Bank Act of 1844

The Bank Act of 1844 followed the 1819 return to the gold standard: that is, convertibil- ity of banknotes into gold, which had been suspended since 1797; the 1819 Act stipulated a conversion rate of £3/17s/10½d (3 pounds, 17 shillings and 10½ pence) per ounce of gold.

The Bank Act went into operation on 31 August 1844. The main provisions were:

(1) The creation of two distinct departments in the Bank of England: the "Issue Department" in charge of issuing banknotes ("promissory notes payable on demand") and the "Banking Department" in charge of the "general banking busi- ness" of the Bank.

(2) The transfer to the Issue Department of 14 million pounds of securities as well as the gold and silver bullion held by the Bank of England. From 31 August 1844, new banknotes would be issued only in exchange for gold or silver. The amount of secu- rities held by the Issue Department could be reduced but never increased, except in specific cases, discussed below.

(3) The silver bullion held by the Issue Department would be limited to a fourth of the gold coins and bullion held in the Department.

(4) The Issue Department would be authorized to increase the amount of securities over the 14 million pounds limit, but only to replace banknotes previously issued by a bank ceasing these operations; such a replacement was limited to a maximum of two-thirds of the amount previously issued.

(5) No new issuer of banknotes would be authorized after the passing of the Act, and issuing rights would be lost by existing banks in case of bankruptcy, amalgamation or issuing discontinuity.

(6) The Act included a model of the statement of accounts to be published by each department. It also indicated the amount that the Bank was to pay to the Treasury and the rate of gold to the banknotes.

Although the law formalized the practice, the Bank of England had actually started as soon as 1840 to hold separate accounts of the amounts issued against securities and against bullion. During the crises that affected Britain in 1847, 1857 and 1866, the Bank of England was again authorized to issue new banknotes in exchange for securities; however, this facility was only actually used in 1847.

The Bank Act was based on the ideas of the Currency School. An author like Colonel Robert Torrens (1857) or a banker and politician like Lord Overstone (1857) considered that a metallic currency is the ideal system of payment but could be replaced by the less costly circulation of banknotes, provided that the notes would strictly be representative of the metal deposited in the Bank of England. To ensure this condition, they believed that convertibility needed to be upheld by the 1844 Act accounting arrangement, which removed any discretionary intervention in the issuing process. Such an infrastruc- ture would then avert any drifting of the system towards the suspension of payments. According to its defenders, this was the sole objective of the Act, and therefore it was beside the point to criticize it for not preventing financial and economic crises as in 1847. The Banking School opponents to the Bank Act, like John Fullarton (1845) and Thomas Tooke (1856), emphasized the diversity of the means of payment, and opposed the Act's view that restricted them to metal and banknotes. They argued that the Bank of England could only control one particular form of money, not the total amount of it, as the latter depended on credit, which is a key variable related to the various costs of pro- duction and therefore all the revenues in the economy. This analysis meant that the appar- ent automaticity brought on by the separation of activities was an illusion, as it actually gave unlimited discretionary powers to the Banking Department. This in turn implied the risk of large fluctuations in the rate of interest and therefore undesirable effects on credit. Convertibility was then viewed by the Banking School as only a way of ensuring that economic agents could switch freely from one instrument of payment to another.

At the time of the Act, the Banking School recommendations seemed to pale in com- parison to the reassuring precision of the Act and the apparent automatic working of the Issue Department under the new law. As an alternative, they only offered guidelines concerning the management of interest rates that relied on the discretionary powers of the directors. In this matter, however, the views expressed by Tooke (1856, pp. 129-38) bear a striking resemblance to the modern concept of the "conservative central banker" (see Rogoff, 1985). The Banking School was also vindicated in that if the currency system was able to accompany economic growth during the nineteenth century in the United Kingdom, this was due to the importance of payments not directly related to metallic money or Bank of England notes. In this respect, the key role of scriptural money was entirely unforeseen by the authors of the Act, because amounts on bank accounts were only viewed as deposits of bullion and notes.

The controversy surrounding the 1844 Act might still retain some relevance in modern payment systems. If, as perceived by Tooke (1844, pp. 71-2 and 124), credit and costs of production are the key variables to consider, then the question of the management of money creation must be shifted from the central bank to commercial banks. This then implies investigating whether it would make sense to look at some sort of separation in banking activities (see Rossi, 2013).

See also:

Banking and Currency Schools; Bank money; Bank of England; Bullionist debates; Financial crisis; Metallism; Narrow banking; Settlement system.