Innovations and the Note Exchange System
One major benefit of competitive markets is that they are generally considered to foster innovation by firms trying to gain market share. The firms involved in Scottish banking were no exception. Many of the new techniques and products introduced during that time are still in use today, albeit typically in an altered form more suitable for today's markets.The first major innovation to come out of the Scottish system was probably also its most important. As mentioned earlier, when the Royal Bank opened it started a competitive war with the Bank of Scotland by turning its notes in for redemption in large quantities, and the Bank of Scotland responded by doing the same. In 1751, both banks realized that they could peaceably coexist and decided to accept one another's currency. In fact, their own self-interest brought about stability to the system. Creating an agreement to accept the other bank's notes improves each bank's own note demand. However, they still did not desire to keep each other's notes for very long. Keeping that in mind, they made frequent trips redeem them. This had a major effect on the systems stability. Knowing that its notes would be brought back for redemption with regularity, the banks had to keep sufficient reserves on hand.
In 1768, Aberdeen and Perth United set up their own exchange. They did so in response to merchants that did business between both cities. The effect was a boost to the banks and to the system itself. As a result of the exchange possibility between the cities, the notes increased in negotiability, which increased the public's demand for those notes. Also, public demand for notes over specie increased.
These exchanges eventually became a single exchange conducted weekly in Edinburgh. Membership "became recognized as a valuable brand-name asset" (White, pg. 31) and was not extended to every bank. Banks desiring membership had to meet the requirements of the member banks, which included being financially sound and gaining their trust. Therefore, banks involved in the exchange had a much higher demand for their notes than excluded banks. In Edinburgh, agents for the banks would meet and determine the net exchanges between banks. Because exchanging the full amounts in specie had long before become too cumbersome and was functionally unimportant, only the differences were exchanged in either a bill of accommodation negotiable in London or specie. This system can be considered the first banking clearinghouse. Today, multiple clearinghouses are set up to exchange checks and other financial instruments between banks.
Another significant innovation came from the Royal Bank in 1728. They set up a new product called a cash credit account, which can be thought of as what is today known as a line of credit. The bank would extend a line of credit to an individual that could be utilized in part or in whole during a future time period. Interest was only charged on the balance outstanding. In order to qualify, the individual would have to prove trustworthiness and provide two cosigners. The Bank of Scotland followed suite and began offering credit accounts the next year. This became a valuable tool for Scotland's growing commerce and manufacturing industries.
In 1707, the Bank of Scotland offered the first interest-paying deposits to try and attract English depositors. However, they were not made readily available until 1729, when the bank was under more competition for deposits during its liquidity war with the newly-formed Royal Bank. While the interest payments became common, there were no signs of aggressive rate wars. Furthermore, there is no record of price collusion regarding interest rates between banks.
The next significant innovation during Scottish Banking was the first modern bank draft, which worked much like a cashier's check does today. Sending notes through the mail left much to be desired. Many times the notes were stolen. In 1748, the Royal Bank started offering a bank draft, which was only issued in the set amount of 25 pounds. However, due to the obviously limited usefulness by the constraint on the amount the draft was redesigned in 1753 to allow for it to be issued in any amount over 10 pounds. This draft became another important tool in the proliferation of trade and commerce in Scotland.
Be Sure to Continue to Page 6 of "A Brief History and Analysis of Scottish Free Banking, 1716-1845".
