History has a habit of repeating itself. And financial history is no different. JB Equity analyst Desmond Woods reveals why studying financial history helps us to improve our understanding “one mistake at a time” in order to better manage risk.
At a recent event held at Edinburgh’s Library of Mistakes, the JB Equity team heard from a local business figure Tom Ward who explored the collapse of the City of Glasgow Bank – known as one of the greatest financial disasters in history.
The Library of Mistakes
Down a cobblestone lane in Edinburgh’s New Town sits a small and discreet townhouse known as the Library of Mistakes. This curious two-story alcove with its creaking wooden floorboards is adorned floor to ceiling with books and resources dedicated to the study of financial history.
Founded in 2013 by some reputable names in the finance world including the likes of Baillie Gifford & Co, Russell Napier and Anne Richards to name a few, the Library of Mistakes exists to allow students, professionals and members of the general public to study financial history to understand how finance has worked, rather than how it should work if key unrealistic assumptions are made. A Keeper of the library aims to ensure that the space grows to become the world’s best business and finance library, sharing knowledge of historical events that have shaped the financial sector – and indeed the world – today.
Earlier this month we gathered at the Library of Mistakes to hear Tom Ward share his academic research covering the collapse of the Glasgow City Bank. Mr Ward was a key member of the executive team that developed Scottish & Newcastle plc (S&N) from a small UK regional brewer, pub operator and hotelier, in the 1980s, to one of the world’s largest international brewers creating substantial value for shareholders in the process. The share price rose from under £1 in 1984 to £8 in 2008; and the enterprise value rose from £300 million to over £10 billion.
Mr Ward’s key roles included finance director of the beer business, brewing director and latterly, corporate development director for the group involving substantial contact with City of London advisors, brokers, investment bankers, corporate lawyers, and public relations. Tom left S&N plc upon completion of the takeover by Heineken/Carlsberg in August 2008, and since then has taken on a mixture of business, charitable and academic non-executive positions.
Mr Ward currently sits as a non-executive director on JB Equity’s board.
When undertaking a Masters in Intellectual History at the University of Edinburgh in 2008, Mr Ward conducted extensive academic research and writing on the largest financial collapse witnessed in Scotland prior to the 2008 Global Financial Crisis – The City of Glasgow Bank Collapse (1878).
The City of Glasgow Bank Collapse, 1878
‘It was a calamity so unlooked for, so huge and disastrous, that it riveted men’s gaze and made their hearts stand still.’ Wilson (1879)
The closure of the City of Glasgow Bank (CGB) in October 1878 marked the greatest financial disaster of the Victorian era. The CGB had established itself as one of the largest banks in the United Kingdom in the years preceding its demise. However, following a loss of confidence by providers of wholesale funding in 1878, CGB turned to other Scottish banks and the Bank of England for liquidity assistance. This request for assistance fell upon deaf ears as investigations into the perilous financial position of CGB unearthed fraud and severe mismanagement on a gargantuan scale. In fact, the CGB was the last [and only]? banking collapse where the entire board of directors served time in prison for their fraudulent behaviour.
In June 1878, the reported balance sheet of CGB did not present any cause for alarm with net assets of GBP 1.5m, equal to 13 per cent of assets, and directors issuing a buoyant dividend. There was no concern that CGB would be inadequately capitalised to absorb any losses that might reasonably occur.
Despite this healthy façade, the financial stability of CGB was diseased by a highly-concentrated lending book, with borrowers of far less than salubrious reputation. The media of the day described them as a ‘gang of desperate adventurers’.
The CGB’s credit exposures were reported to be four times its reported equity value in 1878, with further losses on direct investments in Australasia and the US, creating a significant deficit between its exposures and value of collateral held against them.
These liabilities were simply balanced by CGB directors allocating a wild value to their gold assets. A level of mismanagement and leadership on monumental proportions.
Shareholders of CGB had unlimited liability – meaning alongside wiping out the capital value per share, CGB shareholders also had to absorb additional losses. CGB shareholders became legally liable to cover the shortfall between CGB’s assets and liabilities. This resulted in the financial ruin and social suffering of many shareholders, a large percentage of whom were regular working class men and women with small holdings in CGB. Public sympathy led to the establishment of a relief fund – raising GBP 379,670 in donations by 1882.
Such public sympathy was not displayed toward the CGB directors, however. Criminal charges were brought against the CGB directors, general manager and company secretary in October 1878. Custodial sentences were dished out for the fraudulent activity, although the sentences were described by the Economist as ‘inadequate’.
Undoubtedly the collapse of CGB had a profound and lasting effect on the UK financial sector. The CGB episode led to a greater adoption of limited liability of shareholders of UK banks. The merits of this shift are for another debate (unlimited liability and the Global Financial Crisis of 2008 would be an interesting discussion), however it is clear that the CGB contributed to an increased liberalisation, proliferation and adoption of companies incorporating with limited liability.
External audit of banks became increasingly common, with banks moving to reassure shareholders that their balance sheets had the strength and muster to absorb losses – indeed, in 1879 the Banking Act was promulgated, setting out a new legal framework which gave banks an incentive to appoint auditors – in effect, banks wanted to adopt limited liability; and the Banking Act required limited liability banks to be audited. This new legal framework provided banking stability in the U.K. for the next 50 years – not a bad outcome!
By studying the past, it becomes possible to incorporate historical insights into our investment analysis today. The financial world may have a far different landscape and architecture today than it did in the late 19th Century, however we must be cognisant of past crises to help in our analysis of financial risk today. This can only be of benefit, as after all, the underlying causes of financial crises have a habit of repeating themselves. And, thanks to the Library of Mistakes, that awareness can grow and be shared for future reference.
 Button, Richard and Knott, Samuel and Macmanus, Conor and Willison, Matthew, Desperate Adventurers and Men of Straw: The Failure of City of Glasgow Bank and its Enduring Impact on the UK Banking System (March 12, 2015). Bank of England Quarterly Bulletin 2015 Q1. Available at SSRN: https://ssrn.com/abstract=2577723
 Four borrowers accounted for 75% of total loans
 The Times, 31 December 1878