06 March 2009

Why Scottish Banknotes are Riskier

As David Mundell is using a private member's bill in an attempt to give Scottish banknotes the same status at Bank of England notes [1], I thought it might be worth addressing some of the misconceptions surrounding banknotes, especially David Mundell's idea that "A Scottish tenner is as just as good as a Bank of England one."

The crucial difference is that Scottish bank notes are issued by private sector banks, whereas Bank of England notes are issued by the central bank, which puts them on a very different footing.

Scottish bank notes are a historical anomaly. When the Bank of England was given the monopoly on the issuance of Sterling notes, a concession was given to the Scottish banks so that they didn't have to withdraw their notes from circulation. They were allowed to issue notes without specific backing, up to the level of their average circulation for the year up until 1 May 1845, a level which applies to this day. The banks also issue notes well in excess of this level, but the additional notes must be backed 1 for 1 with reserves at the Bank of England, so those notes in effect are as good as Bank of England notes.

According to RBS, out of a total of £1,500m of Scottish notes in circulation, only £3m are issued on the basis of the original concession [2], so it is only a tiny proportion of the total, but none-the-less, it does mean that, in effect, Scottish notes are riskier than Bank of England notes. If one of the note issuing banks were to fail (and not be bailed out by the government), the Bank of England reserves relating to their notes would be less than the total notes issued. Only if that original £3m concession were withdrawn, resulting in all Scottish notes being backed 1 to 1 with Bank of England reserves, would Scottish notes truly be equivalent to Bank of England notes. Until then, part of their value is in effect an IOU from a private organisation and that is something which I don't believe warrants the status of a legally enforceable currency.

I think it's also worth addressing the BBC's comment that:

People who use Scottish notes in England have no legal recourse if they are refused. The only notes that carry the force of law are those issued by the Bank of England.

It's a misrepresentation of the situation, because if shops refuse Bank of England notes, the person trying to spend the money has no legal recourse either. Bank of England notes are legal tender in England, but being legal tender only means that they have to be accepted in settlement of debt. As a shop is only offering goods for sale, there is no pre-existing debt, so legal tender rules are irrelevant; the shop is quite within its rights to demand payment in whatever form it likes, be it Bank of England notes, Scottish notes, Euros, Dollars, gold, Vietnamese Dong or brass buttons.

What makes this proposed law an even more intriguing prospect is that only coins are legal tender in Scotland and Northern Ireland; neither locally issued notes nor Bank of England notes are legal tender, so this law could result in Scottish notes having a higher legal status in England than they have in Scotland!

1. http://news.bbc.co.uk/1/hi/scotland/7926843.stm

2. http://www.rbs.com/about03.asp?id=ABOUT_US/OUR_HERITAGE/OUR_HISTORY/OUR_BANKNOTES/HISTORY_OF_OUR_BANKNOTES

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