The Bank of England’s Lending during the Panic of 1825

While the causes of the Panic of 1825 are unclear, the stock market crashed in early 1825, resulting in commercial failures and, by fall 1825, a series of bank failures (Bordo 1998; Morgan and Narron 2015). By mid-November, a prominent banker observed that the Bank was “restricting their discounts” and that “almost all the bankers are more or less distressed” (Pickering 2018). In December, two major London banks collapsed. The Bank extended a secret GBP 400,000 loan to Pole, Thornton, and Co., a major London bank, on December 6, 1825, only to see the bank fail just six days later. Pole, Thornton operated as a significant connection for many country banks, as 44 country banks held accounts with it (Pickering 2018). This meant that the failure of Pole, Thornton resulted in contagious bank runs and failures against the connected country banks. As they fell, this caused a general run on other country banks and quickly spread to London, forcing bankers to the Bank of England, since country banks were not eligible for the Bank’s discount window (Neal 1998).

Therefore, it appears that the Panic of 1825 began with the failure of a few systemically connected London banks, which caused disruptions for country banks in general. This contagion ended up bringing the panic back to London with a widespread banking run. In previous crises, the Bank had not expressed a significant interest in serving as a backstop to the London money market. In that vein, the Bank initially attempted to ration credit during the Panic of 1825, through more stringent discounting (James 2012). This tactic seemingly backfired and resulted in the need for the Bank to operate as a private lender of last resort amidst the panic by expanding lending through the discount window.

In the years prior to 1825, the Bank of England’s interest in crisis fighting was “limited, episodic and inconsistent” (James 2012). However, “[t]he one exception in which the Bank was forced into a more active role was in the midst of the panic of 1825” (James 2012).

The idea of the Bank as a lender of last resort to the British banking sector originated in the 1790s. While some scholars argue that the Bank acted as a lender of last resort, other historians believe that the Bank was “considered an essentially private business” (James 2012). It appears that while the Bank avoided assuming any explicit role as a lender of last resort, it still functioned as a de facto lender of last resort, as it stepped in at times of illiquidity and crisis (James 2012).

According to Bordo (1998), the Bank functioned more as a public bank, rather than a central bank in 1825. The Bank occupied an awkward middle ground among three different constituencies: its shareholders that demanded profitability, the British government that granted it certain privileges, and commercial bankers that relied on the Bank for ensuring financial stability (Bordo 1998). According to Bagehot ([1873] 1979), the Bank “does make enormous advances in every panic . . . but, on the other hand . . . it does not distinctly acknowledge that it is its duty.” Because the Bank was not a central bank, its actions as the lender of last resort did not necessarily come from any explicit legal authority, but rather from its unique position in the banking system at the time.

At the time of the panic, the Bank had a monopoly on London note issuance and on joint-stock banking in the country. Bank of England notes counted as cash reserves for both country banks and private London banks, as opposed to just gold. Pickering (2018) states that this possibly allowed country banks to engage in riskier behavior through more speculative lending and note issuance, which could have played a role in the Panic of 1825. If country banks could only issue banknotes backed by their own gold reserves, the limit on issuance would have been much firmer.

When asked by a Secret Committee of Parliament if the Bank’s actions had any backing from the government, J. Horsley Palmer, a governor of the Bank after the panic, replied that the actions of the Bank were done entirely independently from the government (Committee of Secrecy 1832, 47). However, there are indications that the Bank consulted the government several times during the Panic of 1825. For example, the Bank spoke with the government about its decision to expand its discounting of longer-term bills and government securities. Additionally, the Bank asked the government for assistance when its gold reserves began to dwindle, although the government refused to help the Bank by suspending payments (James 2012).

There were no related programs operated by the Bank or the government during the Panic of 1825.

The Bank of England maintained discount and advance committees during the 19th century; these committees acted as advisory watchdogs, analyzing past lending and proposing future adjustments to the Bank’s discount operations (Ogden 1988).^FHowever, it does not appear that these committees had the best documentation and research. For example, Ogden (1988) finds that the Special Discount Committee of 1867 paid no attention to the Panic of 1866 in its review of the previous year’s discount activities despite a serious and significant panic in the discount market.

The Bank was likely not prepared for the volume of lending during the Panic of 1825. The Drawing Office, which was responsible for discounts, cut its staff significantly in the lead-up to the panic, and the remaining staff were frequently reassigned temporarily (Neal 1998). In the early 19th century, the Bank typically discounted bills only on Thursdays (James 2012). This does not appear to have been the case, however, during the worst of the Panic of 1825, which implies that the panic forced the Bank to increase its discount window availability to a daily basis (Pickering 2018).

The Bank had two major avenues for lending during the Panic of 1825. The Bank conducted discounts—outright discounted purchases of short-term unsecured debt, known at the time as bills of exchange. Additionally, the Bank provided advances—collateralized loans with a structure similar to modern repurchase agreements. Participants sold eligible securities to the Bank, with an agreement to repurchase the securities at a later date. Although there is little documentation on advances themselves, it appears that government bonds and railway stocks were the most common forms of collateral (Anson et al. 2017, 14).^FIt was not until 1894 that the Bank split its simple reporting of “advances” into “advances on bills” and “advances on securities” (Ogden 1988).

Detailed information on how the Bank of England’s discount window operated is not readily available. However, there is evidence that the discount window functioned as an on-demand facility, depending on the hours of the office. It did not participate in or conduct auctions during the Panic of 1825.

Available sources suggest that the Bank restricted eligibility at the discount window to London residents. This ruled out country banks from participating in the discount window directly. Instead, country banks rediscounted their bills with their London banks, which turned to the Bank’s discount window (James 2012).

The Bank was both a commercial bank and a banker’s bank, so eligible discounters ranged from small businesses to large banks and merchants (James 2012).

The Bank funded the lending expansion by running down its reserves (Ogden 1988). In fact, the Bank nearly exhausted its reserves, with its stock of gold declining from GBP 10.7 million in December 1824 to just GBP 1.3 million a year later (Bagehot [1873] 1979). By December 16, 1825, the Bank’s specie reserves were down to only 100,000 sovereigns, and the Bank began to prepare for the possible suspension of payment the next day (Pickering 2018).^FThe Bank preferred for the government to demand the suspension of payment, which the prime minister refused to order—instead advising the Bank to leave a note on its door stating that its specie reserves were exhausted (Pickering 2018). The Bank avoided this likely disaster due to two events: the usage of a box of GBP 1 notes with up to GBP 500,000 inside that had been pulled from circulation in 1821 and an influx of gold from the Bank of France (Ogden 1988; Pickering 2018).

The Bank’s lending had no stated total size. However, because its notes had to be backed by gold, its lending was constrained by its reserves, which it nearly entirely depleted (James 2012). At the height of the panic, the Bank discounted almost GBP 6 million bills from December 12 to 17. For comparison, the Bank’s weekly average of discounted bills during the November period, when the panic had already begun to spread, was only GBP 1 million. In total, from December 12 to 24 (the peak of the panic), the Bank discounted about GBP 8.6 million of bills (Pickering 2018). Ogden (1988) calculates that in the three weeks after the start of the crisis, the Bank’s discounts rose from GBP 5 million to GBP 15 million. Additionally, a member of Parliament referred to GBP 7 million of advances conducted by the Bank during the Panic of 1825, but it is unclear what time frame this is measured over (Committee of Secrecy 1832, 16).

Specific information on individual participation limits could not be found for the Bank’s lending during the Panic of 1825. However, there is evidence that the Bank of England maintained individual caps on discounts in 1815. The Special Discount Committee of 1815 specified limits based on participant classification, ranging from an upper limit of GBP 30,000 for the most esteemed bankers to GBP 5,000 for “people of little business who were low in the estimation of the Bank and of their peers” (Ogden 1988). These limits could have changed by the Panic of 1825. Also, according to Ogden (1988), it is “doubtful however whether they were ever treated as the absolute limits that perhaps they were intended to be.” For example, the Special Discount Committee of 1819 reported that more than 100 discounters had exceeded their classification limits by almost GBP 1 million on discounts of GBP 2.5 million in the previous year (Ogden 1988).

The Bank of England initially set the discount rate at 4% going into the Panic of 1825. However, during the crisis, the Bank raised the discount rate to 5% on December 14, 1825, due to fears of declining reserves and profits (Olmstead-Rumsey 2019). Specifically, Governor Palmer stated that he believed “the motive was to limit the issue as far as possible; I do not think it had any material effect in diminishing the demand” (Committee of Secrecy 1832, 49). The Bank could not raise the discount rate higher than 5% because of the usury laws, so the Bank could not further ration credit through increasing the discount rate (James 2012).

Neal (1998) notes that the Bank charged a discount rate much higher than the market rate before the Panic of 1825 intensified. As a result, the Bank lacked vital information on market pressures and developing situations. The Bank was only truly aware of the situation when a sudden influx of discount requests arrived in December.

According to James (2012), the Bank was “quite particular” about bill criteria during noncrisis periods. These bills had to be endorsed by two London bankers (which the Bank later expanded to two British names, with the acceptor of the bills one of the names). The originators of the bills had to be respectable companies known to the Bank. The bills themselves had to come from commercial transactions in which goods were transferred and had to mature within 65 days.

Such provisions ruled out more than two-thirds of the paper sent to London by country banks. London banks therefore most of the time had to offer their own paper for rediscount at the Bank rather than just passing on that of their country correspondents. (James 2012)

During the early stages of the crisis, there is evidence that the Bank decided to not lend against certain categories of collateral due to perceived riskiness, but it is unclear which collateral the Bank refused to lend against (Neal 1998). However, as the crisis worsened, the Bank began discounting Exchequer bills, bills longer than 95 days, and long-term government securities. Despite widening the eligibility for discounts, the Bank still restricted discounting to a “highly conservative character” (James 2012). The widening of eligibility simply admitted “a class of borrowers on irreproachable security who nevertheless had been barred by previous limitations” (James 2012).

It is important to note that specific collateral criteria documentation does not exist from this period, so a reliance on anecdotal sources is necessary. One researcher concludes that that the discounted bills carried little risk (Sissoko 2014). This could explain why the Bank did not feel the need to rigorously document this information. Nevertheless, despite what may be characterized as somewhat conservative evaluation criteria for discounted bills, the Bank’s view of its activities was somewhat more liberal, as evidenced by contemporaneous parliamentary testimony. Governor Palmer stated:

I believe every sort of security was tendered to the Bank at that period, upon which advances were made without much inquiry as to their nature, provided they were deemed to be eventually secure. (Committee of Secrecy 1832, 16)

Prior to the crisis, the Bank of England required bills of exchange to have a term of 65 days or less, which were much shorter maturities than accepted elsewhere (James 2012). However, on December 14, the Bank decided to allow the discounting of bills with more than 95 days left on their term (Pickering 2018).

It does not appear that the Bank implemented any other conditions on its lending, as it likely did not have that ability as a private bank.

On December 15, the cabinet granted the Bank the authority to issue GBP 1 notes, as an attempt to reverse the credit crunch and rapid decline in Bank reserves. Initially, the cabinet intended this action to be temporary, but it lasted until October 1826 (Pickering 2018). Beyond this, there did not appear to be much attention paid to the effect of the Bank’s lending on monetary policy transmission.

As a result of the gold standard, the Bank was heavily restricted in its ability to influence monetary policy. The Bank became involved in monetary policy only later in the 19th century, as it experimented with limited open market operations (Sayers 1936). Even though the Bank tried a variety of options for affecting monetary policy, “it was not very happy about any of them” (Sayers 1936).

According to Governor Palmer, the British government did not provide any form of a guarantee or indemnification to the Bank of England during the crisis (Committee of Secrecy 1832, 47).

In responding to the Panic of 1825, the Bank faced a conflict between its private need to protect its reserves and its implicit public responsibilities to serve as a pseudo lender of last resort. Therefore, the Bank initially attempted to protect its reserves by restricting its advances and discounts (Bagehot [1873] 1979). It responded to the early signs of the crisis by rationing discounts, refusing to lend to even the most esteemed bankers on Lombard Street (James 2012; King 1936). According to Bagehot ([1873] 1979), this decision resulted in:

A period of frantic and almost inconceivable violence; scarcely any one knew whom to trust; credit was almost suspended; the country was . . . within twenty-four hours of a state of barter.

This stance did not work, and the Bank instead switched to an expansionary lending policy. At that point, the “Bank eventually threw everything it had at the Panic of 1825” (Morgan and Narron 2015). It is important to note that the Panic of 1825 served as a learning experience for the Bank, typified by the passage of the Bank Charter Act of 1844, which granted the Bank more public powers and responsibilities. Over the following decades, the Bank took lessons learned from additional financial crises and eventually came around to following Bagehot’s doctrine (Bordo 2014).

The Bank considered other options to arrest the Panic of 1825 without requiring it to serve as the lender of last resort. For example, the Bank considered suspending payments as it did during a banking panic in 1797, even subtly asking the government to authorize this action. The government declined this request (James 2012). Additionally, the government issued Exchequer bills in previous crises during 1797 and 1811 as a strategy to increase liquidity and faced public pressure to do the same in 1825. The government refused to do this in the Panic of 1825 and instead “advised the Bank to take the whole affair into their own hands at once” (Bagehot [1873] 1979, citing a letter written by Sir Robert Peel, home secretary during the panic and later primate minister and chancellor of the Exchequer).

As mentioned previously, the Bank almost ran down its reserves during the panic and considered suspending convertibility. However, this was avoided in part by a GBP 400,000 loan from the Bank of France on December 19, 1825 (Bordo and Schwartz 1998).^FAt the time, England was on the gold standard and France was on the silver standard. The Bank essentially traded silver to the Bank of France in return for gold. Favorable rates on gold in England versus France helped speed the exchange and made it mutually beneficial (Bordo and Schwartz 1998).

Research did not uncover significant communications by the Bank during the Panic of 1825.

Although the Bank of England maintained internal daily ledgers of lending activity, it did not publish this information. The governor of the Bank of England stated that publishing the Bank’s accounts would have “endangered” the Bank by encouraging a further run due to the reserves being run down (Committee of Secrecy 1832, 56). However, another witness in front of the same committee argued forcefully for publicizing the Bank’s accounts, claiming that better information sharing by the Bank would have prevented much of the Panic of 1825 (Committee of Secrecy 1832, 193–94).

The Bank did not publicize an initial large loan due to fears that its reserves would be swiftly depleted. Early in December 1825, the Bank of England gave a secret GBP 400,000 loan to a bank on the brink of collapse, Pole, Thornton & Co.^FAccording to Neal (1998), the Bank’s governor and deputy governor presented the cash to the leader of the borrowing bank, with no other Bank employees in attendance. The Bank sought this level of secrecy to prevent other banks from swarming the Bank and demanding assistance.^FHowever, the governor of the Bank was “particularly connected with the house of Pole & Co. by marriage and other circumstances of relationship,” which could have affected the Bank’s decision to get involved (James 2012, citing Lawson 1852). Neal (1998) argues that a “responsible lender of last resort” would have announced the relief to soothe the turmoil in the banking sector and project confidence in the Bank’s ability to support the market. Pole, Thornton failed just six days after this loan, which is possible evidence that conducting this secret loan failed both the individual borrowing institution and the banking sector at large (Ogden 1988).

It does not appear that the Bank of England had stigma concerns, especially since bankers quickly turned to the Bank for help in times of crisis. In fact, the Bank’s secret loan to Pole, Thornton reveals that the Bank was more worried about too many bankers coming to the discount window rather than bankers avoiding it due to perceived stigma (Neal 1998).

Research did not reveal a set exit strategy planned by the Bank of England during the Panic of 1825.