act.
A few changes, mostly of minor significance, were made in the Bank Act between 1871 and 1880. One change of more importance was made in 1879 when all lending on bank stock was prohibited, for it had become evident for some time that such loans were developing serious abuses. From Confederation until 1873 or 1874, the country had been quite prosperous, but from then to 1880 it suffered from a very severe depression which had serious repercussions on the banks. It was estimated that some $12,000,000 was lost in this period by shareholders in Canadian banks. These conditions, of course, made themselves felt during the discussion which preceded and attended the revision of the Bank Act in 1880; but, even so, there were not many significant changes made in the Act at that time. There was some further discussion of reforms along American lines, but no legislative action resulted.
Sir Leonard Tilley was the minister of Finance at this time, and was in charge of the new Act. The main change was that, in case of failure, bank notes were made a first lien on a bank's assets - an innovation suggested by the bankers themselves. The law dealing with loans on warehouse receipts was further developed, the required holding of Dominion notes was extended to 40 per cent. of the bank's cash reserves, notes were to be in denominations of $5 (the minimum) and multiples of this sum, and the form of the monthly return was elaborated. Proposals for government inspection of the banks were successfully opposed by the bankers and were not to be adopted until more than half a century later.
The period from 1880 to 1890 saw the further economic development of the country and also some very unfortunate bank failures. Both these influences affected the revision of 1890, which was more extensive than that of 1880. Sir George Foster was the minister of Finance in charge of the 1890 revision, and he had some definite views on certain aspects of banking. Among other things he thought (1) that bank notes ought to pass at par in all parts of the country; (2) that some further security should be made for the notes of failed banks; (3) that the authorized note issue (the paid-up capital) was too high; (4) that a specified minimum cash reserve should be specified, and (5) that the conditions governing the starting of new banks should be more stringent. The bankers met with the minister, and objected in particular to 3 and 4, but he adhered to his views on 4. The bankers then asked for an interview with the whole cabinet, and managed to persuade it not to proceed with the specified minimum reserve requirement.
After much discussion, in which the Bank of Montreal made clear its desire to have a secured note issue, there was a fairly satisfactory combining of views. The notes of failed banks were made to bear 6 per cent. interest from the date of the suspension of the bank until their redemption was announced. The banks had to designate an office of redemption for notes in each province; thus insuring the circulation of notes at par. A "circulation redemption fund" for the redemption of the notes of failed banks was set up; all banks were required to subscribe 5 per cent. of their circulation to this fund, which was placed under government supervision, and they were allowed 3 per cent. interest on such deposits. Further calls of not more than 1 per cent. per annum could be made. In effect this plan made the banks mutual guarantors of their note issues and was very similar to the scheme developed much earlier in the state of New York. The Dominion government was given a second lien on the assets of failed banks, and provincial governments a third lien. The capital provisions were made larger and more severe for new banks. The "pledge" sections were completely overhauled and the procedure under them simplified. One interesting change was a reversion to the early principle that in lending on warehouse receipt, etc., the bailee must be a third party, but the essential principle of the sections was not altered. Many other changes were made, and many other proposals rejected. All in all, this was the most severe overhauling that the basic Act of 1871 had yet received.
Very few changes were made in the Act at the revision of 1900, when W. S. Fielding was minister of Finance. The most important gave the Canadian Bankers' Association, which had been organized in 1892, statutory recognition by conferring on it certain duties with respect to the supervision of failed banks and the handling of bank notes. The interest rate on the notes of suspended banks was reduced to 5 per cent., the scope of the "pledge" sections was extended, and the form of the monthly return was altered to distinguish between the internal and external business of the banks. This change recognized the growing foreign business of the Canadian banks. In 1908, the Act was amended to allow the banks, during October to January, to issue notes in excess of their paid-up capital to the amount of 15 per tent. of their combined capital and reserve fund. Such "excess issue" was to be taxed at the rate of 5 per cent. The economic expansion of the country had expanded the note issue, so that it was pressing against the statutory limit - the paid-up capital.
Although the bank charters expired in 1911, the imminence of a general election caused the revision to be postponed until 1912. The elections resulted in a new government, and the revision was again postponed until 1913. One or two changes of importance were made at this time. One change provided for a more rigorous shareholders' audit which, it was hoped, would give further protection to the public. Another new section set up the "central gold reserves", which was to be under the supervision of four trustees - one appointed by the minister of Finance and three by the Bankers' Association - and which was to provide the banks with a means for issuing notes over the statutory limit by depositing gold or Dominion notes. The banks could issue their own notes dollar for dollar of such deposits. This device was used by the banks to the almost complete avoidance of the taxed "excess issue", but it ended the much vaunted elasticity of the note issue, for it made it dependent upon the stock of legal money.
Some changes were made consequent on the War, but, most of them were of minor interest. One Act, however, was of great significance to the banks, although it was not part of the Bank Act. This was the Finance Act, passed at the outbreak of war, as a temporary measure, but made permanent in 1923 and kept in effect until the establishment of the central bank. It gave the department of Finance, among other things, power to advance Dominion notes (cash reserves) to the banks upon the pledge of satisfactory securities. The importance of this Act was that it set up a rudimentary central bank which altered completely the credit control of the monetary system. Previously, the chartered banks extended or limited credit in light of their cash reserves, which could be increased only from without Canada. After the passing of the Finance Act, they operated in the same conventional way, but cash reserves could be increased within Canada by borrowing cash. (Dominion notes) from the department of Finance. This made it the apparent ultimate seat of credit control.. This transformation was not appreciated at the time, for the country was on an inconvertible paper standard. But after the War, when Canada returned to the gold standard, it did not take very long for the change to show itself, although even then its full significance was not appreciated.
The next important revision of the Bank Act took place in 1923, when Fielding was again minister of Finance. He is the only minister who was responsible for more than one revision of the Act. The provisions respecting the shareholders' audit were further strengthened. A good deal of criticism had been directed at the "pledge" sections of the Act, because the banks' prior lien was a secret one, and provision was now made that when security was taken under these sections of the Act it had to be registered in the office of the assistant receiver-general for that province. Other changes were also made.
As a result of the Home Bank failure in 1923, which demonstrated the inadequacy of the existing law respecting audits, the Act was amended in 1924 to provide for government inspection of the banks, which was one of the most important changes of this century, and which had been suggested fifty years earlier.
The most recent revision of the Bank Act took place in 1934. Many changes were made in the Act, but none was of major significance. Because of the concurrent establishment of a central bank, certain changes had to be made in the Bank Act to bring it into conformity. Provision was made for the extinction of the note issue, so that by 1946 the banks will have a note issue equal to 25 per cent. of their paid-up capital. Thus we record the virtual passing of a banking function which has occupied a large place in the development of the Canadian banking system, and which was the source of much legislation. Another provision allows the double liability of the shareholders to be diminished proportionally with the reduction in the note issue.
Early in 1929 it became evident from the action of the foreign exchange rates that there was not an unhampered export of gold from Canada and that the gold standard, which had been reestablished on July 1, 1926, was not being maintained. An analysis of this situation leads to the conclusion that operations under the Finance Act were responsible, that this Act had passed its usefulness, and that a central bank was needed. From this time on the discussion of a central bank grew in volume and importance - largely the result of current depression, it may be ventured - until during the parliamentary session of 1932-3 the government announced its intention of appointing a royal commission to investigate the problem. The commission consisted of Lord Macmillan, an eminent British jurist who had been the chairman of the famous British Macmillan Commission, Sir Charles Addis, a British international banker of repute, Sir Thomas White, Canadian minister of Finance during the War, J. E. Brownlee, then prime minister of Alberta, and Beaudry Leman, the general manager of the Banque Canadienne Nationale.
The commission began work in the summer of 1933, crossed Canada and took evidence in all parts, heard bankers, conferred with the provinces, and received briefs from various interests. Its report, which was made public in November, recommended by three to two the establishment of a central bank, Sir Thomas White and Beaudry Leman being the minority. This was, in effect, the only major recommendation made. In an appendix to the report proper, some "Suggestions" (using the word in the title) on the form of the bank were made. These included private ownership and control, sole right of issue, and many other points which cannot be enumerated here. These "suggestions" are not recommended specifically by anyone, and it is not clear that they were supported by a majority of the commission, and it is therefore a matter of regret that one of the most important parts of the document should be placed in such an ambiguous position.
As the Canadian prime minister had indicated even before the report was made public that he was in favour of a central bank, there was little doubt that the recommendation would be accepted. Upon publication of the report, the government so announced, and indicated that legislation to this end would be introduced. When the bill was brought into the House of Commons it was clear that it was based on the "suggestions" in the appendix. The main features of the Act provide that the shares of the bank shall be owned by private individuals, who elect the directors, who in turn appoint the managing officers, subject to the approval of the government. (The first set of officers, however, were appointed directly by the government.) The Central Bank must keep in gold a reserve equal to 25 per cent. of its liabilities, and it has the usual powers given to a central bank. It is to have the right of note issue, and the chartered banks are to retire their issues. It is to act as the government's banker, and manage the public debt. The commercial banks are to keep with it a minimum reserve, in the form of central bank notes, or a deposit, equal to 5 per cent. of their liabilities to the public of Canada. The bank took over the government note issue and the gold held against it, and the discrepancy between these two was made up by the government with 3 per cent. bonds. These, in brief, are the main provisions of the Act, which was passed after some opposition on detail and on the form of ownership. The Opposition groups in the House advocated public ownership of the bank, but this view did not prevail. The deputy minister of Finance, however, is an ex-officio member of the board of directors.
Immediately after the Act was passed, the organization of the bank was begun. Mr. G. F. Towers of the Royal Bank was appointed governor, and Mr. J. A. C. Osborne of the Bank of England was selected as deputy governor for the initial period; doubtless, after experience has been gained a Canadian will fill this post. Mr. L. P. Saint-Amour of the Banque Canadienne Nationale was appointed assistant deputy governor. The share capital of $5,000,000 was oversubscribed by the public, and under the informal, but effective, leadership of the Canadian Chamber of Commerce, the shareholders selected a geographically diversified group of directors. On March 11, 1935, the Bank of Canada opened its doors for business, thus ushering in a new era in Canadian banking.
It may be ventured that, once the Finance Act became part of the Canadian banking structure, it was just a matter of time until a full-fledged central bank should be established.
The general eulogistic view of the Canadian banking system has been greatly distorted by the common practice of comparing and contrasting it with that of the United States . If, for example, the Canadian system were compared with the British system, which is not so well known in Canada , a less biased view of it might exist. The proximity of the United States, of course, accounts for this condition. The two features which attract most attention on this continent are branch banking and bank failures; these two may be discussed first.
As branch banking is the common form of banking in practically all civilized nations of the world and unit banking rare, it is the American system which is unique. Without analysing in detail the workings of the branch system, it may be asserted that in general it is the more efficient form of banking - economically speaking. The fear which the American bankers have of its introduction is some evidence of this. But branch banking means few banks and large banks - concentration of banking resources in a few hands. This is the aspect of branch banking which is disliked in the United States and which is avoided - to some extent - by unit banking. It may be that the price paid is too high, but the decision to pay it is not an irrational one.
Because of the lack of loan diversification, a unit system is almost bound - even with equally good management - to have more bank failures. The United States has accepted this as the price, and in the past - though less so now - an American bank failure was just a bankruptcy, more painful than usual, but still an accepted economic process not calling for government aid. Such was the attitude in Canada in early days. Until 1866 there had not been a serious bank failure in Canada ; from Confederation until 1914 there were approximately 24 failures, some quite important. Although some banks sustained losses and sold out, there has been only one bank failure since 1914 - that of the Home Bank, in 1923. But in this one case the government made a compassionate allowance to the depositors. With a few large banks a failure is no longer a casual economic process; it becomes a nation-wide calamity, which no government can permit. It is doubtful if any Canadian bank would be allowed to fail, even though public funds were needed to clear its liabilities. Under such conditions bank failures in Canada may be dismissed from further serious consideration, and there is little point in making comparisons with other systems. It may simply be accepted that a peculiar condition of affairs has developed in Canada which seems to make for the safety of the depositor's funds.
The requirements of a return or statement of affairs from the banks has always been one of the distinctive aspects of the Canadian system, even in early days. As a result Canada has a body of banking statistics probably unequalled anywhere. The first charters required merely annual returns, but after the union of the Canadas this was soon changed to semi-annual returns. In 1851 the "Free Banks" were required to make monthly returns, and in 1856 this requirement was extended to all banks in the United Province . The same provisions were maintained after Confederation, so that the Dominion of Canada has monthly banking statistics for the whole period of its existence. From the first all such returns had to be published in some public document. The Maritime provinces never required more than semi-annual returns. The purpose of such returns was, of course, to allow the public to judge the position of the bank. This is still true, but as the body of data grows its value is even greater as a basis for the study of the economic history of Canada.
It soon became evident, however, that bank returns alone were not sufficient protection to the public, and that some provision for the inspection or audit of the banks was necessary. For many years it was maintained that an annual "shareholders' audit" - that is by outside auditors - was ample, and that the branch system made impossible the type of government inspection which existed in the United States. The failure of the Home Bank, in 1923, made a public outcry for some form of government inspection irresistible, and the government passed an amendment to this effect. By it there is an inspectorgeneral of banks, who personally - he has no staff of inspectors - inspects the banks at irregular intervals and sees that their position is kept sound. Such inspection takes place only at the head office and the main branches; but this is deemed sufficient, for nearly all the bank failures in Canada have been "head office" failures - that is, as a result of actions taken there. Although the idea was opposed for fifty years after it was first seriously advanced, it is now a generally accepted and commended feature of the Canadian system.
Canadian banks axe regarded as commercial banks, and their ordinary business is that of making short-time loans for commercial and other business purposes. They also make loans to brokers and financial houses - call loans; and they themselves are very heavy holders of short-term first-grade bonds. Thus they are an important factor in the investment market. It is sometimes felt that they do not give enough assistance to agriculture, but the banks must make short term loans and do not consistently meet the peculiar requirements of agriculture for longer loans.
The three or four largest Canadian banks have developed a considerable foreign business and have branches in foreign countries, mainly in the West Indies. This has come about in part through the commercial relationships established there, and partly because the nature of the Canadian economy in early days-the very great importance of the import and export trade made them dealers in foreign exchange and developed an aptitude for this business. The Bank of Montreal, for example, was one of the main dealers in the New York exchange market during the Civil War. It is doubtful if the outside business of the banks directly draws capital either to or from Canada ; in general it is pretty much self-supporting.
The New York financial market has always been important to Canada , and most of the banks have maintained agencies there. This connection has provided Canada with an inexpensive and efficient market for foreign exchange purposes and for the carrying of reserves. It has been the practice of the Canadian banks to keep part of their reserves in the form of call loans in New York . This system has worked very well and assisted the efficiency of the Canadian system; doubtless it will be modified somewhat when the Central Bank provides an alternative method of handling reserves.
Although every Canadian bank has a savings department distinct from the current one, there is no difference in the uses of the deposits so obtained. In the United States a bank is a commercial bank, and most of its deposits are demand, non-interest deposits; its saving deposit business is small, and usually such deposits must be segregated and invested only in certain ways. Savings banks are usually distinct and separate institutions. Most of the banks which failed there have been commercial banks, and thus bank failures affect demand deposits rather than savings deposits. In Canada the so-called savings deposits axe not treated differently from the others and are generally checked against (although to a lesser degree) demand deposits. Thus, when a Canadian bank fails, a savings bank as well as a commercial bank fails. This combination in the Canadian bank means, of course, that all the mobile funds of the country are used for commercial purposes - a matter of importance in earlier days.
In common with most branch systems, there has been a concentration of resources into the hands of a few banks. There were approximately 28 banks in operation at Confederation, something over 44 in 1880, about 40 in 1890, 36 in 1900, 29 in 1910, 18 in 1920, and 10 in 1934. This reduction in the number of banks, through failure and amalgamation, has been accompanied by a growth in total banking resources of the country, so that the individual bank has grown greatly. Also a few banks now control a greater proportion of the banking resources than previously, with the result that at the present time the four largest banks have control of more than three-quarters of the whole system's resources. This raises the matter of competition and monopoly.
In some matters, such as the rate of interest on savings deposits, the banks act in concert. The same is probably true with respect to what they term "minor profits" - that is, exchange charges and such like. A Canadian borrower also deals with only one bank. unless his account is a very large one. In other fields, there is evidence of competition. Managers compete for accounts and customers, and often make concessions to obtain them; much of the rivalry shows itself in "service" rather than direct financial offers. It may be concluded that even though there are also evidences of concerted action, there is still considerable competition in the day-to-day business of banking.
One form in which bank competition occurs is in the establishment of branches. At Confederation there were approximately 123 bank branches in Canada ; by 1905 this had grown to 1,145, by 1916 to 3,200, and by 1920 to more than 4,600. The number decreased until now there are approximately 3,600.
The great increase in branches coincided with the development of the West, which was given banking facilities as soon as the slightest need was shown. This rush in opening branches caused it to be overdone, with the result that in recent years many communities have been overbanked - from the viewpoint of the business to be done - and the banks have been withdrawing in an orderly manner. But the result has been that Canada has been given adequate banking facilities and practically all its areas have been well served. The ease with which a branch can be established has been a great factor in bringing such facilities to the newest areas. In many cases the first bank in a mining territory, for example, has been a tent with the bank's name on a board beside it. Yet this tent could offer the same facilities as the elaborate city office. Undoubtedly this capacity to offer the immediate service of a well-established organization is a great advantage of the branch system which is unrivalled in its capacity to meet the rapid development of an expanding country.
While the branch system has assisted greatly in the development of the new areas, it has been somewhat at the expense of the other parts. There is little doubt that some sections, such as the Maritimes, have contributed a great deal of capital to the development of the other sections of the country. This has doubtless been to the benefit of the country at large, but not necessarily to the part contributing the capital.
In conclusion, it ought to be said that the Canadian system is an efficient commercial banking organization. It has a long record of achievement and efficient functioning which should not be underestimated or unappreciated, although like most human institutions - it has had some members who were without honour or honesty. The system of training the personnel develops good "practical bankers", but does not train men in the broader aspects of their business. This, in the past, was not a serious matter, but now it is of more importance, and doubtless the system will adapt itself to the new needs. The creation of a central bank rounds out the Canadian banking structure and gives the head and direction which is needed in a present-day banking system. With its efficient commercial banks and the mechanism for a unified control of its monetary system, Canada has a monetary and banking system which is capable of serving the commonwealth well.
Bibliography: B. H. Beckhart, The banking system of Canada (New York: Holt, 1929), which is a reprint from H. P. Willis and B. H. Beckhart (editors), Foreign banking systems (New York: Holt, 1929) ; R. M. Breckenridge, The Canadian banking system 1817-1890 (New York: American Economic Association, 1895); R. M. Breckenridge, The history of banking in Canada (Washington: Government Printing Office, 1910), which is one of the publications of the National Monetary Commission; C. A. Curtis, Statistics of banking (Toronto: Macmillan, 1931), which is vol. I of Statistical Contributions to Canadian Economic History ; J. H. Creighton, Central Banking in Canada (Vancouver: Clarke & Stewart Co., 1933) ; Interviews on the banking and currency systems of Canada (Washington: Government Printing Office, 1910, which is a publication of the National Monetary Commission; H. M. P. Eckardt, Manual of Canadian banking (Toronto: Monetary Times, 1909); E. L. S. Patterson, Canadian banking (Toronto: Ryerson Press, 1932) ; Report of the Royal Commission on Banking and Currency in Canada (Ottawa: King's Printer, 1933) ; Adam Shortt, "Currency and Banking, 1760-1841", in Canada and its provinces (Toronto: Glasgow, Brook & Co., 1914), vol. 4.; Adam Shortt, "Currency and Banking in Canada, 1841-1867", ibid., vol. 5; Adam Shortt, "The Banking System of Canada", Ibid., vol. 10; B. E. Walker, A History of banking in Canada (Toronto: 1909).
Source: C. A. CURTISS, "Banking", in W. Stewart WALLACE, ed., The Encyclopedia of Canada , Vol. I, Toronto , University Associates of Canada , 1948, 398p., pp. 151-164. |
© 2005
Claude Bélanger, Marianopolis College |
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