Course 3

The Banking System in England

1 The evolution of the Bank of England
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 bank’s functions are quite different from those of the commercial and
other banks’ and, being the Government’s 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 three hundred or so years have shaped
and influenced the role and responsibilities of the Bank. They have molded 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
 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.
The establishment of the Bank of England
The Bank of England was established with the very privileged position of being the first joint-
stock banking company. 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 of larger banking units on the one hand
and to control the note issue on the other.
The Bank of England gradually assumed responsibility for the currency supply and as the
holder of the country’s 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 the other banks and concentrated on its
new role as the first central bank in the world.
Nationalization of the Bank of England
The Bank was nationalized in 1946, when the conduct of the Bank was placed in the hands of
a Court of Directors headed by the Governor of the Bank of England. The Crown appoints the
Directors and the Governor and senior officer’s work in close liaison with the Treasury.
In May 1997 the Government gave the Bank responsibility for setting interest rates to meet
the Government's stated inflation target.
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.
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, the Finance 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, nationalized 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 banking system 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.
Interest rates decisions are taken by the Bank's Monetary Policy Committee. The Monetary
Policy Committee has to judge what interest rate is necessary to meet a target for overall
inflation in the economy.
The Bank is also responsible for maintaining stability in the financial system - a healthy
financial system is vital to the proper functioning of the economy. The Bank analyses and
promotes initiatives to strengthen the financial system, and monitors financial developments
in trying to identify The Banking System in England 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.
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. This involves 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 Functions of the Bank of England
The main functions of the Bank of England are:
a) The Government’s bank
The Bank of England is responsible for running accounts for all of the Government
Departments and it has been the Bank’s general policy not to maintain accounts for
individuals and firms in the private sector (the non- Government sector of the community).
b) 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.
c) Lender of last resort
If the London Money Market is short of funds, the Bank of England must always 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 England’s Minimum
Lending Rate for a period of seven days. If the Bank decides to give direct assistance it will
buy bills or Government stocks 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.
d) Carrying out the Government’s 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 Rate and changes in it had strong psychological effects upon not only the
money market but upon the community as a whole. A reduction in the Bank Rate was
regarded as signal that restraints upon economic expansion were to be relaxed whereas a rise
in Bank Rate heralded a period of credit restriction. If interest rates are raised then borrowing
is discouraged and thus the credit creation process is slowed down. If interest rates are
reduced then borrowing becomes more worthwhile and this stimulates the creation of new
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 by way 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 reserve ratios. 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, day by day, a
minimum of 12 per cent of eligible liabilities in the form of eligible reserve assets. These
assets are mainly those whose supply can be regulated by the Authorities and comprise
balances with the Bank of England commercial bills, call money with the London Money
Market, Treasury bills, Government stocks with less than a year to maturity, local authority
bills and company tax certificates.
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 meet seasonal demands, e.g. at Christmas and during the summer holiday
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 organized 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 June 1998 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-coordinating 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
Monetary Analysis and Statistics
This area is made up of the following Divisions:
International Economic Analysis
Structural Economic Analysis
Monetary Instruments and Markets
Monetary Assessment and Strategy
Conjectural Assessment and Projections
Monetary and Financial Statistics Regional Agencies.
The Banking System in England
The Monetary Analysis divisions are responsible for providing the Bank with the economic
analysis it needs to discharge its monetary policy responsibilities. Its economists conduct
research and analysis of current and prospective developments in the UK and international
The Monetary and Financial Statistics Division compiles, publishes and briefs on financial
statistics; in particular the monetary aggregates and banking statistics. Special studies directed
at international harmonization and improvements to the statistics are also a feature of their
Financial Market Operations
This area is made up of the following Divisions:
Gilt-Edged and Money Markets
Foreign Exchange
Banking Services
Market Services
Risk Analysis and Monitoring
Registrar's Department
The Market Operations divisions - Gilt-Edged and Money Markets and Foreign Exchange -
plan and conduct the Bank's operations in the core financial markets, in particular the money
market in order to establish short-term interest rates at the level required by monetary policy.
They also manage the UK's foreign exchange and gold reserves. They contribute market
analysis and intelligence to the Monetary Policy Committee and the Financial Stability
Committee from their operational presence in the markets and, in line with the Bank's core
purpose; they seek to promote efficient structures in these markets.
The Banking and Market Services divisions provide banking services to the Government and
other customers, principally banks and other central banks. They manage the note issue. They
also play a key role in the provision of safe and efficient payment and settlement services for
the UK markets and for the country as a whole.
The Risk Analysis and Monitoring division is responsible for integrating management
information on the risks arising from the Bank's operation in the financial markets and for
analyzing the balance sheet implications of those operations.
Financial Stability
This area is made up of the following Divisions:
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
The work of the Financial Stability divisions covers both UK and overseas financial systems
and markets, and the functioning of the international financial system. The divisions identify,
analyze 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' 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
The Co-ordination Unit for Europe is responsible for co-coordinating the Bank's work on
Europe, specifically in relation to the Euro. It monitors the evolution of the Euro financial
markets and supporting infrastructure; and provides information on this (and other Euro-
related matters) in the biannual Practical Issues report.
It monitors the use of the Euro in the UK.
Central Services
This area is made up of the following Divisions:
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 the Printing Works provides technical and specialized 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 of the most cost effective note
producers world-wide.
Internal Audit is an independent function authorized by the Court of Directors 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 organization as a
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 recognized
internationally as a leading centre of intellectual excellence for the study of practical central
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 known 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 the Bank's functions and the most effective use of the Bank's
The Monetary Policy Committee
The Act establishes the Monetary Policy Committee as a Committee of the Bank sets a
framework for its operations. The Act provides that the Bank's objectives in relation to
monetary policy shall be to maintain price stability and, subject to that, to support the
Government's economic policies, including its objectives for growth and employment. At
least once a year, the Government specifies the price stability target and its growth and
employment objectives in conformity with the Act.
Audit Committee
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 accounting
policies 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 the Management Committee, comprising the Deputy
Governor (Financial Stability), the Deputy Directors, the Finance Director and the Director of
4 Banking today
The banking sector in the United Kingdom has traditionally been highly segmented. 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 license 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 banks and
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 major part of retail bank operations. In recent years, they
have offered an increasing range of financial services, based on the marketing idea of “one
stop shopping” so that it is now possible, within an individual branch, to buy and sell foreign
currency, buy an insurance policy, open a personal pension fund, invest in units trusts, and
buy executor and other services.
British merchant banks provide a complete range of corporate financial services. These range
from accepting deposits and making loans, to advising 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, often on 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 Britain’s banking and financial structure is the Bank of England.
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 whole England 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 banks sometimes 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 centers. The
activities these banks perform are very diversified including trading activities, accepting
financial commitments in exchange for a commission fee, company financial advice.
Savings and lending institutions
Sources of savings. In the United Kingdom, each individual saves on average 8 per cent of his
income. This may seem a very high proportion, but it is not always realized that an individual
saves not only by depositing money and buying securities but also by paying premiums on an
insurance policy or by contributing to a superannuating scheme.
National savings. This term is used to identify or to name the part of personal savings which
is deposited with the National Savings Bank and Trustee Savings Bank or is used to buy
National Savings Certificates, Premium Savings Bonds, or British Savings Bonds or is saved
through the Save as You Earn Scheme.
Functions of a savings bank. A savings bank accepts deposits and pays interest on them. It
may also provide payments mechanism, though this is not essential function. For instance, on
request, the National Savings Bank will provide a depositor with a draft, which can be used in
the same way a cheque to settle a transaction, and the Trustee Savings Banks now provide
their customers with chequebooks.
The National Savings Bank provides two types of account facilities: ordinary accounts and
investment accounts. Ordinary accounts may be opened for or by anyone over seven years of
age with a maximum deposit of 10000 pounds.
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 actually participate 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 ½ per cent below that on shares
and as there is comparatively little difference in practice in the ability to withdraw fairly
sizeable 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
 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 account holders 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
give seven days’ notice of their intention to make withdrawals from their accounts.
Present - day commercial banks offer a wide range of services from those suitable for
individual customers who have modest expectations and requirements of their bankers,
through to the complicated requirements of the large multi-national companies with banking
operations on a worldwide basis.