IT was in this week in 1728 that an Edinburgh merchant, William Hog or Hogg, asked his bank to allow him to take more money from his account than was in it. The Royal Bank of Scotland agreed, and thus the world’s first overdraft was arranged.

It now seems very commonplace, but back then a £1000 cash credit – equivalent to about £120,000 today – was revolutionary, and as I shall show, Hog’s prototype overdraft was one of the most important financial transactions in Scottish history.

There had been several developments that allowed the fledgling Royal Bank to grant Hog his advance. The Bank of Scotland had been founded in 1695 with a charter established by an Act of the Scottish Parliament, with operations beginning in February 1696. The Act gave the Bank a monopoly on public banking for 21 years, and the terms of its charter were quite specific – it was to support Scottish business and, unlike the Bank of England co-founded a year earlier by a Scot, William Paterson, it was not to lend money to the government of Scotland.

Paterson was the man behind the ill-fated Darien Scheme whose collapse threatened to bankrupt many Scots and which saw leading figures agitate for union with England which was also promoted by Queen Anne.

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The Act of Union of 1707 saw the pound sterling become the currency of the new state of the United Kingdom, and the Scots pound was replaced, with that currency pegged to sterling at the rate of 12 Scots pounds to one pound sterling. The “compensation” which bribed the parcel of rogues to vote for the Union was called the Equivalent, and the Society of the Subscribed Equivalent Debt was set up to protect the Equivalents. It became the Equivalent Company in 1724, and its pro-Union directors then asked Parliament and King George I for permission to become a bank.

After the Union, the Bank of Scotland was suspected by the Hanoverian government of having Jacobite sympathies so permission and royal approval was duly given for the Equivalent Company to become the Royal Bank of Scotland (RBS) in direct competition with the Bank of Scotland, both headquartered in Edinburgh.

RBS received a huge influx of cash investment before it started – and under its first Governor, the very pro-Union Archibald Campbell, the Earl of Ilay and later the Third Duke of Argyll. From its outset in 1727 the bank was able to make risky investments and promoted itself as a bank for entrepreneurs.

Enter William Hog. Little is known about him except that he was a merchant with a premises in the High Street of Edinburgh and was both a buyer and a seller of goods.

At that time the only way to borrow money was to do so with a loan repaid over a fixed period. He was successful in business and well known in the capital, and so when Hog approached the bank for help to resolve his main problem – simply put, he wanted a flexible way of borrowing – its board of directors, sitting on all that shareholders’ cash, were happy to discuss ways to help.

They could see that Hog had what we would now call a temporary liquidity problem and they knew that he was good for plenty of income over the long term. No one knows exactly who proposed the idea of cash credit, but the minutes of the meeting of the board of directors in May, 1728, record that a special arrangement had been made for Hog to be allowed to overdraw as much as £1000 more than he had in his account. The word overdraft appears in those minutes, and though we don’t know what Hog actually did with it, we do know that the world’s first overdraft was a success.

We know that because having invented this new flexible system of borrowing, RBS promoted it to their customers, most if not all of whom were known to the bank – relationship banking as it would be called today.

As the RBS official history explains: “In 1728, the Royal Bank of Scotland was uniquely well-placed to begin offering this new facility. Unlike its older rival Bank of Scotland, it was only a year old, and therefore held in its coffers large quantities of shareholder money that it had not yet had a chance to invest. Cash credits were a good way to get that money out into the community, helping customers while earning interest for the bank.

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“The new service was helpful for existing businessmen, but indispensable for those wishing to start up new enterprises. Conventional loans had to be backed by some kind of security, but the new cash credits required only the bond of the applicant and two or more men who were prepared to vouch for him. In the small business community of 1720s Edinburgh, it was easy enough for the bank to know who it was dealing with, and the risk of the applicant and his guarantors all letting down the bank was fairly small.”

RBS had gained an advantage over the Bank of Scotland, but they remained fiercely competitive for decades and soon many other banks were following the innovation of RBS. Scotland benefited because many new businesses, particularly manufacturers and international traders, were able to start with cash credits from their banker, and when the Industrial Revolution came along, the idea of flexible cash advances was absolutely crucial in financing new enterprises.

In his famous essay On Money, the Scottish Enlightenment philosopher David Hume set aside his usual distrust of banks to write about overdrafts: “There was an invention of this kind, which was fallen upon some years ago by the banks of Edinburgh; and which, as it is one of the most ingenious ideas that has been executed in commerce, has also been thought advantageous to Scotland.”

Next time you use your overdraft, you might wish to reflect that it was a Scottish invention.