The possibility that Britain’s eighth-largest bank might collapse came as a nasty shock to Northern Rock’s customers until the Bank of England intervened to guarantee its survival.

Yet, a “run on the bank” was familiar to Victorians. In those days there were many more small banks without the resources to cover bad investments. Nothing, however, prepared savers for the news on October 2, 1878, that one of Scotland’s biggest banks had crashed. A hastily scribbled telegram from the head office instructed its branches: “Bank has stopped payments. Close your door at once and pay nothing whatever.” What happened next spurred a fundamental change to banking practice.

The City of Glasgow Bank had appeared a respectable place for sober investors. It had 133 branches and issued its own banknotes. Away from the counting house, many of its directors spent their Sundays immersed in the austere Presbyterian sermonising of the Free Church of Scotland. Its creed did not encourage a bit of a flutter.

But while the directors may have seemed respectable, their management team were far from responsible. Although the bank had more than £7 million in assets, its liabilities exceeded £12 million. Further risk was added by the concentration of a high proportion of lending to a relatively small number of enterprises. Too many eggs were in too few baskets.

With the situation becoming perilous, the management put aside their Free Kirk rectitude and falsified the balance sheets. This provided only a temporary flight from reality. The liquidity crisis that hit Britain’s financial sector in 1878 ensured the City of Glasgow Bank’s ruin. This, in turn, brought down the smaller Caledonian Bank. As angry crowds gathered around the bolted doors of the branches, troops were put on alert.

In the event, it was not the depositors who needed to worry. They eventually got their money back. It was the shareholders who suffered because the City of Glasgow Bank had unlimited liability. As such, 1,819 people were liable for the entire loss. Only 254 emerged solvent.

Although one English bank went under two months later, others were able to survive the liquidity shortage by drawing on the Bank of England’s reserves. Back in Scotland, the Glasgow bank’s directors were put on trial for fraud. They received between eight and eighteen months in prison.

Of more lasting effect, the banking codes were changed. Previously there had been no compulsion for all banks to be independently audited. This was changed. Another important reform was also introduced. Henceforth, banks would not have unlimited shareholder liability. In other words, the ordinary depositors could lose their money instead. And this was all the more reason for the Bank of England to intervene as the lender of last resort.

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