Stability in the Absence of Deposit Insurance: The Canadian Banking System, 1890-1966

Article excerpt

THE STABILITY OF THE CANADIAN BANKING SYSTEM in the period before the introduction of formal deposit insurance in 1967, and in particular, the Canadian banks' immunity from the crisis that afflicted the U.S. banking system in the Great Depression, are well known. Between 1890 and 1966, only twelve Canadian chartered banks failed; six of these failures resulted in losses to the depositors. No bank failures occurred after the suspension of the Home Bank of Canada in 1923. Explanations for the relative stability of Canadian banking have focused on the structure of the system, particularly the economies of scale and portfolio diversification achieved by the large branch banks in Canada (Friedman and Schwartz 1963; Haubrich 1990) and the creation of a government rediscount facility in 1914. Some (Bordo 1986; Shearer, Chant, and Bond 1984; White 1983) suggest that the Canadian federal authorities and the Canadian Bankers Association (CBA) implicitly guaranteed bank deposits by arranging mergers. Most recently, Kryzanowski and Roberts (1993, p. 362) claim that all of the major Canadian banks were insolvent during the 1930s, and explain the absence of a banking crisis by the fact that the Canadian government provided "an implicit one hundred percent guarantee of bank deposits."

We utilize new archival data from the Department of Finance and the CBA, together with evidence from equity markets and the financial press, to undertake a comprehensive examination of the political economy of Canadian banking in the period from 1890 to 1966. We show that neither the CBA nor the Canadian government arranged mergers for insolvent institutions, and that depositors in some insolvent banks did suffer substantial losses. We counter the claimed existence of implicit insurance for insolvent banks by using the working papers compiled by the auditors of the fourth-largest Canadian chartered bank in 1930, The Bank of Nova Scotia, to demonstrate that at least this institution was solvent throughout the 1930s. The history of Canadian banking provides a compelling case against the view that deposit insurance is a prerequisite for banking system stability.


Between 1890 and 1966 the number of chartered banks operating in Canada decreased from thirty-nine to eight but there were no binding legislative barriers to entry. Between 1900 and 1929, twenty-five new charters but only eleven new Treasury Board certificates to begin operation were issued, while from 1920 to 1966 five new bank charters were issued but only two were utilized. None of the three autonomous domestic institutions who obtained charters in the period from 1930 to 1966 raised the capital necessary to begin business. This may indicate that economies of scale limited the number of banks that could operate at the efficient size in the domestic market (Carr, Mathewson, and Quigley 1994b).

Failures account for a large portion of the reduction in the number of Canadian chartered banks between 1890 and 1966 (Table 1). Claims that Canada had implicit deposit insurance must be reconciled with the fact that six of the failures, including the last three, resulted in major losses to depositors. In addition, in all cases where the assets of the bank were insufficient to meet the liabilities to creditors, calls were made on the double liability of the shareholders.(1) Without vigorous enforcement of double liability the proportion of failures resulting in losses to depositors would have been larger.(2) We examine in detail the last five failures shown in Table 1.


A. The Ontario and Sovereign Banks

The failures of the Ontario and Sovereign banks assume particular significance because of the actions of the other Canadian banks, who joined together to facilitate open-door liquidation of both institutions. The assets and liabilities of the Ontario Bank were assumed by the Bank of Montreal in October 1906, with the other members of the CBA giving it a guarantee against ultimate loss. …