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* 150 years ago, Overend Gurney, the largest discount house in the City of London, suspended payment. The Times immediately christened this date 'Black Friday' due to the financial panic that ensued. The failure of Overend Gurney was caused by a change of business model, whereby it entered the lending business but with poor lending practices and insufficient risk management.
* The Bank of England, a private bank at the time, refused assistance to Overend Gurney but supported the refinancing of viable banks and brokers by depleting its own reserves. Over a ten-day period, the bill discount rate (the Bank Rate of the time) was increased four times to 10%. Financial stability returned in the following months.
* This lending by the Bank of England led to valuable debates around optimal central bank lending and limited liability and inspired Walter Bagehot's principles for lender of last resort. There are several lessons which remain relevant today.
Overview
The failure of Overend Gurney -a discount house which had been larger than its three next largest competitors combined - sent shockwaves through the financial system in May 1866. The seeds of its demise had been sown many years earlier. Despite its profitable bill broking business, Overend Gurney had been on the brink of failure for some time, incurring enormous losses from the bad loans it had extended with little credit risk assessment, in 1865 in an attempt to salvage Overend Gurney, its partners had converted the broker to a limited liability company. But ultimately, the combination of more generalised economic instability, some unfortunate rumours and a court case which ruled they could not collect from a debtor pushed Overend Gurney into failure.
On 9 May 1866, Overend Gurney asked the Bank of England for assistance, which was refused on the basis of the broker's insolvency; Overend Gurney suspended payments at 15.30 on 10 May 1866.
To mitigate the panic that followed the Bank of England, a private bank at the time, extended the largest market-wide lending it had ever done and drew heavily on its own reserves. Bagehot praised the Bank for accepting its lender of last resort role, setting an expectation that the Bank would act in the same fashion in similar circumstances in the future....