How did banks get limited liability status? Debates from 19th century Britain..

This is a superb paper and we need more such research.

It is written by Matthew Willison of Bank of England. It tracks the debates in UK in 1850s on whether banks should be given a limited liability status or not.

In 1853 a Royal Commission was set up to investigate whether laws related to limited liability in Britain needed to be modified. As part of its evidence gathering the commission issued a questionnaire that included a number of questions on whether banks should be subject to the same liability laws as other types of commercial enterprises.

This paper analyses the responses to the questions about banks to understand whether banks were seen as a special case. Support for modifying the law to make limited liability more easily available to banks was lower than for enterprises in general.

Banks were seen as a special case because of the risk of bank runs and because their creditors were not able to assess accurately the riskiness of banks. But the special nature of banks caused others to favour limited liability because it made banks’ capital levels more transparent. These arguments echo wider debates during the nineteenth century and are similar to contemporary theories for why banks are regulated.

In Britain, there was limited liability for chartered banks, unlimited liability for others.

There were arguments on both sides for limited liability for banks. Those who supported unlimited liability said that depositors and note holders are not well-informed and unlimited liability gives them comfort. Those which supported limited liability said it gave a truer picture of the bank’s financials. The shareholders may not be in a position to pay back all the debts.

In 1857, limited liability status was given to banks in UK.

In 1861, limited liability status was given to banks in India too (and may be other colonies). Before this, lack of limited liability was seen as a major reason for instability in banks. Large number of banks failed in Bengal before 1861.

This change in law along with US Civil war led to several banks coming up in Bombay catering to the demand for cotton. There was huge euphoria leading to eventual panic in 1865 as civil war ended with closure of these banks. Even Presidency Bank of Bombay had to shut shop in 1867. So clearly limited liability hardly made much impact as far as prudence in Indian banking is concerned.

But the key here is how ideas shape up. How law and finance come together and become so critical to thinking about financial organisations…

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