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Colombo to Haldummulla, Sri Lanka's centres of free banking

Jul 01, 2019 18:21 PM GMT+0530 | 1 Comment(s)

FREE BANKING:  An image of a specimen one pound note issued by Bank of Ceylon, a free bank.Source- lakdiva.org/Kavan Ratnatunga

ECONOMYNEXT - Sri Lanka (then Ceylon) had issued currency notes at multiple locations ranging from Colombo and Galle to plantations districts of Haldemulla and Nuwara Eliya, during the free banking era of the island, an expert said.

Under free banking more than one bank could issue notes, which would circulate in parallel. A free bank typically issued notes, with a promise to pay back a specific weight in silver or gold (a convertibility undertaking), depending the metallic standard in use.

Ceylon Free Banking 

By Ordinance Number 23 of 1844, the British colonial administration had allowed private banks in Ceylon to issue currency notes, starting off a free banking period, which ended in 1885 with the setting up of the fully foreign reserve-backed Currency Board with a one-to-one convertibility with the Indian rupee.

This was around the time when the British parliament passed the Bank Charter Act of 1844, which sought to limit money printing by the Bank of England in a bid to end balance of payments troubles, as the arguments of bullionists' finally found favour defeating 'anti-bullionist' Mercantilists.

But it was too late to prevent the British Railway Bubble, analysts say.

"The first private bank to issue notes was the Bank of Ceylon, not the current Bank of Ceylon," explained Kavan Ratnatunga, a retired astrophysicist who is also the Vice-President of the Sri Lanka Numismatic Society, and the Archaeological Society of Sri Lanka.

He was speaking at a monthly lecture of National Trust Sri Lanka, a heritage society with a broad focus.

A free bank was expected to issue specie backed money (gold or silver pegged), but it may also be tempted to issue unbacked money (expand reserve money) without deposits, especially when credit demand grew.

Its paper money would then be 'depreciated' and the rising gold or silver prices would encourage holders to demand gold or silver back according to the convertibility undertaking, as dollar are demanded in the forex market from a dollar pegged central bank now.

Redemption will then shrink reserve money, and boost the value of the paper, bringing stability back.

A modern day state-owned central bank will however print more money through reverse repo and other liquidity facilities, boosting credit beyond deposits raised, to target a policy rate, generating a full blown balance of payments crisis, until rates are finally allowed to go up.

If the private bank could not redeem at the promised rate (convertibility undertaking) it will 'default' and the bank collapsed. Its directors could also face criminal prosecution if not all the deposits, denoted by gold was returned.

A modern government central bank however would default and give a lower amount of dollars for the money it printed (depreciated or devalued), and escape with no accountability, generating large losses to holders of the paper and everyone who held assets denominated in that paper.

Currency Competition

Meanwhile, the first Bank of Ceylon had operated from 1844 to 1849. The Ceylon Government also continued to issue Sterling notes until 1856, in a period of currency competition.

Though Ceylon had officially adopted the Sterling by this time, up to about 1879 the India rupee was also circulating in parallel.

"It was the currency used by most of the people," Ratnatunga said. "Most of the people people were used to rupees than pounds. It had the standard exchange rate of 10 rupees to the pound."

Ratnatunga had located a specimen two sterling pound note issue by the Bank of Ceylon from the British Museum. He also maintains a website on matters of historical interest Lakdiva.org, where images of Sri Lanka's current and also could notes could be viewed.

The undated note had the denomination printed in Sinhala, Tamil and English.

In Sinhalese it said Lanka Mudal Nidanaya, which was used to describe the word treasury, he said. It was issued in Colombo. 

"There was a camel in the logo," Ratnatunga said. "There is a camel in addition to an elephant. May be the people in England did not really what animals to put." 

Paper Money driven BOP Crises 

The first known paper money was issued in Sri Lanka in 1785 in the form of a note called credit brieven, by Dutch Governor Vandergraff, when Britain declared war on Holland as a fallout of the American War of Independence. 

The credit brievens generated one of the earliest known balance of payments troubles, long before the central bank generated repeated monetary instability crises and depreciation by printing large volumes of money from 1951. 

The original credit brievens that were printed were exchangeable at 48 stuivers for each Rix dollar. 

The Governor paid the soldiers with paper, and auctioned the Dutch East India company's metal money. 

"This may be the first step, in lowering the Ceylon Exchange and the depreciation of its currency," wrote Anthony Bertolacci, a civil servant who came with British Governor Frederick North several decades later. 

"The silver ducatoons, which in 1785 had been exchanged for not more than eighty stivers each, were sold, in 1795, at one hundred." 

After the British came more paper Rix Dollars were printed creating even more disruption and hardship

for the people was created, sending prices shooting up. 

Bertolacchi says by 1812, ducatoons were bought at two hundred and eight stivers, or four Rix-dollars and four fanams each. 

Branch Banking 

The Mercantile Bank of India, London and China - Ceylon Branch had started issuing notes from 1857.

Notes were issued under the name of The Chartered Mercantile Bank of India, London and China (after getting a Royal Charter). 

It had issued notes from Colombo, Kandy and Galle branches. 

"Each branch issued its own notes," Ratnatunga said. "It said the note was redeemable either at that brand or the Colombo branch." 

"Its notes were withdrawn in 1884 when all the private bank notes were discontinued," Ratnatunga said.

The Asiatic Banking Corporation, had started in 1864 and ended in 1866. 

"It had an existence of only three years, and it was liquidated," Ratnatunga said. "It is relatively expensive to get one (of its notes) but it is not extremely rare." 

In 1846 the Oriental Bank - Ceylon Branch had started issuing notes. 

"The Oriental Bank was the Bank of Western India which was founded in Mumbai in 1845 and was reconstituted as the Oriental Bank moving its headquarters to London. 

"In 1849 the Oriental Bank took over the failed Bank of Ceylon. That was the end of the Bank of Ceylon, till 1938 when we go the new Bank of Ceylon." 

It first issued sterling notes. 

The bank was given a Royal Charter in 1851 in London as the Oriental Bank Corporation, Ratnatunga said. 

The bank then issued rupees. 

It was a practice at the time to tear a note in half, post it and when the first half was received, post the second half, as a measure against stealing, he said. 

Ratnatunga found notes issued by the Oriental Bank Corporation in Jaffna, Kandy, Badulla, Galle, Nuwara Eliya and Haldummulla. 

"Ten years ago when I went to Haldummulla there wasn't even an ATM (automated teller machine) there. But in the British Era they issued their own currency notes," Ratnatunga said. 

"So it was an important location with tea and coffee estates." 

The Dutch credit brievens were issued in Batticaloa and Trincomalee. 

Currency Board 

In 1884, the Oriental Bank Corporation collapsed when coffee plantations were hit. 

Banking analysts have also said the firm was hit by unhedged exchange rate risk as it had borrowed sterling which was gold and loaned rupees which was silver based. When silver/gold parity changed, it was exposed to exchange rate risk. 

Sri Lanka's central bank was hit by a 14 billion rupee unhedged forex loss in 2018 due to a somewhat similar event. 

"The government took over its liabilities and there was a bill in 1884 that the government would be issuing currency," Ratnatunga said. 

The Ceylon Currency Board started issuing notes from 1885. It issued foreign reserve backed currency which was fully convertible. The Ceylon Currency Board had a fixed exchange target of 1 Indian rupee (which later became gold backed), and interest rates floated. 

In general a currency board will have foreign assets in excess of 100 percent (usually about 115 percent) of the notes in issue to cover of exchange fluctuations or other impairment of reserve assets. 

Under the currency board, Ceylon became financial centre where companies from countries like Malaysia raised capital. 

It is often said that by the time the central bank was set up, Sri Lanka's living standards were only second to that of Japan in Asia. 

The Currency Board did not collapse. But was abolished in 1950 not because it failed but following machinations of the US State Department and Treasury to set up dollar pegged soft-pegs in the post World War II Bretton Woods system, analysts have said. 

"Currency boards have existed in about 70 countries, and none have failed," explains Steve Hanke, a Professor at Johns Hopkins University who had helped set up modern hard pegs. 

"The demise of currency boards resulted from a confluence of three factors. A choir of influential economists was singing the praises of central banking’s flexibility and fine-tuning capacities. 

"In addition to changing intellectual fashions, newly independent states were trying to shake off their ties with former imperial powers. 

Additionally, the International Monetary Fund and the World Bank, anxious to obtain new clients and “jobs for the boys,” lent their weight and money to the establishment of new central banks." 

"In the end, the Bank of England provided the only institutional voice that favored currency boards."  

Malaysia, Singapore, Maldives and Mauritius and Hong Kong, which had not got independence from Britain in the formative years of Bretton Woods, escaped. 

The currency boards of those countries provided a strong foundation for stability and growth. 

The Philippines was badly hit by central banking. South Vietnam was devastated. South Korea however learned fast analysts say, probably helped by its wartime experience under Japan. 

Sri Lanka's rupee collapsed from about 4.70 to the US dollar at the time it was created, to 176 by mid 2019 generating economic crisis after crisis, restricting free trade, capital flows generally de-stabilizing the economy. (Colombo/June30/2019 - Update II)


 

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1 Comments

  1. Lalith July 01, 02:44 AM

    Another reason finance minister JRJ abandoned the currency board was that Ceylon was owed a large sum by Britain which it could not receive as Britain was broke. The sterling area prevented Ceylon monetising these receivables on Wall Street. The 1953 rice riots put paid to fiscal discipline. I doubt Ceylon Politicians could carry a currency board then or now. We just send the bill down to future generations

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