Tuesday, December 13, 2022

Free vs Regulated Banking: Canada’s Free Banking Era – Did Canadian Free Banking Have Any Regulations? (Part 1)

5 MIN READ - After reviewing how Canada’s two centuries of banking have been crisis-free while the United States has experienced at least seventeen banking panics, the Cautious Optimism Correspondent for Economic Affairs and Other Egghead Stuff explains next why Canada resisted adopting the USA’s awful, destabilizing bank regulations plus what few regulations Canada did enact.

John Richardson, M.P. J.P.
-"Father of Canadian Banking"
-Bank of Montreal cofounder
-Scotsman from Banffshire

In our previous columns we reviewed how Canada has avoided even a single financial crisis during its 205 years of commercial banking, despite having the industrialized world’s most unregulated banking system from 1845 to 1935 and the second most unregulated system (after Scotland) from 1817 to 1845.

We also contrasted Canada to the United States, which had the industrialized world’s most regulated banking system from 1863 to 1933, and was neck and neck with England for most regulated from 1784 to 1862. 

During those 149 years the United States suffered from fifteen systemic banking panics.

If you missed that column it's right here:

The case for the superiority of Canada’s “free banking” system over America’s badly regulated one is strong, but a logical question readers may ask is: “From 1817 to 1935 were there literally no bank regulations in Canada at all?”

The answer is a decisive no. There are no cases in history of 100% laissez-faire banking going back to at least the Scottish Enlightenment. 


But there are cases of “almost laissez-faire” systems such as Scotland: (1716-1845) and “very lightly regulated” Canada (1817-1935).

In fact, it’s no coincidence that Canada’s embryonic banking industry developed along such deregulated lines starting with the Bank of Montreal’s opening in 1817. Because early 19th century Canada was a period of massive Scottish immigration.

Hence when the Bank of Montreal’s original nine founders—five of whom were Scottish including John Richardson, named “the father of Canadian banking”—opened for business they relied heavily on Scottish banking as their model, just as the founders of other early Canadian banks did. 

Being Scottish settlers, the harebrained regulations being enacted in the United States—like making bank branching illegal, establishing privileged monopoly central banks, or forcing banks to back their paper note issuances with lousy state government bonds or scarce federal government bonds—never crossed their minds.

Incidentally, if you doubt the impact of Scottish immigration on Canada’s development, just look at all the “Mc” and “Mac” figures in Canadian history. 

-John Macdonald, Canada’s first Prime Minister.
-Alexander Mackenzie, Canada’s second Prime Minister.
-James McGill, founder of Canada’s prestigious McGill University.
-George Stephen, first President of the Canadian Pacific Railway.
-William Lyon Mackenzie King, Canadian Prime Minister for 21 years including during the critical periods of the Great Depression nd World War II.
-Sarah McLachlan: Pop singer and founder of Lilith Fair.

OK, the Economics Correspondent will strike Sarah McLachlan off the list of historically important Canucks. But the point is Scots and Scottish heritage are still prevalent in Canada even today. Go through any record of Canadian history and you’ll lose track of all the Mc’s and Mac’s although admittedly a small number of them are Irish.

But back to the Scottish model.

Not only was Scotland operating under its own free banking system in the early 19th century, but 1800-1845 is also considered the golden age of Scottish free banking, a time when Scottish banks were large, publicly traded, heavily capitalized, and had already established nationwide branch networks.

So sound were Scottish banks that in the 1820’s British Parliament was urging reform of the English banking system — which had suffered from ten crises in the previous 130 years — along the Scottish model which had experienced none.

However, there is one key difference between Scottish and Canadian free banking.

The Canadian free banking period (1817-1935) took place about a century later than Scotland’s, and by the turn of the 20th century western governments everywhere were imposing more progressive and interventionist measures on their economies. 

So Canada’s free system — lightly controlled as it may have been — was still a product of the times and subject to a handful more regulations.

We’ll examine the most important few here.


Even in the earliest days of Canadian banking there were still a few regulations common to the various provinces. However they virtually all involved policing fraud and insider conflicts of interest.

Few were outright edicts of government but usually conditions of receiving a charter.

And none of them mirrored the foolhardy U.S. regulations that prohibited branching, forced banks to buy lousy government bonds for permission to issue currency, or established central banks that blew multiple asset bubbles which ultimately crashed into financial panics.

For example, in exchange for a charter Canadian banks had to agree to open their finances to their shareholders.

Also limits were placed on the size of loans banks could make to their own directors, and banks were prohibited from using shares of their own stock as borrowing collateral.

The Bank of Montreal’s charter established “double liability” for its owners in the event of failure. The system seems to have worked, still providing painful enough consequences for insolvency to focus on sound credit quality, but not unlimited to the point of bankrupting all the owners.

Such conditions would offend few aside from the most purist libertarians, and if anyone were to propose they become today's new U.S. banking regulatory regime we would surely hear cries of “irresponsible laissez-faire!” from all corners of government, academia, and the media.

There was also a common clause that chartered banks must accept the notes of other chartered banks at par to keep the currency uniform, but this requirement quickly proved unnecessary as nationwide branch banking and the establishment of private clearinghouses made accepting, verifying, and redeeming competing banks’ notes at par universal and virtually effortless.

Nevertheless, Canadian banking was an infantile industry in the 1820’s and 1830’s and, not having yet accrued vast experience, there were initially several isolated bank failures, something that became much rarer around the time of Confederation.

In fact the closest thing Canada ever had to a systemic banking panic was also in its early days: the 1837-1839 period. 

During this time, the effects of two panics in the United States had spread to Canada (the Panics of 1837 and 1839), but compounding matters were two major insurrections known as the Patriot War (1837-38) and the Canada Rebellions (1837-38).

Some historians liken these two rebellions to bordering on civil war (that may be a slight exaggeration), but chaos, violence, and civil unrest did force a handful of Ontario banks to suspend specie payment and one notable bank actually failed.

Still, even the 1837-1839 period is not considered by any monetary historian to be a systemic banking panic, even enduring the strain of two major financial crises in the larger, neighboring USA while converging with two domestic rebellions. 

To produce only one bank failure under such duress, while hundreds of banks were failing in the older, more mature and more developed United States market, illustrates how resilient the Canadian system was even in its infancy. 

Part 2 on Canadian regulations after Confederation to follow shortly.

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