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Bank Of England

( Originally Published 1909 )



EVERY schoolboy knows, and most grown-up people have consequently forgotten, that the Bank of England was founded in 1694 to finance William III.'s Government. Since its foundation it has been the keeper of the national balance and the channel through which the nation has conducted its financial operations.

Its notes are the only form of paper currency that is legal tender in England, that is to say, that has to be accepted in payment of a debt, and it is the only joint-stock bank which is allowed to issue notes in London. As we have seen, the advantages possessed by the cheque have enabled it to supplant the note as circulating currency, but the Bank's privileges in the matter of note issue undoubtedly were of great service to it in its earlier history, and were an important cause of the prestige which now makes its name a household word for stability and soundness throughout the civilized world. It may also be presumed that they were an indirect cause of the fact that now gives the Bank its source of greatest strength and importance, namely, its position as the bankers' bank.

It has already been shown that the Bank of England's privilege in the matter of note issue in London was intended to give it the monopoly of joint-stock banking in London, and that the flank of this monopoly was only turned when it was discovered that note issuing was not an essential part of banking. The result of this discovery, instead of weakening the Bank of England by the creation of a host of nimble competitors, strengthened it by providing it with a number of enterprising and wealthy customers, who developed banking facilities all over the country in a manner which would have been impossible to it, without a radical alteration in its machinery and constitution, left with it the cash balances that were not required for their till money and country reserves, and so not only increased its dignity and visible strength, but made its task of financing the Government simpler and cheaper, reducing it to a great extent to a matter of entries in its own books.

For see what happens when the Government has to pay its quarterly dividends on Consols and other Government stocks, and finds itself in need of two millions or so for this purpose. It borrows two millions from the Bank of England, and the Bank of England gives it a credit for this amount in its books, against which the Government draws its dividend warrants. But only a small fraction of this amount is actually withdrawn. For the most part the warrants are paid into the other banks to the credit of their Consols-owning customers, and are paid in by them to the Bank of England to the credit of their balances with it. So that instead of making a great provision of cash the Bank only has to set its clerks to work with their pens rather faster than usual, and the thing is done. Thus two of the principal duties of the Bank of England, its management of the Government's money matters and its custody of the other banks' balances, fit into and assist one another very aptly. Equally simple is the Bank's still more important task of providing emergency currency, and again for the same reason, the fact of its being banker to the collective banking community. In all economically developed communities there are periods when the normal supply of cash is insufficient, as, for example, at harvest time in agricultural countries and at the ends of the quarters, when everybody has to pay his rent and meet other periodical demands, and especially in this country at the end of the two half-years, when a large number of firms and companies all over the kingdom draw up their balance-sheets and strive to show a fine proportion of cash in their assets. And at the end of the December half-year these demands coincide with a big movement of actual currency into circulation to provide for Christmas travelling and money paid over tradesmen's counters for Christmas presents and the material ingredients of Christmas jollity. Consequently, at these periods there comes a seasonal demand for what is called money, and the Bank of England, by reason of being the bankers' bank, is able to provide it with extraordinary ease and expedition.

For money in England, as we have long ago recognized, chiefly means a credit with a bank, carrying the right to draw a cheque. In so far as it means actual coin and notes, the problem here is the same as elsewhere, and the periodical withdrawals of these for the cash payments alluded to periodically affect the Bank's reserve. But the great proportion of the seasonal demands are met by cheques, and a large part of them, those arising out of the desire to show large cash holdings in balance-sheets, are for ornamental purposes, and are only wanted to impress shareholders and customers.

Hence it follows that a large proportion of the emergency currency required at the end of the quarters is created for show and not for use, and is borrowed from the Bank, not to be withdrawn or passed on, but so as to figure in balance-sheets included among "cash in hand and at the Bank of England."

We thus arrive at an important distinction between the credits given by the Bank of England and those of the other credit-making banks. When the latter make an advance against any kind of security or buy stock for investment, they create a deposit and give a right to draw a cheque, which is probably exercised ; the cheque drawn transfers the customer's credit to the customer of some other bank, and, as we saw in Chapter V., the loans of one bank create the deposits of another, except when the loans are raised with one bank for repaying another. But in the case of the Bank of England, its position as the bankers' bank results in any credits that it makes for its customers being left with itself, having been transferred from one bank to another in its books ; and, what is still more important, the credits that it makes rank as cash for the rest of the banking world, so that the demand for cash for ornamental purposes in balance-sheets can be satisfied with remarkable ease by book entries.

And thus banking development has outwitted and eluded the well-meant effort of the Legislature to guide and regulate it.

The Bank of England's monopoly of note issue, which was intended to give it the monopoly of joint-stock banking in the metropolitan area, was nullified by the discovery that note issuing was not the most important part of banking, and yet some years after this discovery had been marked by the foundation of the joint-stock banks, which are now, collectively, the Bank of England's biggest and most important customer, the Legislature passed an Act which elaborately regulated the note issue of the Bank of England as if its note issue were still the central feature of its business and the only thing which merited the consideration of parliamentary wisdom.

It will be remembered that the Bank Charter Act of 1844, or peel's Act, as it is sometimes called, laid down the principle that the amount of notes issued by the Bank against securities should not exceed the sum of 14,000,000, unless by the surrender of the note-issuing privilege by other banks, which exercised it, of course, outside the circle of the Bank of England's monopoly. Any more notes issued were to be based on metal held in the Bank's vaults.

The business of a bank, as the word is now understood, consists in providing currency payable in gold, and earning a profit by calculating the amount of gold that it is necessary to hold against this liability. The Bank Charter Act thus proposed to revolutionize banking by taking away from the Bank of England the right of allowing it to judge for itself of the proportion between cash and securities that it held on the assets side of its balance-sheet against the notes issued on the other. " Your securities," it said in effect, " are to remain as they are, and for every extra 45 note that you issue in future you shall hold 5 in coin or bullion." As to what might have happened if the Act had worked in the manner intended by its promoters, is a matter of interesting but idle speculation. Banking evolution has evaded or avoided the question by the development of a habit of regarding a credit in the books of the Bank of England as just as good as so many bank-notes or sovereigns or bars of bullion. Borrowers do not, as a rule, ask it for notes, but for a credit in its books.

By means of this system emergency currency and credit are provided with extraordinary ease. It has grown automatically, commands complete confidence, and works with a perfection that no theoretically planned scheme can rival. If the supply of money runs short, borrowers come to the Bank of England with securities of the kind that it approves, and in the course of a few minutes' conversation with the principal of the discount office add a million or two to the basis of credit as expeditiously and easily as the ordinary citizen can buy a pair of gloves. The machine is a miracle of ease and efficiency.

The result, as it appears in the published statements of the Bank's position, is merely that the Bank of England shows an increase in securities on one side of the balance-sheet these being the securities against which it has made advances and an increase in deposits on the other; and the popular habit of gauging the position of a bank by the amount of its deposits would lead hasty observers to the gratifying conclusion that some fresh mass of accumulated wealth had been stored up and deposited at the Bank, and that it and its customers were richer than ever. Really all that has happened is that the Bank of England has lent " money " to some more borrowers, and, being banker to the other banks, has been able to do so by making a book entry, instead of seeing the " money " taken away from it in the shape of notes or coin.

Actually, of course, the Bank of England's position has been, when strictly considered, weakened by the operation, because the increase in deposits is an increase in liabilities, and the increase in liabilities without an increase in cash necessarily means that the proportion between cash and liabilities has been lowered, and the proportion between cash and liabilities is the most obvious touchstone that is first applied to the position of a bank in considering its apparent strength. And this question of the cash brings us to the Bank of England's other most important function that of acting as keeper of the gold reserve for the rest of the banking community.

This function, it is interesting to observe, also arises out of the fact that the Bank of England is banker to the other banks. They, by keeping their balances with it, have, as we have seen, greatly facilitated the readiness and despatch with which the Bank finances the Government and creates emergency currency ; but, at the same time, they have imposed on it this heavy burden and responsibility of maintaining the ultimate reserve, and the Bank of England is never able to forget that its liabilities are not as the liabilities of other banks, since they contain that big block of bankers' balances, which the other banks regard and treat as cash, and use as the basis for the soaring structure of credit that they build up on it.

The obligation and responsibility are all the more onerous, because they have arisen, as it were, as an unsuspected irrelevance, and were long unrecognized and unacknowledged. It might have been thought that when the Bank Charter Act of 1844 had definitely laid down the duty of the Bank of England with regard to its note issue, all that it had to do was to carry out its legal responsibility with due punctuality, and, for the rest, to carry on banking business on ordinary banking lines.

This, in fact, was the view long entertained by an influential section of the Bank's Court of Directors, and its fallacy was exposed in that most brilliant of all essays in practical economics, Walter Bagehot's great work on "Lombard Street." Bagehot not only exposed the fallacy, but killed it, buried it, and damned it. To do the Bank Court justice, it should be mentioned that even those of the directors who maintained it in theory did not advocate its practice, but spoke of a 33 per cent. cash reserve as adequate, though the ordinary banks would even now regard such a proportion as extravagant. In these days, even the theory has been abandoned. and the Bank of England has so effectually recognized the gulf that separates it from other bankers that it normally shows a proportion of cash to liabilities that is roughly twice as large as that shown by those of the other banks which are strongest in that respect, and perhaps twenty times as high as that which is apparently considered adequate by the weakest.

In other words, the Bank might, if it reverted to the theory that it was only one bank among many working on the same principles, double the amount of its liabilities with a corresponding increase in its investments and dividends without altering the amount of its cash.

It is true that the greater part of the Bank of England's cash reserve in the banking department consists of its own notes issued by its issue department. But these notes are secured according to the provisions of the Bank Charter Act, and the other banks, with the practice of which we are now comparing the Bank of England's, include in their cash not only Bank of England notes but credits in its books.

But Bagehot's brilliant criticism of the manner in which the Bank recognized its responsibilities was chiefly concerned with its handling of the demands brought upon it by internal crises, and in days when an internal crisis meant a demand all over the country for Bank of England notes. Since its publication the position has been modified in two important respects. In the first place, the development of the use of cheques and of book-entry credits has been so great that it may fairly be inferred that at least the early stages of an internal crisis need not have much effect in the shape of a demand for notes.

It is, 0f course, possible, that a panic might arise in England so severe that members of the mercantile community might refuse to accept one another's cheques in payment of debts, and that we should take a temporary step backwards to the exclusive use of sovereigns and Bank of England notes. In that case the situation would have to be met by a suspension of the Bank Act in the old-fashioned style, the temporary abrogation of the limits imposed by it on the Bank's freedom of action, and the unlimited creation of notes to meet the demand. But apart from actual general cataclysm it seems reasonable to expect that any gap in credit might probably be filled by a mere enlargement of the Bank's advances, and a consequent increase in the credits which it gives to other credit-makers to serve as a basis for their operations. In other words, instead of the Bank's reserve being depleted by internal panic, it might have the effect of merely increasing its holding of securities and its liability under deposits, as normally happens at the end of the half-years.

In the second place, the problem that the Bank of England has to face is much more external than it seems to have been when Bagehot wrote. During the last thirty-five years the machinery of internal credit has worked so well and smoothly, and succeeded, in 1890, by the application of the principle of co-operative assistance, in facing a very serious difficulty with so little discomfort when the magnitude of the possible disaster is considered that the possibility of real internal panic is almost forgotten, and is ignored by some of our less prudent banking institutions to an extent which is perhaps a little dangerous. On the other hand, the general adoption of the gold standard by the economically developed countries of the world, accompanied by the fact that London has remained the only market in which every draft and every credit are immediately convertible into gold as a matter of course, has greatly intensified the responsibility of the Bank of England as custodian of a gold reserve, which is liable to be drawn on at any time from all quarters of the habitable globe from which a draft on London may be presented.

The difficulty of this task that it has to perform is increased, if not created, by the fact that it has, in normal times, little control over the extent to which these credits in London are granted. For here again we find that the other banks are once more ultimately responsible, just as we have seen that they are now chiefly responsible for the creation of a mass of internal credit and currency, which they build on the foundation of the Bank of England's reserve, but expand at their own discretion and at rates which have no connection or sympathy with the official rate that is named by the Bank. By the bills that they discount and lend against, by financing the bill-brokers, and by advancing against Stock Exchange securities, the other banks give foreign financiers a pull on the Bank of England's reserve, and the Bank of England is expected to maintain it. This responsibility is shared by the accepting houses, which by accepting for a foreigner, create a bill which he can discount at the Bank of England through a bill-broker, and so give him credit which he can convert into gold.

Owing to the extent to which banking facilities have been developed outside it, the Bank of England's official rate is often a quite empty formula, and the business of the London market is carried on without any relation to it ; and herein is another point in which the money market of today differs from that described in Bagehot's " Lombard Street," for we find Bagehot constantly assuming that any change made by the Bank of England in its rate would at once affect, and be followed by, those current in the open market. "At all ordinary moments," he writes, " there is not money enough in Lombard Street to discount all the bills in Lombard Street without taking some money from the Bank of England." This is no longer true.

Nowadays the Bank, in order to make its rate effective often has to take special measures of a kind which will be described later.

At present let us recapitulate the work that the Bank of England has to do, and then briefly consider the organization by means of which it faces its responsibilities.

It keeps the balance of the British Government and manages its finance.

It keeps the balances of the other banks, which treat their credits in its books as equivalent to cash.

It provides emergency currency at seasons of stringency, by expanding its book-entry credits and so increasing the amount of this so-called cash. It keeps a cash reserve which is relatively about double that held by those of the other banks which are strongest in this respect, and perhaps twenty times as big as those which are weakest.

It keeps the central gold reserve of the one money market in which any form of credit instrument is immediately convertible into gold, and so has to be ready for any emergency that may arise anywhere, making somebody with a credit in London determined to take away its proceeds in the shape of metal.

Its advantages and responsibilities are thus very evenly divided. Its acting as banker to the Government gives it prestige which is invaluable, conveys the impression that it always has the Government behind it, and in fact often produces the mistaken notion that it is a State institution, instead of a company with stock-holders. And its holding of the balances of the other banks enables it to lend money to Government and to create emergency currency by a mere transfer in its books. On the other hand, since the bankers use their balances with it as cash and as the basis of the credit that they make, the Bank of England has therefore to see to it that the reserve against these balances is not exposed to the demands of too many other customers ; and hence the relatively high proportion between its cash and liabilities, which tells heavily on its power to earn dividends. This obligation of maintaining a relatively big cash reserve is increased in intensity, and made more difficult in execution, by the fact that the Bank of England holds the central gold stock of the one free market in gold in the world, and has to be prepared to meet at any moment demands on it that may come forward from abroad, and have been rendered possible by credits given by its credit-making customers, or created by accepting houses in the shape of bills discounted with it through a bill-broker. Having thus reviewed the Bank of England's responsibilities and privileges, difficulties and advantages, let us see what kind of machinery and organization it brings to bear on its problems.

It is like no other bank in the world, and its eccentricities begin before you have crossed its threshold. Its external appearance, which its inhabitants and frequenters take as a matter of course, makes the country visitor gape with wide-mouthed wonder ; one of them, on learning to his surprise that it was not Newgate Gaol, accounted for his error by saying that he thought it must be a prison because it had not any windows. Except where pierced by windows over the main entrance, the Bank's external walls are all solid, but of course it is part of its business to be among other things a fortress, capable of resisting physical attack by needy gentlemen too eager in the interests of the better distribution of wealth. It has done so before now, as every one knows, because the story of the Gordon Riots is told not only in history books but in " Barnaby Rudge." Even more obvious and impressive is the low level of its roof, and the fact that this big block of space in a spot where ground is worth so much a foot is covered by a building most of which consists of vaults and two stories. An enterprising American, viewing sadly this waste of an invaluable site, remarked that if that old bank had a live president, he would run up twenty floors on the top of it, make ten times its dividends as a real estate company, and not bother any more about the mouldy old banking business.

Internally it boasts spacious courtyards and a garden full of brilliant bloom and green leaves, in seasons when such things are possible, making a most effective and restful contrast with the grim grey walls, the roar of traffic outside, and the jingle of gold that can be heard occasionally from the big hall in which notes are being cashed. It also contains a certain amount of consecrated ground, part of its site being an old churchyard. Hence it was that an unfortunate giant, who was also a clerk in the Bank, fearing that his seven feet of skeleton would be too valuable a prey for the body-snatchers to miss, got himself buried within the Bank's walls in the vain hope that his bones might there rest in peace. Not many years ago some workmen making alterations in the vaults came on a gigantic human jaw-bone ; it was sold to a dentist, who proudly exhibits it to patients, and so the giant's fears have been partially realized.

When we come to consider the Bank's organization, its most striking features are the constitution of its Court of Directors, and its system of government by rotation, and these are points on which the Bank's critics have fastened with the keenest energy and determination.

The Bank Court is a committee recruited chiefly from the ranks of the accepting houses and merchant firms, and its members are nominated by itself, subject to the purely formal confirmation of the shareholders ; and it is an unwritten law that no banker in the ordinary sense of the word, that is, no one connected with what we call the cheque-paying banks, can be a member of it.

At first sight this is one of those anomalous absurdities so common in England, and so puzzling to the intelligent foreigner, who cannot understand why we suffer them. A Court of Directors ruling the Bank of England, and so performing most important banking functions, and yet disqualifying for membership any one with an expert knowledge of banking, is a tempting subject for an epigrammatically minded satirist. But in fact this anomaly, like many of our others, not only works excellently well in practice, but is, when calmly considered, clearly based on sound common-sense. For in the first place it would obviously be undesirable that a member of one of the outer ring of banks should have the insight into the position of his rivals which membership of the Bank of England Court would give him, unless all the others were similarly privileged. But if all the outer banks were represented on the Bank Court, it would become a committee of unwieldy dimensions, perhaps reproducing or reflecting in the Bank parlour the rivalries and jealousies that stimulate the outer banks to work against one another, but are not conducive to their working together. And the question of proportionate representation would be difficult to settle. As it is, the Bank Court, being free from connection with the outer banks except by keeping their balances, is able to watch their proceedings with a wholly impartial eye, and, on occasion, to make suggestions with salutary effect.

Moreover, the functions, already described, that are performed by the Bank of England, are obviously different in many important respects from those fulfilled by the outer banks. Its chief customers, the Government and the other banks, are so special in kind that the custody of their funds has to be approached from a special point of view, and the Bank's duty of maintaining the gold reserve by regulating the ebb and flow of the international bullion stream is a problem for which the ordinary banker's training would be of little assistance, and for which the Bank's directors are obviously better qualified, owing to the closer touch with business affairs abroad, which arises from their connection with the accepting houses and merchant firms.

Nevertheless the narrowness of choice that limits the Bank Court in selecting its new members is certainly one of the drawbacks of its organization, and its difficulty in finding fit recruits tends to increase owing to the changing conditions of modern business. Some widening in the sweep of its net seems to be desirable, and will doubtless be brought about by the alertness that the Bank has shown in recent years in adapting itself to alterations in its environment. As an example of this alertness it may be mentioned that the Bank was one of the first institutions in the City to adopt female clerical labour on a considerable scale.

More genuine are the objections to the rotatory system, by which the Governor of the Bank holds office for two years, having previously served for two years as Deputy Governor, and then so say the critics of the system, just at the time when he has mastered his duties, retires into the obscurity of the Committee of Treasury, which is composed of members of the Court who have "passed the chair." Apart from the objection already noted, one result of this system is that a Bank director is not likely to become Governor until he has been many years a member of the Court. Consequently the new members of the Court have to be chosen when young, in the hope that in twenty years or so they may be capable Governors, and this is sometimes a matter of perilous hazard.

It cannot be denied that the system by which the Governor is put into the chair is somewhat haphazard. Nevertheless, it has its advantages. The Committee of Treasury represents a body of experience which is always at the Governor's service, and the periodic tenure of office makes the Governor more inclined to lean on the experience and suggestions of his colleagues on the Court, and of the heads of the various departments, and to be less a self-sufficing autocrat than he would probably become if he held office permanently, as is often proposed. And it is very important that the ruler of the Bank of England should be amenable to, and express, the broad common-sense of the commercial community as a whole, and not the prejudices and convictions of any individual, however gifted. But it is not the purpose of this work to enumerate and examine the many proposals that have been made for improving the constitution of the Bank of England. Subjected to the test of results, it shows a record that is not only unrivalled, but unapproached. For no other institution in the world attempts even to face the problem of being always ready to carry out the immediate conversion of any draft on the centre of which it is the head, which is cheerfully and composedly undertaken by the Bank of England. The elasticity of the English system, which works with the Bank as its centre, is the envy of the world, and any alteration, however slight, in so delicate a machine as a credit system, might have effects which were not at all intended.

The Bank of France is frequently pointed to as the ideal exponent of international banking by those whose test of the merits of a bank is the infrequency of the movements in its official rate. This view naturally appeals to Chambers of Commerce and the mercantile community, which chiefly desires to have its money first of all cheap, and secondly, steady in price. But the cause which keeps the official rate of the Bank of France so steady is the fact that the Bank of France is not faced by the problem involved by banking business as we understand it, namely, the immediate meeting of liabilities in gold. France still cherishes relics of Bi-metallism, and its Bank is consequently able to please itself as to whether it will meet its notes in gold or silver. Seated behind this comfortable rampart, which protects him from most of the shocks that banking flesh is heir to, the Governor of the Bank of France can maintain the most dignified steadiness in his rate, knowing that if too many claims are presented on him, he can tender payment for them in five-franc pieces, mere token counters whose bullion value is less than half the price at which he can, by the law of France, hand them to creditors in payment of claims. He is thus enabled to refuse to part with gold except as and when he pleases. It is a delightful position, but it is not banking, as we understand it, and it has its limitations ; at times of crisis even the Bank of France is unable to ignore altogether what is happening in the outside world, which is wanting to turn securities and commodities into gold.

In the last quarter of 1907, for example, when the American crisis threw an exceptional strain on the world's money market, the Bank of England faced the position with cool-headed readiness, and was prepared to meet all demands on it from America, and to reinforce itself by putting its rate up and drawing in gold from other centres. The determination which it showed finally compelled the Bank of France to take some share in the international burden and to send three millions of its gold, not to America but to London, whence it knew that it could rely on getting it back. It has been commonly stated that the Bank of England asked it to carry out this operation, but this is quite untrue. The whole arrangement was made outside the Bank of England, which approved of but by no means asked for it. The Bank of France made an excellent and profitable investment in sterling bills, and helped to mitigate a storm which threatened the French monetary community with unpleasant consequences. And at the same time it was enabled to pose very gracefully as fairy godmother to the world at large, and superficial observers cried out that there must be something in its management that enabled it to play this pretty part. If the Bank of England had the right to meet its liabilities in five-shilling pieces containing half a crown's worth of silver, it might perform with equal brilliance ; but then the whole of the very profitable exchange and banking business which is based on the immediate convertibility into gold of the draft on London, would be an impossibility. Under these circumstances it might be quite easy to keep the Bank of England's rate as steady as that of the Bank of France. But Bank rate has not yet been explained, and it, and its relations to the market rate, will require a fresh chapter.

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