CHAPTER 11 Banking Industry: Structure and Competition 255 The Free Banking Act was passed in Canada in 1850, with the purpose of facilitating the entry of small unit banks along American lines It allowed the establishment of a bank, without a legislative charter, by any group that met the lax requirements set out in the free banking legislation Under this legislation, the minimum amount of net worth to organize a bank was $100 000, branching was not allowed, and although the banknotes of the free banks were untaxed, the amount of note issue was limited to the amount of government debt held by the banks The move to free banking was a step in the right direction, but Canada s experience with free banking was a failure It did not lead to the establishment of a large number of new banks; only five new banks were established, two of which soon failed, and the other three converted to legislative charters The restriction on branching and the issue of banknotes based on government debt, rather than on commercial loans, were blamed for the failure of Canada s free banking experiment The most important factor, however, was the fact that the option of a legislative charter was still available, unlike the situation in the United States where the provision of a legislative charter was simultaneously abolished in those states where free banking was established In Canada, free banking with its restrictive provisions, particularly the restriction on branches and the less-liberal provision for note issue, proved to be less profitable than banking under legislative charters In 1850, there were fifteen chartered banks in Canada; eight in Central Canada and seven in what was to become Atlantic Canada From 1850 until Confederation in 1867, and except for a short period after 1857, the Canadian provinces experienced an economic expansion and thirty new banks were established However, eleven of these failed or closed their doors for other reasons, leaving thirty-four chartered banks with a total of 127 branches at the end of 1867 The Provincial Notes Act, 1866 In the years before Confederation, governments were anxious about the chartered banks control of the note issue They believed that the best way to protect the public from some of the consequences of bank failures would be to separate the currency of the country from the banking interests In 1860, Alexander Galt, finance minister of the Province of Canada, proposed the substitution of a government-issued paper currency for banknotes His proposal, however, was defeated by his critics, especially the chartered banks, for obvious reasons; the substitution of interest-free government debt for interest-free bank debt would have directly reduced their profits In the midst of a minor financial crisis in 1866, with the collapse of the Bank of Upper Canada (Canada s first chartered bank failure), the proponents of governmentissued paper money finally achieved their objective with the enactment of the Provincial Notes Act The Act authorized the issue of provincial notes, which because of their legal reserve status could be substituted for specie With the cooperation of the Bank of Montreal, which had become the government s fiscal agent in 1864 by replacing the Bank of Upper Canada, the banks began to hold the new currency, thereby surrendering their power to issue notes The Dominion Notes Act, 1870 Canada was created by the Constitution (formerly the British North America Act) in 1867 The Act granted the new federal government of Canada exclusive jurisdiction over all matters pertaining to currency and banking, and the first problem to be tackled was the issue of paper money With the failure in 1867 of the Chartered Bank of Canada (the second chartered bank failure in Canadian history), the Dominion Notes Act was passed in 1870 The Act confirmed the rights of banks to issue banknotes on their own credit, but restricted to large-denomination (over