by Sabine Schneider (University of Oxford)
This blog is based on the author’s paper which will be published in the Economic History Review: https://onlinelibrary.wiley.com/doi/10.1111/ehr.13113.
News of the insolvency of Overend, Gurney, & Company on 10 May 1866 generated a scramble for funds in the City of London and urgent appeals to the Bank of England. The financial panic triggered by the collapse of the prominent British discount house became one of the Bank’s most tumultuous modern crises. My article examines the politics of the Bank’s crisis management during the panic and in the ensuing period of financial stringency from May to July 1866. It traces the many-layered rationale that underpinned the Bank’s emergency lending and shaped its long-term development as a lender of last resort.
Widely regarded as a turning point in the Bank’s evolution towards a modern central bank, the 1866 crisis instigated liberal emergency lending to stabilize the capital market.[i] While the Governors came willingly to the rescue of the City, the Bank’s high discount rate, which was maintained long after the crisis had peaked, elicited both political and journalistic scrutiny of the Bank’s policy. Shaped by successive mid-Victorian crises, the Bank’s governance gradually evolved out of a deep-seated conflict between its private business and its public alter ego as the country’s last refuge of liquidity.[ii] Its dual identity not only influenced the Bank’s crisis management; it also compelled its Governors ‘to play a complex and uncertain political game’.[iii] The research reported in this article shows that the Bank embarked on a peculiar balancing act after the 1866 crisis in order to forestall reforms to its Charter and defend its discretionary powers.
By assessing the correspondence, speeches, and publications of Governors, City figures, and financial journalists, the article reports that the Bank’s evolving approach to crisis lending was decisively shaped by its commercial objectives and a prolonged struggle to preserve its autonomy. When confronted with the 1866 crisis, the Bank adopted a pragmatic stance towards the market, which accommodated the credit needs of the City without sacrificing its shareholders’ interests. In the post-crisis months, the Bank crafted a coherent policy framework that neither fully adhered to Walter Bagehot’s theory of a pre-committed lender of last resort, nor surrendered its institutional independence. Swayed by external pressures to justify its conduct after the crisis, the Bank instituted a policy of ‘constructive ambiguity’ that both limited moral hazard and satisfied its duties towards its shareholders.
Central banking statesmanship gradually grew out of this Victorian crisis of confidence, which galvanized criticism of the Bank’s governance and its stance on last-resort lending. Far from adhering to a limited set of policy choices, confined either to credit rationing or to last-resort lending, the Bank’s intervention in 1866 demonstrates that multiple facets of crisis lending co-existed beyond these polar opposites. The Overend & Gurney panic thus highlights that the trade-offs faced by the Bank between financial stability and cooperation on the one hand, and profits and competition on the other, were often mutually compatible in this period. Without infringing the Bank’s Charter, the Governors’ crisis lending offered emergency liquidity through the discount market and allowed them to exercise supervisory authority to punish those guilty of professional malpractice. By combining commercial acumen and moral suasion, the Governors’ strategy of holding the market in suspense as to its conduct in future crises effectively limited the risks of moral hazard. Between 1866 and 1890, the Bank strategically refined its control mechanisms to safeguard the stability of the capital market while simultaneously consolidating its institutional independence.
[i] See M. Flandreau and S. Ugolini, ‘Where it all began: lending of last resort and Bank of England monitoring during the Overend-Gurney Panic of 1866’, in M. D. Bordo and W. Roberds, eds., A return to Jekyll Island (2013), pp. 113–61; V. Bignon, M. Flandreau, and S. Ugolini, ‘Bagehot for beginners: the making of lender-of-last-resort operations in the mid-nineteenth century’, Economic History Review, 65 (2012), pp. 580–608; M. Flandreau and S. Ugolini, ‘The crisis of 1866’, in N. Dimsdale and A. Hotson, eds., British financial crises since 1825 (2014), pp. 76–93; F. Capie, ‘The emergence of the Bank of England as a mature central bank’, in F. Capie and G. E. Wood, eds., The lender of last resort (2007), pp. 300, 307, 314–5.
[ii] C. A. E. Goodhart, The central bank and the financial system (1995), p. 209; D. Ziegler, Central bank, peripheral industry: the Bank of England in the provinces, 1826–1913 (1990), p. 82; M. de Cecco, Money and empire: the international gold standard, 1890–1914 (1974), pp. 82–3.
[iii] C. W. Calomiris, ‘Banking crises and the rules of the game’, in G. E. Wood, T. C. Mills, and N. Crafts, eds., Monetary and banking history: essays in honour of Forrest Capie (2011), pp. 109.