The failure of a key London bank in 1866 led to a key change in the role of central banks in managing financial crises.
Overend and Gurney was a discount bank which provided money for commercial and retail banks in London, the world’s financial centre. When it declared bankruptcy in May 1866, many smaller banks were unable to get funds and went under, even though they were otherwise solvent.
As a result, reformers like Walter Bagehot advocated a new role for the Bank of England as the “lender of last resort” to provide liquidity (cash) to the financial system during crises, in order to prevent a failure of one bank spilling over and affect all the others (“systemic failure”).
The new doctrine was implemented in the Barings Crisis in 1890, when losses by a leading UK bank, Barings, made on its investments in Argentina, were covered by the Bank of England to prevent a systemic collapse of UK banking.
Secret negotiations by the Bank and London financiers led to the creation of an £18m rescue fund in November 1890, before the extent of Barings’ losses became publicly known.
The bankers also organised a committee to renegotiate the outstanding debts owed by Argentina, but a banking crisis engulfed the country and foreign lending to Argentina dried up for a decade.
By Steve Schifferes
Economics reporter, BBC News