Banks to the Rescue
The opening battle of the First World War was won by the Bank of England before the British had so much as fired a shot.
Despite a minor crisis in 1907, Britain’s banks were riding high in summer 1914. The market was buoyant and interest was flowing into London from loans granted in almost every country of the world. The financial services sector was booming, interest rates stood at three per cent and, as in 2008, nobody foresaw the disastrous collapse that lay just around the corner.
The assassination of Franz Ferdinand in Sarajevo on June 28th had caused scarcely a ripple in the financial markets anywhere in Europe, let alone London. However, Austria’s ultimatum to Serbia on July 23rd changed everything. European stock markets experienced a flood of selling, with investors, as always in uncertain times, seeking refuge in gold. By July 27th the panic had gripped London and the Bank of England was besieged by people seeking to change their paper money for gold. The discount market and the foreign exchange market collapsed on the same day. The unthinkable, a total collapse of the British financial system, was happening as the bankers looked on powerlessly.
On July 30th the Bank of England reacted with the only weapon in its armoury: it raised the bank rate from three to four per cent and from four to eight per cent the following day. On July 31st the London Stock Exchange closed for the first time in its 113-year history and on August 1st the Bank again raised the bank rate to a record high of 10 per cent. There had been no planning for such a scenario and neither the Treasury nor the Bank of England had any other contingency plans. Further rate rises were now considered unfeasible.
On Monday, August 3rd the government announced an unprecedented four-day bank holiday to give the Treasury and the Bank time to put a raft of measures into place to save the financial markets. There were two different dangers as the declaration of war approached: first, the threat that a run on any of the joint-stock banks would become contagious and, second, a far greater risk caused by the over-exposure of the respected but highly geared London merchant banks. Of the £350 million (£15.07 billion in today’s money) of outstanding acceptances, between £60 million and £70 million was with German and Austrian clients, together with a further £50 to £60 million with Russians. Like Germany and the Austro-Hungarian Empire, Russia had cut normal commercial communications, which meant that around £120 million (£5.17 billion today) of debt was reduced to what would now be called ‘junk’ status. Against this huge sum, the combined assets of the merchant houses was only £20 million. The joint-stock banks understood the situation only too well and started to call in their loans to the merchant banks, as well as refusing further lending.
The problem before the bankers, economists and industrialists who met at the Treasury was how to stabilise both the joint-stock banks and the merchant banks without restricting them so much that they could no longer trade. The agreed package of measures was released to the press in time for first editions to carry the details when the banks re-opened on Friday August 7th.
The measures were both broad and radical: a ‘General Moratorium’ was proposed on contracted payments, so that banks did not have to pay out on deposits. All other financial contracts would fall due one year after the end of the war, if either of the parties requested the moratorium.
The Treasury, instead of the Bank of England, would issue small denomination £1 and ten shilling notes, up to 20 per cent of the total value of bank deposits; these became known as ‘Bradburys’, because they were signed by Sir John Bradbury, Permanent Secretary to the Treasury.
The banks agreed to pay out wages on August 7th in gold instead of paper money, if requested. The Bank of England agreed to buy all financial assets in risk of default that were held by the merchant banks. The Government provided guarantees to the Bank of England against any losses incurred in buying doubtful financial assets.
On August 7th no bank experienced a run and, from a potential ceiling of £225 million, the Treasury only issued £13m in ‘Bradburys’. The merchant banks were quick to take up the offer to sell their doubtful debts and, overall, the package proved sufficient to stabilise the market. Although the Stock Exchange would not re-open until January 1915, London remained, for the time being at least, the world’s banking and financial centre.
The 1914 financial crisis affected almost the whole world, with all but the Japanese and New Zealand stock exchanges closing and runs on numerous banks resulting in closures. Both the causes of, and the solutions to, the 1914 crisis bear similarities to the crisis of 2008, with a long period of prosperity coming to an apparently unforseen end. The response in both cases saw the Bank of England buying massive amounts of doubtful debt and the government authorising the printing of large sums of money. Yet though the crisis of 2008 was serious, the events of 1914 were potentially disastrous, coming on the eve of the First World War.