August 1914: the longest bank holiday
For banks, the first impact of war was a sudden and severe financial crisis in the last week of July 1914, some days before Britain entered hostilities.
Crisis on the eve of war
The panic began when Austria’s ultimatum to Serbia became known on 24 July 1914. This, far more than the earlier assassination of Archduke Franz Ferdinand, brought home the extreme risk of European war. It led to heavy selling of investments, which caused serious disruption of stock exchanges, money markets, foreign exchange and trade financing. Disruption spread across the continent, and as each market seized up or closed, investors sought to sell their investments in the nearest market that remained open, causing contagion across Europe. The London Stock Exchange and the London money market, where around half of all world trade was financed using sterling loans, suffered increasingly severe stress in the last four days of July. Even in a normal year, this would have been a peak time. The last business day of July was a major settlement day for City firms, and many businesses needed to make large withdrawals to pay wages ahead of the annual August Bank Holiday the following Monday.
London's role as a global financial centre meant that many overseas banks had branches there. As uncertainty grew, they sought to liquidate their positions and send value back home. They called in loans and sold shares and bonds, causing prices to fall. Both actions had the effect of putting brokers and jobbers under severe pressure. They turned to the Bank of England, which made large loans to tide them over, but as the week progressed its interest rate rose from 3% to 10%. Six broker firms and one jobber firm failed.
With exchanges closed, settlement of existing transactions was postponed. This caused liquidity shocks across the globe, and mechanisms for settling international payments largely broke down. Overseas borrowers – even those who wanted to honour their payments – could not obtain the necessary sterling bills, and were forced to default.
Many of the loans were 'accepted', that is, guaranteed, by accepting houses and banks. When the borrowers defaulted, their acceptors had to make huge payouts. By 31 July many accepting houses were facing insolvency. Just 8 of them had a combined deficit of £50m; more than three times the Bank of England's entire remaining gold coin reserves. The foreign banks and some British banks were also facing major losses on their acceptance business, and could not raise the required cash by selling assets because the stock exchange was closed. Fearing further defaults, the main British banks started calling in their loans to City firms. They also stopped issuing new guarantees, and started paying large customer withdrawals mainly in Bank of England £5 notes rather than gold coin. These measures prevented major failures, but the crisis kept getting deeper.
The Bank of England was also under pressure. £12.1m of its £26.5m gold coin reserves were paid out, partly to foreign investors seeking to repatriate their funds. Confidence in the British financial system was failing, with press rumours of runs on banks, and growing queues at the Bank of England waiting to convert banknotes into gold coin. Extraordinary loans made to City firms in difficulties totalled £32m. With only £14m of gold coin left in the Bank of England, sterling itself was at risk of collapse.
Extended bank holiday
The government knew it must not let the crisis deepen. With European war impending it was going to need to raise finance, and that meant keeping the money markets working and the banks robust. To buy time, it extended the national bank holiday on 3 August to include Tuesday 4th, Wednesday 5th and Thursday 6th August, making this the longest bank holiday in British history. These days gave it a chance to negotiate with all the relevant parties and pass emergency legislation to cope with war conditions. One of the key participants in the discussions was Sir Felix Schuster, governor of our constituent Union of London & Smiths Bank, who acted as a spokesman for Britain's banks and an expert adviser to the government.
A month-long payments moratorium was imposed during which no debts could be enforced. This included – as a precaution should it become necessary – bank deposits. This prevented further larger-scale failures of City and other firms. The Treasury made arrangements to begin issuing its own low-denomination £1 and 10 shilling notes, essentially a form of quantitative easing ensuring that cash remained available in the circulating economy, while conserving gold reserves at the banks and Bank of England. The notes had to be printed in an extreme hurry, because a good supply of them had to be ready and distributed to bank branches all over the country ready for their reopening on Friday, when business customers would need cash to pay their weekly wage bills. These notes were given legal authority by the Currency and Banknotes Act 1914, passed on 6 August, which also conferred legal tender status on Scottish and Irish banknotes and postal orders.
Within the banks, senior officials were kept busy with preparations and negotiations, both internal and external. Meanwhile, local branch managers were busy answering the telephone, reassuring worried customers. More junior staff, however, had relatively little to do. Clerks who would normally have been serving at the counter or recording transactions in ledgers were expected to attend work as usual, but all they could do was wait. In preparation for busier days after the end of the bank holiday, all staff holidays were cancelled.
The hurried preparations paid off. By the time the banks reopened on Friday 7 August, Britain was at war but there was no panic, and no run. Indeed, in some areas branches reported that customers were actually depositing money rather than withdrawing it. Amid such uncertainty, this was a striking statement of public confidence. On 8 August the bank rate was brought back down to 5%.
The financial crisis was not over, but disaster had been averted. In the ensuing months the government continued to tread carefully. Further steps were taken to get credit flowing again, including the removal of illiquid bills – largely those unpaid by foreign debtors – at the expense of the Treasury. Although the stock exchange itself did not reopen until 4 January 1915, securities trading for cash resumed in the City quite quickly. Britain's economy had made the transition from peace to war.