GlossaryEnglish cap2

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The Banking System in England

Objectives:

After studying this chapter you should be able to understand:

2.1 The evolution of the Bank of England

The hub of the banking system;

The establishment of the bank;The nationalisation of the bank;

2.2 Functions of the Bank of England

Governments bank;

Bankers' bank;

Lender of last resort;

Carrying out the governments monetary policy;

Control of the currency issue;

2.3 Present - day role of the Bank of England

THE BANKING

SYSTEM

IN ENGLAND


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2.1 The evolution of the Bank of England

The hub of the banking system

In every country where there is a developed banking system, the main bank,

the hub of the system, is the Central Bank.

In the United Kingdom, the central bank is the Bank of England, which was

established in 1694.

Most of the central banks functions are quite different from those of the

commercial and other banks and, being the Governments bank and the

bankers bank, it has a controlling influence over all the other banks as a

whole.

The history of the Bank is naturally one of interest, but also of continuing

relevance to the Bank today. Events and circumstances over the past threehundred or so years have shaped and influenced the role and responsibilities

of the Bank. They have moulded the culture and traditions, as well as the

expertise, of the Bank, which are relevant to its reputation and effectiveness

as a central bank in the early years of the 21st century. At the same time,

much of the history of the Bank runs parallel to the economic and financial

history, and often the political history in a broader sense, of the United

Kingdom.

In the 19th

Century the Bank took on the role of lender of last resort,

providing stability during several financial crises.

World War I: 1914 - 1918 - During World War I the National Debt jumped

to 7 billion. The Bank helped manage Government borrowings and resist

inflationary pressures.

Gold - In 1931 the United Kingdom left the gold standard; its gold and

foreign exchange reserves were transferred to the Treasury. But their

management was still handled by the Bank and this remains the case today.


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This meant that it could have a large number of shareholders and was not

restricted to being a partnership, as were the other banks.

From the beginning, the Bank of England accepted money on deposit,

issued its own notes and made loans in the same way that the other banks

did and was able to increase its business more rapidly than them.

Because many banks had to close their doors, confidence in the banking

system and in the system of credit creation was greatly affected, and

legislation was introduced, especially, to encourage the establishment oflarger banking units on the one hand and to control the note issue on the

other.

Its law2, had three provisions:

a) To divide the Bank of England into two separate departments, the

Banking Department and the Issue Department.

b) To permit the Bank to make a fiduciary issue of 14 million of notes to

be backed by Government securities.

c) Ultimately to centralise the note issue in the hands of the Bank of

England by gradually extinguishing private note issues as the private

banks became bankrupt or amalgamated with other banks.

Thus, the Bank of England gradually assumed responsibility for the

currency supply and as the holder of the countrys gold reserves, apart from

the relatively small fiduciary issue, it had to hold gold as backing for the

note issue.

The Bank of England started in 1694 as a commercial bank and then in the

second half of the nineteenth century gradually stopped competing with theother banks and concentrated on its new role as the first central bank in the

world.

Nationalisation of the Bank of England


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Operational independence May 1997

In May 1997 the Government gave the Bank responsibility for settinginterest rates to meet the Government's stated inflation target.

Managing the modern bank

The 1998 Bank of England Act made changes to the Bank's governing body

too. The Court of Directors, as it's known, is now made up of the Bank's

Governor and 2 Deputy Governors, and 16 Non-Executive Directors.Channels of communication.

There are regular channels of communication between the Bank of England

and the other financial institutions in London, and through these, it is able to

discuss problems as they arise and seek compliance with its wishes. These

channels include the two Committees of the London Clearing Bankers, the

Accepting Houses Association, the Discount Market Association, theFinance Houses Association and a number of other groups representing

financial institutions.

The Bank today

The Bank of England is the central bank of the United Kingdom. Sometimes

known as the 'Old Lady' of Thread needle Street, the Bank was founded in

1694, nationalised in 1946, and gained operational independence in 1997.Standing at the centre of the UK's financial system, the Bank is committed

to promoting and maintaining a stable and efficient monetary and financial

framework as its contribution to a healthy economy.

The Bank's roles and functions have evolved and changed over its three

hundred-year history. Since its foundation, it has been the Government's

banker and, since the late 18th century, it has been banker to the bankingsystem more generally - the bankers' bank. As well as providing banking

services to its customers, the Bank of England manages the UK's foreign

exchange and gold reserves and the Government's stock register.


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potential threats to financial stability. It also undertakes work on the

arrangements for handling financial crises should they occur, and is the

financial system's 'lender of last resort' in exceptional circumstances. In this

task, the Bank co-operates closely with the Treasury and the Financial

Services Authority, the regulator of banks and other financial institutions in

the United Kingdom.

Much of the Bank's work involves liaison and co-operation with the

Government institutions and other central banks. Given London's position as

a large international financial centre, the Bank's work addressesinternational as well as domestic developments. The Bank participates in

many international forums involved in promoting the health of the world

economy and global financial system.

The Bank also works to ensure that the UK financial system provides

effective support to the rest of the UK economy and that the UK remains an

attractive location for the conduct of international financial business. Thisinvolves work on issues such as firms' access to finance and, over recent

years, the introduction of the Euro and the evolution of the Euro financial

markets and infrastructure.

2.2 Functions of the Bank of England

The main functions3of the Bank of England are:

The Governments bank

The Bank of England is responsible for running accounts for all of the

Government Departments and it has been the Banks general policy not to

maintain accounts for individuals and firms in the private sector (the non-

Government sector of the community).

The bankers bank

By maintaining accounts with the Bank of England, the other banks are able

to settle transactions with one another and with the institutions in the public

sector, and also to maintain current account balances, which form part of

their liquid reserves


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Lender of last resort

If the London Money Market is short of funds, the Bank of England mustalways come to its aid, through it will do so at its own price, i.e. it will

determine the rate of interest at which it is prepared to lend.

The Bank may choose to give either direct or indirect assistance in the

market or may force the Discount Houses to borrow at the Bank of

Englands Minimum Lending Rate for a period of seven days.

If the Bank decides to give direct assistance it will buy bills or Governmentstocks from the Discount Houses.

Indirect assistance to the Discount Houses occurs when the Bank of

England buys the bills or stocks from the banks and thus enables them to

increase their lending to the Discount Houses.

Carrying out the Governments monetary policy

The Bank of England is the principal agent for the Government in pursuing

its monetary policy. Not only is it responsible for the fiduciary issue, but

also through its control and influence over the banks and other financial

institutions, it is able to restrain or increase the total money supply.

The main devices used by the Bank in carrying out the monetary policy are:

a) Varying its minimum rate of interest;

b) Open Market operations;

c) Special Deposits;

d) Adjustments to the reserve ratios of the banks and other financial

institutions;

e) Directives to the Banks.

A) The minimum rate of interest.Since the early nineteenth century the

Bank of England has been able to influence the level of interest rates in

the money market by changing the minimum rate of interest at which it

is willing to lend Until recently this minimum rate was known as Bank


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interest rates are reduced then borrowing becomes more worthwhile and

this stimulates the creation of new deposits.

B) Open Market operations. These amounts to the deliberate selling or

buying of Treasury bills and Government stocks in order to mop up

excess purchasing power on the one hand, or to increase purchasing

power on the other. By selling securities in the open market the

Government receives payment for them by cheques drawn by

individuals, firms and institutions in the private sector.

These cheques reduce the level of bank deposits and, as the deposits form

the major part of the money supply, the latter is reduced. Conversely, if the

Government buys securities cheques drawn on the Bank of England pay for

its purchases, and these are paid in as deposits with the commercial banking

system, thus increasing the money supply.

When the Government sells securities and bank deposits are reduced, so are

the cash holdings of the banks. They thus find it difficult to maintain their

cash and liquidity ratios and may have to reduce their lending by way of

loans and overdrafts, which will reduce bank deposits still further. Open

Market operations can therefore be very effective in reducing the

availability of credit to the community.

C) Special Deposits. Since 1960 the Bank of England has used the device

of Special Deposits in order to reduce the ability of the banks to lend byway of loans and overdrafts. A call for Special Deposits takes the form

of a directive to the banks and some other financial institutions to pay

over a set proportion of their eligible liabilities in cash, to be frozen as

deposits with the Bank of England until such time as the bank decides to

repay them. A call for, say, 2 per cent Special Deposits may cause the

banks to reduce their less liquid assets in order to maintain their reserveratios. When Special Deposits are repaid they have the opposite effect

upon the liquidity of the banks, and upon their ability to create new

deposits.

D) Reserve ratios - Since the 70s, all banking institutions have had to keep,


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E) Control of the currency issue - In conjunction with the Treasury, the

Bank of England determines the size of the fiduciary issue and is

responsible for the coinage. The note issue must be increased to meetseasonal demands, e.g. at Christmas and during the summer holiday

period.

2.3 Present - day role of The Bank of England

The Bank of England is the national bank and central bank for Great Britain.

In these capacities the Bank has the functions described:1. Banker to Government;

2. Sole note issuing bank in England and Wales;

3. It is the bankers bank;

4. Lender of last resort to the London money market;

5.

Administers Government monetary policy;

6. Supervises other banks and associated financial institutions;

7. Management of the national Debt.

The Bank is organised into three main operational areas - Monetary

Analysis and Statistics, Financial Market Operations and Financial Stability,

supported by a Central Services area. This structure was introduced in June1998 to reflect the Bank's new responsibilities in the light of the 1998 Bank

of England Act. In addition, the Co-ordination Unit for Europe is

responsible for co-ordinating the Bank's work on Europe, specifically in

relation to the Euro. The Centre for Central Banking Studies offers teaching

and technical assistance to other Central Banks and the Printing Works is

responsible for the printing of all Banks of England banknotes.

Monetary Analysis and Statistics

This area is made up of the following Divisions:

International Economic Analysis


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the financial markets and for analysing the balance sheet implications of

those operations.

The Registrar's Department provides the principal stock registration service

for the Government and an execution-only postal brokerage service for

retail gilt investors.

Financial Stability


Domestic Finance

Financial Intermediaries

International Finance

Market Infrastructure

Regulatory Policy

The Financial Stability divisions have the main responsibility for

discharging the Banks remittal to maintain the stability of the financial

system as a whole. The Financial Stability Committee acts as a focus for the

Bank's work in this area. The Governor chairs the Committee.

The work of the Financial Stability divisions covers both UK and overseas

financial systems and markets, and the functioning of the internationalfinancial system. The divisions identify, analyse and carry out research into

developments relevant to the structure and functioning of the financial

system domestically and internationally, make policy proposals and

encourage changes designed to increase its safety and effectiveness.

The divisions also contribute to the monetary policy process, for example

through the Bank's Deputy Governor for Financial Stability as a member ofthe Monetary Policy Committee. The divisions' analysis is used to promote

public understanding of issues in financial stability through, for instance, the

regular Financial Stability Review.

Co-ordination Unit for Europe


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ordinates the Bank's involvement in the main official and private sector

Euro for; and provides a body of expertise on the European Central Bank.

Working with the Agents, it also monitors the use of the Euro in the UK.

Central Services


Personnel

Secretary's Department

Legal Unit

Finance and Resource Planning

Investment Unit

Management Services

Property Services and Security

The Central Services divisions encompass a range of support functions that

underpin the Bank's activities and help to ensure that the Bank's reputation

is maintained. These include finance, IT, personnel, the Governors' private

offices, and media and public relations, legal and information services.

Printing Works

The Bank of England Printing Works is located on a purposely-built high

security site in Debden, Essex. It employs over 450 people and is

responsible for the printing of over 1 billion notes annually, together with

the manufacture of its own inks, printing plates and threads. In addition thePrinting Works provides technical and specialised security advice to a

number of central banks worldwide.

The notes are produced in a highly developed printing process which

combines high technology and quality craftsmanship, making the Bank one


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Audit

Internal Audit is an independent function authorised by the Court ofDirectors to review the adequacy of the internal control systems within the

Bank and to test compliance with agreed procedures. It aims to provide an

independent view for senior management, to assist in the effective discharge

of their responsibilities and to provide a service to the organisation as a

whole.

Centre for Central Banking Studies

The Bank of England's Centre for Central Banking Studies offers technical

assistance, courses, workshops, seminars and comparative research on and

for central banks throughout the world. Its primary aims are to foster

monetary and financial stability worldwide, to promote the Bank's core

activities, and to provide opportunities for Bank of England staff to obtain

broader perspectives on their own areas of expertise. Its goal is to be

recognised internationally as a leading centre of intellectual excellence for

the study of practical central banking.

Governance of the Bank

The Bank of England Act 1998 provides for the appointment by the Crown

of the Governor, two Deputy Governors and 16 Non-Executive Directors of

the Bank who collectively make up what is know as the Court of Directors.The Governor and Deputy Governors are appointed for five years and the

Directors for three years.

Under the Act, the responsibilities of Court are to manage the Bank's affairs

other than the formulation of monetary policy, which is the responsibility of

the Monetary Policy Committee. This includes determining the Bank's

objectives and strategy, and aiming to ensure the effective discharge of theBank's functions and the most effective use of the Bank's resources.

The Monetary Policy Committee

The Act establishes the Monetary Policy Committee as a Committee of the


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The functions of the Audit Committee are to:

Keep under review the internal financial controls in the Bank. Receive reports from, and review the work of, the internal and

external auditors.

The Committee also considers and makes recommendations on the

appointment of the external auditors, and their fees, reviews the

annual financial statements prior to their submission to Court,

including consideration of the appropriateness of the accountingpolicies and procedures adopted. The Committee reports its

conclusions to Court.

Management structure

Under the Court of Directors, the Bank's senior policy-making body is the

Governor's Committee, comprising the Governors and Executive Directors.

The internal management of the Bank is the responsibility of theManagement Committee, comprising the Deputy Governor (Financial

Stability), the Deputy Directors, the Finance Director and the Director of

Personnel.

2.4 Banking today

The banking sector in the United Kingdom has traditionally been highlysegmented. In its February issue of the Bank of England Quarterly Bulletin

every year the Bank of England lists all those banking institutions to which

it has granted a licence to operate as a bank in the United Kingdom. The list

(of over 450) is divided into seven sections, distinguished sometimes by

function and sometimes by nationality of ownership. As regards functions,

the major distinctions are between retail banks, British merchant banks,

other British banksand discount houses.

The first group provides deposit and loan facilities to the household or

personal sector, together with small and un-incorporated businesses. The

retail banks own the various payment mechanisms, and money transfer is a

j f il b k i I h h ff d


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on alternative forms of finance, advising on risk management strategies,

handling new securities issues and accepting bills issued by firms.

Other British banks are banks, which offer a range of banking services, but

usually limited in some way. Although they may be subsidiaries of retail

banks, they do not usually deal directly with the retail sector.

Discount houses perform a highly specialized and unique role in the UK

financial system. They deal almost exclusively with other banks and with

the Bank of England. They accept surplus funds on a very short-term, oftenon an overnight basis, from banks and use the funds to buy and hold

treasury and commercial bills. They thus provide the first source of liquid

assets to the rest of the banking sector, so that any shortage or surplus funds

are immediately reflected in discount houses ability to buy bills, or need to

sell them.

At the centre of Britains banking and financial structure is the Bank ofEngland (see Annex no. 1).

The commercial banks, sometimes referred to as the high street banks

or the clearing banks, are large public limited companies having many

shareholders throughout Britain and in some cases in countries outside

Britain.

These banks operate through a network of branches covering the wholeEngland and Wales. All commercial banks are profit-seeking companies and

in order to earn money they provide various services to their clients.

Another major group of banks is that of merchant bankssometimes called

accepting houses or issuing houses. These banks are placed in the

City of London, though some have branch offices in other cities and also

some have offices in important overseas financial centres. The activitiesthese banks perform are very diversified including trading activities,

accepting financial commitments in exchange for a commission fee,

company financial advice.


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Building societies. A building society, like other financial institutions,

borrows money and lends it out at higher rates of interest than it pays for it.

It accepts funds in the form of shares and deposits. Shareholders actuallyparticipate in the affairs of the societies as much that in the event of

financial difficulties the power to return their share capital would be

restricted whereas depositors are creditors and, as such, have a prior claim

over the shareholders in the event of liquidation. The rate of interest on

deposits is usually per cent below that on shares and as there is

comparatively little difference in practice in the ability to withdraw fairlysizeable sums on demand, the majority of money is on share account to

attract the higher rate of interest. The shareholders are the owners of the

societies but they are paid interest as mentioned above, not dividends. The

societies are in effect mutual societies in as much many of the shareholders

are also borrowers on mortgage.

Commercial banks

Types of deposits. In a similar way to the savings banks, the commercial

banks accept deposits from their customers, but unlike the savings banks,

the majority of the total sum deposited with them is from industrial and

commercial depositors. This does not mean that the commercial banks have

few private customers, but sums of money involved are much greater for

firms than for individuals.

Commercial banks offer two main types of account to depositors: current

accounts and deposit accounts. Current accountholders receive no interest

on their accounts, but they can draw cheques on them and use the credit giro

service, and they can withdraw some or all of their balances on demand.

Deposit account holders, on the other hand, do receive interest on their

accounts but do not normally draw cheques on the accounts or use the credit

giro system for paying in credits, and technically, they are required to giveseven days notice of their intention to make withdrawals from their

accounts.

Present - day commercial banks offer a wide range of services from those

s itable for indi id al c stomers ho ha e modest e pectations and


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1) When was the Bank of England established?

2) What were the provisions of the Bank Charter Act 1844?

3) Was the Bank of England always a Central Bank?

4) When was the Bank of England nationalised?

5)

What are the channels of communication between the Bank of Englandand the other financial institutions?

6) List of functions of Bank of England.

7) What is meant by the term Lender of Last Resort?

8) Define (a) Direct and (b) Indirect assistance to the Discount

Houses.9) Which tools can the Bank of England use in carrying out the

Governments monetary policy?

10)Define Open Market Operations.

11)What are Special Deposits?

12)

What is the minimum reserve ratio?13)What does savings mean?

14)In what ways does an individual save?

15) What are National Savings?

Progress test


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ANNEX N

BUILDING

SOCIETIESMERCHANT BANKS

COMMERCIAL

BANKS

Members of Building

Societies Association

Examples: Halifax,

Abbey NationalNationwide, Provincial

Members of Accepting

Houses Committee

Examples: Rothschid's,

Hambros, BaringBrothers.

Barclays, Lloyds,

Midland, National

Westminster

Wiliams and Glyn'sand Scottish banks

NATIONALIZED

BANKS

National Savings Bank

and National Girobank

THE BANK OF

ENGLAND

Members of Finance

Houses Association.

Examples: Forward

Trust, UDT,Mercantile Credit.

FINANCE

COMPANIES

Co-operative Bank and

Trustee Savings Bank

Bank of Japan, Bank of

America, Royal Bank of

Canada, and around 300other foreign bank offices

Grindlays Bank,

Standard and

Chartered Bank etc.

MUTUAL BANKSBRIT. OFFICES FOR

FRGN. BANKS

BRITSH BASED

OVERSEAS

BANKS

Types of financial organizations in Britain


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ANNEX No 2

General

management

team at

Head Office

Domestic International

Merchant and

wholesale

banking

Installment

credit services

Related financial

services

Bank branches

throughout

Britain including

any subsidiary

bank companies

Includes any

overseas branches

or subsidiary

foreign banks

owned by the

British clearing

bank

Specialized bank

companies

created to be able

to operate in this

highly specialized

area

Most banks now

own a finance

company which

will offer both

personal and

company finance

arrangements

Banks are now active

in such areas as:

insurance services

unit trust sales

computer services

executor & trustee

appointments

The broad areas of operations in a modern banking group

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