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Silicon Valley Bank: 19th-century financial crises show how today's regulators could help repair the economy

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A bank failure wipes out the money available to its customers and freezes any capital that’s already in circulation. Depositors, borrowers and owners or shareholders all suffer as a result, as does wider economic activity and often the communities or business sectors that the banks serves.

These issues can become all the more concentrated in the wake of a regional or specialist banking collapse due to the specific reach of the failed institution. Silicon Valley Bank (SVB) is the second largest bank failure in US history but its focus was specific, it specialised in providing funding to start-ups, venture capitalists and technology firms.

This banking collapse reminds us of a spate of private bank failures that created a financial crisis at the start of 19th century in England and Wales. Although these banks all differed from SVB in terms of scale and volume of finance provided, these early 19th-century institutions served specific communities.

They also had a tendency to fail. And when they did, the impact on the regional economy was considerable. Lines of credit for local businesses dried up and some struggled to survive.

Banking families were also adversely affected. The failure of private banks owned by Henry Austen, brother of author Jane Austen, for example, had a detrimental impact on the financial health of the wider Austen family. Henry ended up owing £58,000 to his creditors, which would be about £6.5 million in today’s money.

Regulations put in place after these failures aimed to make these organisations more stable by diversifying the way they made money. This could provide some important lessons for regulators assessing the damage of the latest banking crisis.

New laws were passed in 1826, following the 1825-1826 financial crisis in which the country was claimed to have been “within twenty-four hours of barter”. In other words, the financial system was close to collapse – without access to money, people would have to resort to merely exchanging goods.

This crisis saw the failure of 93 private banks across England and Wales – around 15% of the total market.

Our research in this area shows that the causes of the crisis were complex. But the result was a widespread loss of confidence in private banks. These were small-scale, personally owned banks, with a maximum of six partners or owners. This meant these banks drew from a limited pool of capital to lend to their customers and only held a small amount of reserves.

Like Austen, the people that ran private banks were usually privately wealthy, rather than engaged in local manufacturing. There was also no central bank and no national regulator of financial services to keep these organisations on the strait and narrow.

Radical banking regulations

This crisis and the resulting push for reform of the banking system led to legislation that was radical for its time: the 1826 Bank Act. These new laws created the first wave of “joint-stock” retail banks in England and Wales, with 138 formed between 1826 and 1844. These organisations were allowed to issue shares, which gave them wider access to capital from more diverse sources.

The new banks were also run by professional managers and their directors were usually members of the local business community. These meant they had a vested interest in providing successful banking services to the local economy.

Two prospectuses we found in the HSBC Group archives show how these banks recognised the impact of the recent financial turmoil on these regions. The 1829 prospectus of the York City and County Bank declared:

It is impossible to describe the accumulated misery of those failures entailed upon thousands of families and individuals.

The 1827 prospectus for the Huddersfield Banking Company said:

this district has not only suffered the evils resulting from the general suspension of demand, which has been common to all manufacturing districts, but has been visited with an additional local evil in the failure of five banking establishments.

The 1826 Act showed government recognised that a more stable banking system was desirable for the public good. And since shares in joint-stock banks could also be purchased by members of the public, these were public institutions. In fact, our research shows shares were mainly held by local investors.

This so-called “patient capital” (or long-term investment) was provided by committed local individuals. This was a stark difference to the previous private banks, which were operated by a few individuals. Unsurprisingly then, the reforms were opposed by both private bankers and the Bank of England, but were nevertheless passed by parliament.

Helping the local economy

The new banks were motivated to achieve local and regional benefits through provision of successful, stable and profitable banking services. Most survived until the end of the 19th century, when they were absorbed and became branches of the “Big Five” banks that emerged at the start of the 20th century: Lloyds, Barclays, National Provincial, Westminster Bank and Midland Bank. Some of these branches remain on UK high streets to this day.

The private banks of the early 19th century were very different to SVB. They were smaller in scale, operated in a less global, less technologically advanced and less regulated economic system. But the disastrous regional impact of their failure is comparable, certainly in terms of the impact on individuals and businesses.

The shock of a bank failure is both immediate and long lasting, as we know from the 2008 global financial crisis. This kind of situation led to quite radical solutions in 1826 – essentially a restructuring of UK banking services – and again after the 2008 crisis.

Economist Joseph Stiglitz is among those calling again for new legislation or regulations in the wake of SVB’s collapse. Just as in England and Wales in 1826, the personal cost of bank failure is severe and governments should take steps to avoid such consequences.

This article is republished from The Conversation under a Creative Commons license. Read the original article.