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Bagehot for “Followers”: How Did the Bank of Portugal Manage the First Post World War I Crisis?

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Economic Globalization and Governance

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Abstract

The lender of last resort (LLR) function is a form of micro-management employed by central banks, usually in cooperation with or under the direction of governments, either to mitigate banking panics, or to prevent them from occurring. This paper considers the employment of the LLR function in Portugal during the early post World War I years. It is based on primary material in the Bank of Portugal’s archive. Using a detailed account of the first banking crisis of the early 1920s, this study shows that the Bank of Portugal did not conform to Bagehot’s archetype and explains why the departure from this model was unavoidable. It concludes that a lack of awareness of his paradigm was not the reason for the policy option of the Bank of Portugal.

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Notes

  1. 1.

    For Belgium, see Buyst and Maes (2008).

  2. 2.

    Capie et al. (1994), Appendix B, contains a wealth of information concerning the chronology of the historical spread of the LLR function.

  3. 3.

    There is good information, however, on the 1920s LLR’s of Italy and Spain. See Toniolo (1990, 1995), Guarini and Toniolo (1993) and Betrán et al. (2012). For the nineteenth century, there is valuable information and analysis in Bignon et al. (2012) and Buyst and Maes (2008).

  4. 4.

    Belgium, Finland, Italy, Spain, Bulgaria and Greece were also in this group. See Feinstein et al. (1995a, b).

  5. 5.

    See Reis et al. (1995) and Valério et al. (2006). There are small differences between the data used by these authors.

  6. 6.

    Only two well documented failures caused by improper or even illicit behavior have been identified, namely the Banco Industrial Português, in 1925, and the Banco Angola e Metrópole, in 1926.

  7. 7.

    In addition, a secretary-general was appointed by the government and sat on all meetings of the board, without a vote. His function was to inform the authorities of what went on and to inform the Bank in turn about the government’s views concerning board decisions.

  8. 8.

    This would only happen in 1931. See Banco de Portugal (1946b), vol. VI. Even in 1931, the preambles, respectively, of the monetary reform and banking reform laws of that year made it clear that it was thought impossible for the BP to become, overnight and by legislative fiat, a true central bank. Rather, it was expected that eventually it would develop in that direction, but only gradually and under state guidance. See Mata and Valério (1982).

  9. 9.

    The BP published a report in August 1876 describing these efforts and calling for its status as a special bank to be reinforced so that it might undertake this function more regularly and effectively. This request was not heeded until the crisis of 1929–1931. The BP could not have been more precocious as a LLR given that it was not until the 1870s that the system gained a reasonable dimension and required centralized intervention in moments of stress.

  10. 10.

    Between 1873 and 1887, a number of troubled banks were discretely assisted by the BP. In some cases, the sums employed were significant.

  11. 11.

    The dual issue continued until 1931, by which time the official thinking of the ministry of finance had evolved in the direction of this being an “incomprehensible arrangement” (Banco de Portugal, 1946b, VI: 12).

  12. 12.

    Bordo (1990) organizes the causes of bank failures into two categories: internal (poor management, dishonesty) and external (changes in relative prices).

  13. 13.

    The causes of contagion are much debated. One of the issues is whether the public is able during a panic to distinguish between solvent and insolvent banks. See Gorton (1985).

  14. 14.

    Bagehot’s (1873/2006) recommendations have been organized in the literature in various ways. This is due to the fact that Bagehot himself did not lay them out as a body of rules but dispersed them about the text of his chapter VII on “A More Exact Account of the Mode in Which the Bank of England Has Discharged Its Duty of Retaining a Good Bank Reserve, and of Administering It Effectually”. The present organization follows Bordo (1990) and Fischer (1999). Bignon et al. (2012, p. 581) limit theirs to three principles: free lending, good collateral and penal rates.

  15. 15.

    A matter of debate is whether the central bank should lend only to solvent banks, assuming that it can identify them, even if they are temporarily illiquid. Bagehot (1873) seems to have thought that if a bank had “good securities” to offer, then it must be solvent and there would be no need to make this distinction (VII: 58). His argument was that most of those in need during a banking panic were “sound people”, i.e. not insolvent.

  16. 16.

    A greater probability of moral hazard exists when the central bank intervenes to help individual banks rather than the system as a whole (Capie et al. 1994).

  17. 17.

    Quotes of Bagehot’s rules are from his Lombard Street. In this case, see Bagehot (1873/2006, p. 198): “in time of panic it [the Bank of England] must advance freely and vigorously to the public out of the reserve”.

  18. 18.

    GC meeting, 04/06/1920.

  19. 19.

    The conto was the unofficial thousand-fold multiple of the escudo ($): 1 conto equaled 1,000$00.

  20. 20.

    Director Mota Gomes at GC meeting, 25/06/1920.

  21. 21.

    At the GC meeting of 29/11/1920, director Ulrich claimed that the total bill would be something in the region of 60–80,000 contos, but lesser figures circulated too. At the meeting of 15/11/1920, the discussion on the current state of the BNU is illustrative. It pitted those who saw it as “comfortable” (e.g. Silva Viana) or “solid” (Seixas) against those who saw it as “highly delicate” (e.g. Ávila Lima)! On the other hand, Seixas cautioned, probably more sensibly, that “the state of the BNU is hard to determine”.

  22. 22.

    Ávila Lima, GC meeting, 15/11/1920.

  23. 23.

    Burnay, GC meeting, 03/08/1920.

  24. 24.

    Both cases were discussed at the meeting of the GC on 09/08/1920.

  25. 25.

    GC meeting, 03/08/1920.

  26. 26.

    This is the view of the government as expressed by Secretary-General Seixas at the GC meeting of 14/07/1920. This secret authorization was later transcribed into the minute book of the GC meetings. See Livro G2-19, fls.10-10vº.

  27. 27.

    A negative value of the “excess” represents a situation in which notes were being issued above the limit; a positive figure, the opposite.

  28. 28.

    Seixas at the GC meeting of 14/07/1920.

  29. 29.

    On 29/11/1920 the governor informed the GC that heads of banks were mobbing the Bank, demanding amounts which were simply impossible to satisfy. By 11 a.m. that day, their requests totaled 4,500 contos and the Bank only had 3,500 available, an “alarming” situation.

  30. 30.

    Frequently, it is claimed that Bagehot’s statement mentioned “at a penal rate”. In fact, his words were that “these loans should only be made at a very high rate of interest” (p. 199).

  31. 31.

    For numerous examples prior to 1891, see Reis (2007) and Esteves et al. (2009).

  32. 32.

    If the GC had read Bagehot carefully, they would indeed have expected that “if the central bank responded promptly and vigorously, the panic would be ended in a few days”, an occurrence which was actually unlikely in the troubled times after World War I. See Humphrey and Keleher (1983, p. 28).

  33. 33.

    For a balanced view of the respective merits of these two views, see Fischer (1999). For a defense of the second, more systemic approach, see Capie and Wood (2006), for whom the first one is not a proper LLR function.

  34. 34.

    Curiously, in 1931, the dictatorial government in which Salazar was finance minister, would still express doubts about the Bank’s ability to “resist interesting possibilities from the point of view of profit taking” in its new role as official central bank (Banco de Portugal 1946a, VI: 13).

  35. 35.

    Stated in the meeting of 11/10/1920.

  36. 36.

    During the crisis, we assume that none of the rescue operations undertaken went unregistered in the minutes of the GC, given the delicate nature of these decisions.

  37. 37.

    Director Burnay to GC, meeting of 03/08/1920, and various speeches at the meeting of 15/11/1920.

  38. 38.

    See the general discussion at the GC meetings of 07/12/1920, 08/12/1920 and 11/12/1920. The BP tried to get the government to intervene on its own account without result. It also tried to organize a syndicate of banks to shore up Totta, but none of them accepted.

  39. 39.

    Speech by director Motta Gomes to the GC meeting of 15/11/1920.

  40. 40.

    Speeches by the governor to the GC meeting of 30/07/1920 and of the secretary-general at the meeting of 15/11/1920.

  41. 41.

    Secretary-General’s speech to the GC meeting of 07/12/1920.

  42. 42.

    There is no statement in these precise terms in Lombard Street but Bagehot berated the Bank of England for its lack of clarity. See p. 208.

  43. 43.

    The author was the director of the Banco Português do Continente e Ilhas, and had close family relations with the BP’s leadership. For a similar though more official view, see the preamble to the 1925 law on banking in Banco de Portugal (1946b, vol. V: 140).

  44. 44.

    Spoken at the GC meeting of 30/07/1920.

  45. 45.

    Speeches by Lobo d’Avila and Silva Viana at the GC meeting of 29/11/1920 and by Burnay on the 08/12/1920.

  46. 46.

    Speech by director Ulrich to the GC on 08/12/1920.

  47. 47.

    “…these advances should be made on all good banking securities” (p. 199).

  48. 48.

    Our approach here is the same as that of Bignon et al. (2012), i.e. we are interested in what contemporaries would have considered “good collateral”, not what ought to have been, in retrospect, considered “eligible” by the authorities.

  49. 49.

    Report on this exchange in the GC meeting of 08/12/1920. The BNU was the exception: its collateral was usually taken without examination. Director Mota Gomes, GC meeting of 15/11/1920. This volume of rejections was about 40% of outstanding bills at that time. In the balmy days of the gold standard, the rejection rate was of the order of 1%.

  50. 50.

    As in the cases of Totta and the BPB.

  51. 51.

    Bagehot however complained that the Bank of England did the same, to his despair, and that in this matter “there is always great uncertainty as to the conduct of the Bank” (VII: 75).

  52. 52.

    Silva Carvalho’s speech to GC meeting of 07/12/1920. This problem became so important that a scheme was floated to found a “bad bank” with a capital of 50,000 contos to take the vast amount of illiquid stock out of the hands of the banks and discount it at the BP. The latter did not adhere to this plan. See GC meeting of 12/12/1920.

  53. 53.

    The question was posed by director Ávila Lima in the GC meeting of 11/10/1920.

  54. 54.

    See Elementos Históricos, AHBP, which shows that Nunes and Nunes suspended payments during 1920. The BP’s evidence places this in 1921, undoubtedly as a consequence of the crisis. It was one of the twenty-nine institutions which received support from the Bank.

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Acknowledgements

The author thanks the Bank of Portugal for allowing him to consult its historical archives and for financial support for this research. Invaluable assistance at this archive was received from Dr. Stella Pereira.

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  1. Instituto de Ciências Sociais, Universidade de Lisboa, Lisbon, Portugal

    Jaime Reis

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  1. Jaime Reis
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Editors and Affiliations

  1. Nova School of Business and Economics, Universidade Nova de Lisboa, Carcavelos, Portugal

    Luís Brites Pereira

  2. Nova School of Business and Economics, Universidade Nova de Lisboa, Carcavelos, Portugal

    Maria Eugénia Mata

  3. Department of Economics, CICP, CEFAGE, University of Évora, Évora, Portugal

    Miguel Rocha de Sousa

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Reis, J. (2021). Bagehot for “Followers”: How Did the Bank of Portugal Manage the First Post World War I Crisis?. In: Brites Pereira, L., Mata, M.E., Rocha de Sousa, M. (eds) Economic Globalization and Governance. Springer, Cham. https://doi.org/10.1007/978-3-030-53265-9_2

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