The day the bankers went to prison

The ruin of the City of Glasgow Bank in 1878 was the biggest collapse in British banking history – until 2008. Its story contains salutary lessons for bankers in any age.

The event was surprisingly full for a cold, wet winter night in Edinburgh. But the Library of Mistakes knows how to sell a good story…

And it’s true. If a long time ago, and in Glasgow. “A few months after posting record results a major Scottish bank goes bust, impoverishing many of its shareholders and depressing the whole economy. Is this 2008?” asked LoM, swiftly answering: “No it is 130 years earlier – and despite the similarities with the 21st century credit crunch, there are differences.In 1878 the whole board of directors was arrested, put on trial and sent to prison. Over ten years since the collapse of RBS and HBOS we are still waiting for the official report into the conduct of the directors.” 

The December event, part of the EICC Live programme, was hosted and chaired by Russell Napier, the founder-keeper of the Library of Mistakes –  a charitable venture set up to promote the study of financial history in the hope that we may “improve financial understanding one mistake at a time”.

They learned nothing from the experience

The ruin of the City of Glasgow Bank in 1878 was the biggest collapse in British banking history – until 2008. Its story contains salutary lessons for bankers in any age.

The Bank had come close to bankruptcy in 1857, but had learned nothing from the experience. It fell into all the traps the Western Bank, which had collapsed that year had succumbed to – maintaining insufficient reserves, becoming snared into continuing to support a handful of very large borrowers and investing in highly speculative early-stage foreign ventures – but had compounded these errors with fraud.

What may have started as merely trying to cover up mistakes, soon became routine institutionalised lying. To support its note issue, the bank invented gold reserves it did not have and reported the false figures to the Government. The accounts it gave to shareholders were works of fiction.

How had the deception gone undetected for so long? The directors rarely exhibited any interest in the real position of the bank and any who did were eased out of the company to be replaced by ‘men of straw.’ Any staff who raised objections were replaced.

Thousands of small shareholders were bankrupted by the collapse, which cast a cold economic shadow over Glasgow and Scotland for years afterwards.

Some things don’t change

Past banking collapses are some of many lessons explored in my new book  The Rise and Fall of the City of Money – a financial history of Edinburgh which begins and ends with financial catastrophe.  

The Darien disaster of the early eighteenth century drove Scotland into union with England, but spawned the institutions which transformed Edinburgh into a global financial centre. The crash of 2008 wrecked the city’s two largest and oldest banks (RBS and Bank of Scotland) – and its reputation.

In between there were many other banking disasters.  There is a depressing familiarity about the reasons banks fail, whether they are operating in the Scottish market in the eighteenth or nineteenth centuries, or global credit markets in the twenty-first. 

The immediate cause is the bank running out of cash because its depositors and those it needs to borrow from lose faith that they will get their money back. That loss of trust is caused by a perception (usually correct) that the bank has been lending to people who will be unable to pay off their loans and that the bank has insufficient capital to withstand its losses.

Look at the reasons for the failure of Scotland’s two largest banks in 2008 and you will find the same milestones on the way to disaster. And although the 21st century directors did not cook the books, they were guilty of taking the most optimistic view of the figures.

With the failure of Bank of Scotland and Royal Bank of Scotland came the end of Edinburgh’s two largest concerns as independent Scottish headquarters and a demotion of the city as a corporate capital. There were human losses too.  Millions of shareholders saw the value of their holdings in either or both banks decline by as much as 90 per cent. Tens of thousands of employees were made redundant. 

The impact on Edinburgh was not nearly as bad as it had been on Glasgow 130 years earlier but it did have an effect. Unemployment in the capital, though still low by national standards, jumped by almost 50 per cent (from 11,000 in 2007 to 16,200 in 2008).  

There was widespread public anger across the whole of the UK, not only in Scotland. Yet – unlike the directors of the Bank of Glasgow – in 2008, the men most responsible for the plight of two once great institutions went largely unpunished.  

The size of the audience in the conference centre on a cold wet night before Christmas – and their questions focused mainly on the 21st Century – indicate a still angry desire for lessons to be learned.

The Rise and Fall of the City of Money is published by Birlinn and available in all good bookshops – including Toppings Edinburgh in the former RBS branch, where I am delighted to be speaking on Wednesday 5 February.