215tion of the bank’s investment portfolio predominated. Consequently, British banks sought, above all else, to place their funds in negotiable liquid assets. The question of returns, if considered at all, was secondary. This desire for liquidity gave rise to an extremely conservative investment policy that saw banks investing almost exclusively in safe and reliable British government securities and consols. Industrial and foreign shares were eschewed.134 This orthodoxy was enshrined in the banker’s code
132 Hall, London Capital Market, p. 51.
133 Not all banks had investment funds, however. In 1880, the Liverpool Union and
Bradford Bank Company, for example, reported no investment securities at all among
their assets. See M. Baker and M. Collins, ‘English Bank Investment Portfolios, 1880–
1910’, unpublished working paper, University of Leeds School of Business, 2007,
pp. 3–6. We are very grateful to Professor Collins and Dr Mae Baker for their insightful
comments on this section and for allowing us to see a draft version of their new and
important paper on bank investment in England.
134 C. A. E. Goodhart, The Business of Banking, 1891–1914 (London: London School
of Economics, 1972), pp. 127–9; A. R. Holmes and E. Green, Midland: 150 Years
216of practice. The Midland’s deed of settlement, for instance, expressly limited the bank’s investment activity to a narrow range of securities that included government stock, Navy and Exchequer Bills, Bank of England or East India Company bonds, and annuities.135 Similarly, the by-laws of the London Joint Stock Bank (hereafter LJSB) prohibited it from investing in foreign issue, irrespective of their rate of return.136 As Charles Gow, the General Manager of the LJSB, explained to the US National Monetary Commission in 1910, from the bank’s point of view, the interest any security bore was of ‘secondary importance to their negotiability’.137 Such disregard for the rate of return was not simply a norm for the industry, but in time became a shibboleth with which the financial prudence of an institution was established. As such, a policy that openly sought to maximise the bank’s return from its investments came to be regarded as a sure sign of profligacy and, consequently, was frowned upon by all ‘right-minded’ bankers. Take the case of the Westminster Bank, whose board in 1852 had just voted to deviate from this orthodoxy. Sir David Salomons, an absent member of the erring board (and Alderman of the City of London and Middlesex), wrote with notable disgust to the bank on 1 September: I am sorry to learn that at a small Board today a resolution was come to that we should take a line in the new loan for the Turkish Bank. This seems to me so great a departure from our usual principle of business that I do think it ought not be acted on till the Board should have had an opportunity of considering whether they will so far relax their usual course of conduct in respect to foreign speculations. I do not discuss whether this new stock be or be not an eligible general investment of money. I am, however, quite sure that an application from the Bank will become a subject of conversation for the purposes of giving the new security a character and we shall possibly be judged as paying out high dividends from these speculative things rather than from the scrapings of slow and less adventurous business.138 Over the second half of the nineteenth century such conservatism among British banks with regard to investment gradually broke down.
of Banking Business (London: Batsford, 1986), p. 49; and M. Collins and M. Baker,
Commercial Banks and Industrial Finance in England and Wales, 1860–1913 (Oxford:
Oxford University Press, 2003), pp. 63–4.
135 Holmes and Green, Midland, p. 49.
136 Suzuki, Japanese Government, p. 31.
137 National Monetary Commission, Interviews on the Banking and Currency Systems of
England, Scotland, France, Germany, Switzerland and Italy (Washington, DC, 1910), p. 68.
138 T. E. Gregory, The Westminster Bank through a Century (Oxford: Oxford University Press,
1936), p. 265 n. 2.
217Information and investment By the beginning of the new century, the investment portfolios of many banks were beginning to be managed in a very different manner.139 While there was considerable variation in practice between banks, these changes manifested themselves in two main ways.140
First, an increasingly broad range of assets was deemed acceptable investments by the banks. This process began with colonial government securities, which, from the 1870s, steadily came to be seen as safe and liquid enough assets for even the most traditional of banks. From the 1890s, they were joined by colonial and domestic municipal stock as well as Canadian and, then, eventually American railway bonds. As the First World War approached, a limited number of foreign and other securities started to appear in some banks’ portfolios.141 The converse side of this broadening of investment was that the proportion of the portfolio devoted to traditional assets, most particularly consols, declined, though it is noteworthy that public sector securities overall (either British or colonial in origin) continued to predominate.142
Typical of this changing investment composition was the experience of the Metropolitan Bank. Figure 5.2 provides snapshots of its investments between 1880 and 1913. Beginning in 1880 with a portfolio almost completely dominated by UK government stock, by 1913 it included a wide variety of assets from across the globe. The first step in the internationalisation of its portfolio, however, had been its embrace of empire stock. It was not till the second decade of the twentieth century that assets from
139 It is worth noting that the proportion of assets banks were devoting to investments
at this time also declined from about 21 per cent on average in 1890 to about 15 per
cent by 1913. The 1913 percentage, however, was still significantly above that of 1860,
when only about 11 per cent of bank assets were invested. See Collins and Baker,
Commercial Banks, pp. 75–6. If the percentage is calculated so that each bank’s con-
tribution counts the same irrespective of size, then it does not decline, but remains
fairly constant after 1900. These figures are, of course, averages: individual bank invest-
ment ratios could vary considerably and in ways unrelated to bank size. See Baker and
Collins, ‘Investment Portfolios’, pp. 3–6.
140 Some banks continued to adopt a very traditional approach to investment well into the
twentieth century. The Lincoln and Lindsay Bank, and the Union Bank of London, for
instance, continued to invest purely in consols and other government annuities right
up until the First World War. See Baker and Collins, ‘Investment Portfolios’, p. 16.
For other examples, see Goodhart, Business of Banking, p. 135; National Monetary
Commission, Interviews, pp. 179–85.
141 Industrial shares, however, never figured prominently in the banks’ investment port
folios prior to the First World War; Collins and Baker, Commercial Banks, p. 67.
142 Hall, London Capital Market, pp. 7–15; Collins and Baker, Commercial Banks, pp. 63–8;
and Goodhart, Business of Banking, pp. 130–41. With respect to the public sector’s con-
tinued dominance, Baker and Collins, ‘Investment Portfolios’, pp. 12–13 show that
between 76 per cent and 87 per cent of bank investments between 1880 and 1910 went
to public sector securities.
218100
90
80
70
60
1880
50
1889
40
1904
30
1913
20
10
0
Colonial
Other
UK
UK Stock
US Stock
Stock
Foreign
Figure 5.2 The Metropolitan Bank of England and Wales’
investment portfolio, 1880–1913 (share of total investments).
outside the empire, including inter alia Brazilian, Chinese and Danish bonds, made their presence felt. Even then, a third of all Metropolitan Bank investment were still based in the empire.
The second change, which underpinned the transformation in the composition of the banks’ investment, was a subtle shift in the management, and indeed rationale, of their investment funds. As Charles Goodhart notes, there was at this time a change in the importance of the earning capacity of assets relative to their desirability as reserves. As a result, greater attention began to be focused on the fund’s rate of return.143
What drove this change in banks’ investment behaviour? The most common explanation is the steady, late-nineteenth-century decline in the interest rates on consols, which slowly but surely tarnished their reputation as a reserve asset. Holding on to large volumes of consols no
143 Goodhart, Business of Banking, p. 134. This view has recently been challenged. Baker
and Collins, ‘Investment Portfolios’, p. 22, contend that the change in investment pat-
terns was less to do with the banking sector’s increasing use of its investment funds as
sources of income and more the result of the wider range of public sector stock available
on exchanges towards the end of the nineteenth century. Given the fact that the banks
at this time did not embrace large amounts of high-yielding foreign or industrial shares,
but merely came to hold a more diverse portfolio of public sector securities, such a
view is certainly plausible. Yet, from the perspective of the argument advanced in this
chapter, it matters little why this diversification occurred. If British banks in this period
chose to acquire more colonial stock, they must have done so because they were now
better aware of the advantages of holding such stock. Therefore, it still comes back to
the question of the timing and availability of information. Colonial securities became
popular because the banks steadily learned that they were negotiable liquid assets and
that they brought decent returns.
219Information and investment longer guaranteed protection for the banks against runs: the very opposite, in fact, for as their price diminished, so did the security they could offer. Banks had no other option but to look further afield to regain that sense of safety. It was a long-term search. No revolution in behaviour occurred, just a gradual, though perceptible, move towards a new pattern of investment.144 That bankers readily responded to market incentives in altering their investment behaviour is hardly surprising. Yet, while the banks’ new behaviour may have had its origins in a fundamental transformation in the relative rates of return and liquidity of the different assets available to them, such an explanation cannot in itself account for the actual pattern and timing of the diversification in portfolios. Specifically, it leaves unanswered the question of why the banks first turned to colonial, then US, and finally to foreign stock. The answer cannot simply lie in the relative rates of return, for highly profitable foreign ventures continued to be ignored by banks well into the twentieth century.
Bankers tend to be conservative creatures, arguably not given to great turns in either thought or deed. As such, it is unlikely that, when confronted by altered circumstances, they would have instantly rejected an orthodoxy that had served them so well in the past. Instead, they were more likely to have made piecemeal accommodations to prevailing conditions; in other words, change would have come as an evolutionary process that, over time, and almost unwittingly, transformed the basis of the investment strategy of banks. Given this gradualist approach, how does this process of change start: where, if you like, would have banks looked first for their new investment opportunities? It seems in areas they knew best. Thus, when the Imperial Bank of Persia began diversifying its portfolio in the 1890s, its first recourse was to turn heavily towards Persian government stock, only later broadening out to include colonial and then some Chinese, Japanese, US, Mexican and Russian government stock. Similarly, nearly 40 per cent of the African Banking Corporation’s investments in 1913 were in South Africa, mostly in government securities.145
Thanks to the informational asymmetries inherent in the capital market in the latter half of the nineteenth century, British banks knew and trusted best colonial securities. Moreover, once a decision to branch into a new type of stock had been taken, banks had an incentive to continue to support that stock, so as to retain their negotiability. This obligation drew banks closer and closer to certain types of securities and helped to foster the special relationships that some had begun to establish with
144 Goodhart, Business of Banking, pp. 130–3; Jones, British Multinational Banking, p. 93.
145 Jones, British Multinational Banking, pp. 93–4.
220specific colonies. The case of the London and Westminster Bank is illustrative. Having assumed responsibilities for the underwriting of Western Australian colonial loans, they now held a large number of Western Australian securities in their portfolio. To protect the value of those assets, the Bank determined in June 1910 that it would take up as much as £100,000 worth of any Western Australian stock that appeared on the market.146 In its initial stages, the pattern of portfolio diversification often closely correlated with the personal connections of senior bank personnel. These connections tended to be heavily biased towards the British and Anglophone worlds. As better information on other markets became available, this bias gradually diminished. Despite its importance, this networking left relatively few traces in the written records of banks. It was, after all, an unofficial, almost invisible, activity. A rare yet excellently documented example of the role of personal contact in banking can however be pieced together from the archives of the Midland Bank.
In the mid nineteenth century, the Midland, like most British banks, managed its portfolio in a rather unsophisticated manner. Lacking much first-hand knowledge and experience with securities, it typically opted to accept the recommendations of its London agent. Detailed discussion of investment choices at the board level rarely took place, and independent advice from brokers or other financial intermediaries was not sought. Decisions about investments were uncomplicated and involved few people. Adherence to the accepted canons of banking practice, of course, obviated the need for much deliberation.147 Nevertheless, the nature of the process placed great emphasis on the personal contacts, experiences and preferences of those whose duty it was to manage the bank’s investment funds. Individuals, therefore, were well placed to influence the bank’s investment behaviour, particularly when portfolio diversification became a priority. For the Midland, Edward Holden, its Managing Director between 1898 and 1919 (and Chairman between 1908 and 1919), played such a role.148 From its inception, the investment portfolio of the Midland was managed as a reserve fund very much in accordance with the canons of British banking practice. It is therefore telling that when the Midland Bank departed from this conservative investment strategy during the 1870s and 1880s, it did so first and foremost by diversifying into colonial issues, most prominently Canadian, Australian and Indian railway stock. So dramatic was the shift that, by early December 1888, colonial stock
146 Goodhart, Business of Banking, p. 138.
147 Holmes and Green, Midland, p. 50.
148 Ibid., p. 141.
221Information and investment alone already constituted no less than 46 per cent of the bank’s entire investment portfolio. This choice was driven not only by a desire for higher yields, but by the availability of reliable information about such stock that was readily obtainable from the bank’s London agents and increasingly from its manager’s own correspondence with and travels to overseas branches.149 From 1904, Holden made a number of trips to the USA and Canada in order to acquire first-hand knowledge of business practices and opportunities on the other side of the Atlantic. He hoped that this knowledge could be used to expand the bank’s business there. Holden kept a fascinating diary of his first eight-week journey to North America (10 September to 5 November 1904), in which he detailed all of his meetings and impressions. His trip took in New York, Toronto, Niagara and Chicago. In each location he met leading bankers, manufacturers and politicians; delivered speeches to various business communities; and toured prominent industrial sites. It was, by all accounts, a life-changing experience for Holden and he was noticeably impressed by what he had witnessed. Canada was, in his words, ‘a grand country’ ripe with opportunity, where, if only British capital could be delivered in sufficient quantity, ‘the wealth that will come out of the land ultimately will also be enormous’. He was particularly struck by the Power Company at Niagara and the new lines being built by Canadian railway companies, the bonds of which he regarded as ‘good investments’. In the United States, he was amazed by the slaughter and stripping houses of Morris Beef in Chicago, an establishment that he described at great length in his diary. Holden returned to Britain eager to utilise the knowledge he had gleaned from his trip. Above all else, through the trip he had succeeded in establishing a number of North American business contacts for the bank.150
Holden cultivated those links and soon found himself at the centre of a transatlantic network that was largely of his own making. He was regularly called upon by North American businessmen who valued his advice and input. On 27 May 1909, for example, a Mr J. Child paid Holden a visit at the bank. Child, it turns out, was a client of the Traders Bank of Toronto and had arrived at the Midland with a personal introduction from the Traders Bank’s manager, Mr E. W. Strathy, whom Holden had met back in 1904. Child represented a syndicate, which had obtained a large land grant from the Canadian government to establish a paper-pulp
149 Ibid., pp. 49–51, 80, 141.
150 Hongkong and Shanghai Banking Corporation Archives (hereafter HSBC Archives):
ACC 150/2, ‘Mr Holden’s Report on his Visit to America, 10 September to 5 November,
1904’.
222concern, and was now intending to buy out the Spanish Pulp and Paper Co. Ltd of Espanola, Ontario. The funds for the purchase were to come from a $4 million bond issue to be underwritten by the UK company, United Mining and Finance Corporation. Child sought Holden’s advice both about the reputation of United Mining and Finance and the prudence of the financial measures proposed. Holden promised to make enquiries for Child.151 Similarly, Mr Crichton, a barrister from Winnipeg, saw Holden in September 1909, to ask his advice about placing some (unspecified) Canadian securities on the British market. Holden recommended that he advertise his requirements and take a room at a hotel so as to carry out negotiations with interested parties. Holden further advised him to emphasise to potential backers the fact that there was no income tax in Canada.152 Sometimes these inquiries led to more business for the bank. The President of the Robert Simpson Department store (founded 1872) in Toronto called on Holden on 31 July 1907. Some of Robert Simpson’s directors sat on the board of the Canadian Bank of Commerce, which Holden had visited three years earlier. The store sourced material from Britain and continental Europe and hoped that, on the basis of the initial contact that had been made in 1904, the Midland would agree to take the company on as a customer and handle all of its European banking requirements. Holden obliged, and a long-term relationship was established between Simpsons and the Midland. When, in 1910, the company expanded its Toronto store and acquired a branch in Montreal (operating under the name of John Murphy and Co.), it sought and received detailed advice from Holden on how to finance the expansion. Two years later, when a further £900,000 was sought by Simpsons, Holden again offered his assistance, recommending that the funds be raised by a mixture of an issue of preference shares and bonds. He further promised that his bank would provide guidance on the correct pricing of the issue.153
But Holden was not always so supportive of North American companies. His interest in Canada was always based on hard, commercial realties. In August 1909, for example, Mr E. Jackson of the Midland Railway Carriage and Wagon Company called to see him about work that his company had been offered in Canada. The Hudson Bay and Pacific Railway and Development Company had requested £100,000 worth of railroad materials from his company. However, it had come
151 HSBC Archives: E. H. Holden Diary, ref 26/7 (Midland Bank Papers), 27 May 1909.
152 Ibid.
153 HSBC Archives: E. H. Holden Diary, ref 26/7 (Midland Bank Papers), 31 October
1907, 24 May 1910, 13 March 1912.