Chapter 3 - The Evolution of the Chartered Banking System
 
Presented by Group # 2 - Philip Chung, David Ko, Brian Storry, and David Wong

The Canadian Banking System was the banking model least suited to promoting industrial development in the colony.
Instead, they focused on the outward flow of staples to British and to a lesser degree, American markets.

• The Canadian banking system didn't evolve into being but it was more or less an import taken from the English commercial banking system. Unlike the country banks of England (which conducted local business by servicing the industrial sector, the original Canadian banks serviced the commercial sector only.  As such, Canadian banks lacked any tradition of either investment banking or industrial banking.
• Canada's economy at the time was focused on staple-extracting, that is the exporting of furs, timber and grain to British markets.
• Banks operated by issuing their own notes (bills) which were not backed (at least initially) by government bonds.
• Monetary reform was fought to a standstill after Confederation (1867).  Sir John Rose fought bitterly in parliament to have government bonds to back chartered notes.  The Bank of Montreal (BoM) supported the move and offered to control the policies but the other banks (mostly in Upper Canada - Ontario) refused as this would put them at the mercy of the BoM.  (it was powerful at the time and managed to destroy 2 of Upper Canada's banks by denying them credit)
• The chartered banks were furious with Sir John Rose and had him forced out of office.  He would be the first in a series of finance ministers to fall before the banks.  The Prime Minister at the time (John A. Macdonald) was helpless to do anything to stop the banks - he had to maintain the coalition of Ontario-Quebec and Reform-Conservative interests.  Not only was he helpless to stop the banks from forcing Rose out of office but he also had to appease them by appointing suitable people for the post of Finance Minister!

• The chartered banks was only interested in the short term gains and connections to provide for the movement of staple products.
• Attempts in the 1840's to introduce a provincial bank to issue bank notes was defeated.  Later, an effort to create a "free banking system" to help the government raise long term capital for railway construction and canals was a failure.
• Banks could print money as required - in effect creating money out of thin air to be lent to customers at interest.
• Sir Francis Hincks (Finance Minister) suggested and introduced a compromise which allowed government notes to be pushed into circulation but only of the smallest denominations.  The chartered banks still held on to the printing of the large denomination bills.  Chartered banks could still print money at will - and they were secured by collateral of the entire banks' holding and double shareholder's liability!
• Unlike in the US, Canadian banks were not restricted by the requirements that each note had to be backed by government reserve bonds.  This centralization of power by the banking system prevented local and regional interests from using easy credit policies for local development.  This also meant that the CDN economy was far more susceptible to international commercial fluctuations.
• Sir George Foster, Conservative Finance Minister suggested legislation requiring chartered banks to pool their notes to form a fixed reserve to protect the public against bank failure.  Foster also tried to get the notes issued at one bank redeemable at another at face value.  The banks once again cried out in protest and had Foster thrown out of office.  Foster would return later in the dog house of the banks - relegated to the post of Trade and Commerce.
• The Canadian Banker's Association opted to appoint liquidators to assess the fitness of new entrants into banking charters.  If they didn't check out, they could not operate.  The CBA also empowered a move for the notes of a failed bank to be accepted at a solvent bank through the pooling of notes (to give public the image of all notes being equally safe)  Bank of Montreal disapproves but cannot do anything.
• Work to make chartered banks hold gold reserves worked adversely.  The banks managed to impose their own gold reserve ratio (100% per note issued) to the government and permitted them to raise circulation in government notes to $25 million, up from $20 million.
• Through time, banks slowly increased their reserves (mostly in call loans from New York).  The CDN government attempted to tie reserves to London.  The hostility of chartered banks goes even further - they would not use government notes as part of their voluntary reserve and even presented them to New York for investment!
• Banks refused the Canadian Mint to coin gold - restricting it to only silver and bronze until 1912.  They would not have anyone else issue money to "their markets".

• The presidents of the major banks often held meetings where power was consolidated between a small number of them.  The banks would exert considerable power on the government dictating who was to be appointed into the Finance Minister post.
• The banks would also pass their own legislation.  Who was governing the country?  The government or the chartered banks?  The Canadian Banker's Association was a tool in the hands of 3 or 4 people to control the whole of the finance in the country.

• British industrial hegemony and movements of staple goods were inseparable.  Canada was a handmaiden to the British economy.  Britain would provide financial capital for the movement of commodities.
• Very little hard currency actually changed hands (thus preventing industrial capital spending).  Most transactions occurred on credit and loans.  Their excuse was the by having lots of industrial spending, would create an army of poor traders who would just break even.
• Public would borrow madly, cheating the system and having their wives listed as being owners to the company to clear their poor credit rating.
• Federal Act of 1869:  Debts could be cleared if bankrupt provided the trader return some percentage of amount borrowed.  As such, lots of traders claimed "insolvency" or "bankruptcy".  A battle ensued between the financial powers and the farmers & traders.
• In 1880, the law was repealed much to the dismay of traders.  For the traders, it meant that they had to pay the full 100% instead of the 50% like before.  For the banks, they opposed the new law and sought to prevent any new legislation.  They enjoyed the right to seize 100% of a failed trader's goods.  The law would remain unchanged until after the first World War due to the bank's great influence on parliament.
• Credit system led to huge failures in traders.  Also led to people deserting productive activities (farming) to try their hand at cut-throat trading (due to wholesaler persuasion to get more sellers - they overimported).  Canada thus fell into a huge deficit in the balance of mercantile debt.
• Rate of failure was estimated:  50% of all businessmen would fail in 10 years.  Banks tried to rebuild the shattered commercial houses - often prolonging their misery.  Businesses would fail due to 'lack of capital' brought on by so much borrowing on credit.

• Even personal savings banks in BNA evolved to complement the chartered banks - often forming partnerships and sharing the same facilities.  It is interesting to note that both types of banks were controlled under the same directorship!
• Not all banks wanted to do the savings business - for example, the BoM had dreams of becoming a super bank (like the Bank of England)interested in public finance.
• With global deflation settling down in 1873, bank notes became stagnant.  Instead, people secured their money in the form of savings deposits.  In the crisis that followed, charted banks lost ground (interms of growth) when compared to government savings banks and mortgage loan companies who earnestly cultivated the savings deposit business.
• The banks recovery came when prices started to go up again several years later.  They had decided to tap into the personal savings of their clients to free up loanable capital.
• Rates of interest from the chartered banks were high which contrasted the government's low interest rates.  This made people shift their savings from government bonds to the chartered banks.  In addition, the cost to borrow for commercial use was much more expensive.  From then on, chartered banks took a renewed interest in savings deposits business and as such the government could not use public capital to fund infrastructure projects (esp. the railroad expansion in the West) Differs dramatically in the US where government funded rail projects.

• Introduction of new chartered banks was restricted and even when new ones were let in, they had to struggle to get operational.
• The bigger banks bought up shares of the smaller banks to add to their market share and power.  The banks also merged and became bigger drawing the ire of the industrial sector who didn't like the reduction in bank competition.

• Unlike banks in the US, Canadian banks had a great deal of interrelated functions.  There were close relations between the chartered banks and the trust companies.  Directorship of these Trust companies was often vested in the directorship of the chartered banks!
• Trust companies tended to specialize in portfolio investments.  A new social class was emerging (the rentiers) who tended to focus investment on municipal bonds, real estate, financial equity and the like as opposed to government bonds.
• The power vested in the directors of these interlocked financial institutions was protested against by the smaller communities in Ontario, the Eastern provinces and in the West.  Businessmen complained of a financial squeeze brought on by the banks.  They argued for decentralization of banking power.
• The existing banks were accused of draining much needed capital away from developing centres (like British Columbia).  In response, the Bank of Vancouver was established in 1911 to respond to local needs independent of the chartered banks.
• The Maritimes were the hardest hit - they saw Massachusetts as a blossoming industrial centre with lots of savings and cheap money available for investment.  Instead, the Maritime situation could be summed up as:  surplus savings - which is to say deposits exceeding loans.  The Canadian Banking system was unable to transfer funds to where it was needed most.
• Chartered banks sometimes blocked access to capital to restrict the transfer of goods thus stagnating the economy even further.  This is made even worse considering that the economies of some Maritime provinces are seasonal (PEI - potatoes)
• The flow of funds went from east to west with Maritime industrial capital being lent westwards to help feed the wheat boom.  Thus the much needed industrial capital that could have fed the Maritimes was diverted instead to exporting staples (grain).

• Banks tended to offer services to the grain industry as opposed to the mixed farming of Central Canada (Quebec & Ontario).  As such, the mixed farming sector was stagnant.
• Also, the banks would make their notes fall in before harvest time in order to squeeze as much out of the grain farmers as possible.  They would also restrict loans to farmers that would permit the farmers to withhold crops but freely allowed buyers to borrow money.  This kept the price of grain down and forced the farmers to sell immediately at poor conditions of trade.
• Banks were involved in every stage in the wheat moving business, often taking eastern capital to finance the movements of grain.  In the West, grain was virtual money.
• Dependence on the staple crop of grain led to a lack of crop diversification as more and more money was locked up in grain trading.  (Grain farmers were in debt and the only way to get out was by producing grain.)

• Banks didn't want to service the industrial sector as they were afraid the money would be locked up in plant and equipment - this would make dividends unhealthy and would depreciate the value of bank stock.  Industry was seen as posing a direct threat to the continued prosperity of the banking system.
• Banks were hesitant on funding industrial mergers.  They would also discriminate by size of industry - smaller firms would have to pay a greater rate of interest as compared to larger business entities.
• Banks would also play this game in the mining industry.  They would not provide loans for mining development work but would only provide it for transportation of mineral ores.

In servicing the commercial sector, Canadian banks neglected to provide for the industrial needs of the country thus keeping the Canadian economy in stagnation from the time of Confederation to the time of the First World War.  The banks had feared that locking up its money in industrial equipment.  The bank cartel
consolidated its power and with it's combined might influenced and restricted political, economic and monetary reform while simultaneously squeezing as much money out of the public as possible.