The Bank Return
( Originally Published 1909 )
THE account issued every Thursday by the Bank of England, giving a statement of its position, is generally regarded as the key to the condition of the London money market as a whole and is so awaited and examined with keen interest. Much ingenuity is often required in unravelling the meaning of the movements in the various items, for the return, which is drawn up in accordance with the requirements of the Bank Charter Act, is by no means a model of lucidity. And some attempt at comprehension of the return is so essential to those who wish to grope their way through the mysteries of the money market, that we must now try to arrive at some sort of distant acquaintance with it. Further than that we need not expect to go. It may be said of all balance- sheets that they are useful as a general indication, but apt to be misleading if used as a basis of detailed inferences, except by those who can go behind the figures and find out what they really mean. In the case of the Bank return, which may be said to be a balance-sheet of a kind, only the broadest and most guarded deductions are possible, and they should be accepted with caution. Parliamentary wisdom, expressed in the Bank Act, decreed that the note-issuing business of the Bank should be separated from its banking business, and that this separation should be shown in its weekly account, which gives two separate statements, one showing the position of the Issue Department, the other that of the Banking Department. It has frequently been suggested that this distinction is unreal and only darkens counsel, and that the Bank return would be clearer and simpler if the two statements were put together. There is something to be said for this view, but perhaps hardly enough to justify an alteration which would change the face of the return so completely and confuse comparisons with its predecessors of the past sixty odd years.
Overleaf is a specimen of the account as now presented. Its figures are influenced by its being the last return of a half-year, so that the Other Deposits and Other Securities are increased by the Bank's provision of emergency credit. But it will serve as an illustration :--
On the left or debit side of the statement of the Issue Department we find one item, that of its notes issued and outstanding, and it must be carefully observed that their amount is not that of the Bank's note circulation, because a large proportion is retained among the assets of the Banking Department, and constitutes most of what is generally called the Bank's reserve. The Bank's note circulation is arrived at by subtracting the notes held by the Banking Department from those issued by the Issue Department, by which process we arrive at the number of notes that are circulating at home and abroad or are held by the other banks to meet daily demands for cash. On the other side of the dividing line that separates the assets and liabilities of the Issue Department appear the items on which the bank-notes are secured. First comes the Government debt, swollen to over 11 millions from the £1,200,000 to advance which to Dutch William the Bank was originally founded ; this is not represented by any holding of stock, but is a book entry between the Government and the Bank, and this item should be noted, because one of the suggestions made for the creation of bigger gold reserves advocates that the Government should pay this debt to the Bank in gold and that the Bank's fiduciary note issue should thus be permanently reduced. The fiduciary (confidential) issue is that part of the issue that is based not on gold but on this Government debt and the next item, Other Securities, which consist of British Government stocks ; these two aggregate nearly 18A millions, and this figure is at present the limit up to which the Bank is allowed to issue notes against securities. It was arrived at by the provision in the Bank Act which fixed the fiduciary issue at 14 millions, and arranged that the Bank should be permitted to take over two-thirds of the authorized powers of any country bank which thereafter might allow its note issue to lapse. By means of these lapses, which arose chiefly owing to the absorption of country banks by connpanies which had London offices and therefore were debarred from note issuing by the Bank of England's monopoly, the fiduciary issue has grown from the 14 millions at which it was fixed by the Bank Act to the 18 1/2 millions now shown.
Above this limit every note must have a bullion basis, and is as a matter of practice invariably based on gold. The Bank Act, however, allows one-fifth of the metallic basis of the note issue to consist of silver, and the weekly account as published by the Bank of England regularly contains the line " Silver coin and bullion " with a blank opposite to it. This power possessed by the Bank of basing part of its note issue on silver is often forgotten, but its existence was brought home to the City in 1897 when the Chancellor of the Exchequer and the Governor of the Bank seriously discussed a proposal for putting it into practice. The arrangement was evidently due to pressure brought to bear on the Government of the day by the Bimetallists, who believed that silver and gold could be made to circulate on equal terms at a fixed ratio, to the benefit of all concerned, and this mooted concession on the part of the Bank of England was part of a scheme for improving the position of silver. But it was nipped in the bud very early in its history.
The Times found out what was afoot and exposed the scheme with dramatic effect. There was such an outcry in the City that no more was heard of the project, and gold remains the sole basis of every note that is issued by the Bank above the 18 1/2 million limit.
Proceeding to the Banking Department, the first item that we see on the liabilities side is the proprietors' capital, which speaks for itself, being obviously the amount subscribed by the original stockholders of the Bank, with subsequent additions.
It differs from the capital of the other English banks by being in stock instead of shares, and by being fully paid up, whereas it is now the fashion for banks to have a reserve in the shape of a liability on their shareholders for uncalled capital. But though the stock of the Bank of England is fully paid, authorities differ as to whether there is further liability on it. It is not a practical question, however, or one that need keep proprietors of Bank stock awake at night, and Parliament has distinguished the stock by including it among the investments open to trustees.
The next item is the Rest, under which quaint name the Bank holds what most other banks and companies, which are fortunate enough to possess one, call a reserve. That is, it is an accumulation of profits which have not been distributed as dividends but kept in hand to strengthen the Bank's position. It may seem at first sight puzzling that the possession of a liability should strengthen a company's position, but this liability, like the subscribed capital, is a liability only between the Bank and its shareholders, and is, of course, represented by assets on the other side of the account, so that the proportion of assets to real outside liabilities the demands that the Bank's customers can make on it is strengthened by its existence. Unlike the reserve of an ordinary bank or company, however, the Bank of England's Rest constantly fluctuates, and it may be supposed that it more or less contains the Bank's profit and loss account balance. But it is shifted about from week to week in a manner which an outside observer can note, but not understand, and apparently most of the profit and loss balance is included in the Other Deposits, which will be dealt with later, and is transferred to the Rest when it is wanted to pay dividends withal. At any rate, it is not unusual to see a large amount suddenly added to the Rest at the end of February and August when the Bank completes its half-year, and from the amount of the Rest at those dates it is possible to calculate what the distribution will be when the Bank Court assembles for the "making of a dividend." For the Rest is never allowed to fall below 3 millions, and the amount above that level at the end of the half-year is roughly the sum available for distribution. It may be noted that this three-million level of the Rest has been constant during many decades, and has not been increased in accordance with the addition to the Bank's outside liabilities. Bagehot's " Lombard Street" gives the Bank return for the last week of 1869 with the Rest just over 3 millions and the Other Deposits at 18 millions odd. At the end of June, 1908, the Rest is still just over 3 millions, and the Other Deposits are 51 millions odd.
The Public Deposits are the balances of the various departments of the British Government, which are held and administered by the Bank of England as its banker. They fluctuate according to the briskness or sluggishness of the revenue payments, and the rapidity or slowness with which the Government is making its various disbursements. A large sum is taken off them at the be- ginning of every quarter, when the dividends on Consols and other Government stocks are paid, and this sum is transferred to the Other Deposits, or ultimately finds its way there. The payment of the Government dividends thus tends to make money abundant, for it means that a credit at the Bank of England has been taken from the Treasury and turned into "cash in hand and at the Bank of England" in the control of the other banks, who can use it as the basis for the manufacture of more credit.
On the other hand in the March quarter of the year, when we are all paying our income-tax and house duty, the Public Deposits swell, the Other Deposits dwindle, and money becomes scarce, or "tight" in the City phrase. It is important to remember that an increase in the Public Deposits means an increase of credits over which the Bank keeps command and control, but an increase in the Other Deposits means an increase in its liabilities to the general public and in the "cash at the Bank of England" which is used, like gold or notes, as a basis for credit-making by the other banks. It thus follows that when the payment of the direct taxes in the March quarter swells the Public Deposits at the expense of the Other, by the transfer of credits from the taxpayers to the Treasury, the other banks, in order to maintain their balances at the Bank of England, have to call in funds that they have lent. They accordingly reduce their loans at call or short notice with the bill-brokers, and the latter in order to fill the gap generally have to borrow from the Bank of England and so restore the basis of credit by producing fresh supplies of cash at the Bank of England, which take the place of those which the taxgatherer's activity has transferred from the banks to the Government's balance. The bill-brokers, being thus the chief sufferers from this seasonal stringency, cry out with great vigour upon the iniquities of a system which thus locks up the money of the tax-payer in the control of the Bank of England, which will only lend at a rate which is normally higher than that current in the market; and they maintain that trade is thus penalized and the clock of economic progress put back, and that it is necessary to adopt measures for a radical alteration in the whole arrangement, by which the big balance accumulated by the Treasury in the March quarter should not be retained by the Bank of England, but distributed among the other banks, which would be prepared to lend at the market rate. In all these objections there is a certain amount of reason, but they are overwhelmingly answered by the practical fact that this normal tightness of money in the March quarter gives the Bank of England a much-needed opportunity of replenishing its reserve against the demands of the latter half of the year. If the Bank rate and market rate were kept normally in closer touch there would be no need for the Bank to take advantage of the period of tax-gathering and tightness in order to strengthen itself. And then it might be possible to discuss measures for relieving this spring-tide strain on the bill-brokers, not by such revolutionary 'means as they are fond of suggesting, but by modifying the system under which the bulk of the direct taxes are paid in the last quarter of the financial year, and perhaps by accelerating the rapidity with which the tax-gathered money is paid out again by the Treasury. But as things are at present, the long period of control of the position which is secured to the Bank by the transfer of taxes to the Public Deposits, gives it its only chance of strengthening itself except by the adoption of borrowing measures to which it is naturally reluctant to resort.
"Other Deposits" is the comprehensive title under which the Bank includes all its liability on deposits to any one but the British Government.
Within this item is locked up the secret of the real position of the money market, for it contains the balances of the other banks, and as the Other Deposits rise and fall it is fairly safe to expect that that part of the basis of credit which consists of the cash at the Bank of England which they show in their balance-sheets also expands and contracts.
This expectation is fairly safe, but it must be remembered that the Other Deposits contain many other accounts besides those of the banks. It is generally believed in banking circles that the average amount of the bankers' balances is 22 to 23 millions. In the return given on page 244 they were probably swollen by the usual proceedings at the end of the half-year. But perhaps about 20 millions consisted of liabilities to other creditors, including governments, municipalities, and the Bank's many private customers. It thus follows that the really interesting movements that take place in the books of the Bank of England are hidden from the public gaze, for they are transfers to and from the various accounts which are included in the Other Deposits, and therefore do not affect their total. And hence it is that the Bank return, though in some senses a very full statement of the Bank's position, is only a tantalizing indication of the outside of things, of which monetary students crave hungrily for details. It is often suggested that more light should be thrown on the position by the separation of the bankers' balances, in the weekly return, from those of the Bank of England's other customers. This demand for more light is attractive, but extreme caution is desirable in approaching this very delicate question. In the first place, it may be observed that no other bank makes any distinction in its balance-sheet between the various classes of its customers, so that the Bank of England by separating the Public and Other Deposits makes a certain concession to the peculiarities of its position. It is also clear that the Bank of England could not fairly be asked to give a separate statement of the balances of its banking customers unless they themselves expressed a definite and unanimous desire that it should do so.
As their banker it is their confidential servant, and it has no right to tell the general public what they have got in its books, singly or collectively, unless under instructions from them.
It appears, however, that the outside bankers are, more or less at least, in favour of the separate statement of their balances. It has been advocated by an eminent chairman of a great bank in a presidential address to the Bankers' Institute, and if the request were made unanimously, it is difficult to see how the Bank of England could refuse it. The Bank of England, however, is believed to deprecate the suggestion. In former days a return was regularly moved for in Parliament showing the amount of the bankers' balances in the Other Deposits, and though the return was inevitably tardy, and only showed how matters had stood at a previous date, it was at any rate a rough indication. A revival of this practice was recently attempted, but when the return was moved for again in Parliament the motion was blocked by the Treasury, presumably at the instigation of the Bank of England. The Bank's objection to the separate publication of the bankers' balances is believed to be based on the view that if at any time its reserve were to fall below the amount due to the bankers, an unfavourable and perhaps dangerous impression might be created. It is easy to answer that the reserve ought not to be allowed to fall below the amount due to the bankers, but this reply is not wholly convincing, for elasticity and adaptability to the conditions of the moment are the most essential of all essentials in dealing with periods of monetary discomfort.
The little item of a few thousand pounds'-worth of seven-day and other billsó" a trifle, some ten-penny matter," as Prince Hal says represents an old-fashioned form of remittance still used for certain revenue payments.
We now turn to the other side of the account to consider the assets which the Bank holds against these liabilities to its stockholders and customers.
We have seen that the two first liabilities, capital and Rest, are owed by it only to its proprietors, and are therefore not a debt in the same sense as the others, and, when working out the proportion of cash to liabilities, it is only the liability to customers, the Government and other depositors, and the holders of seven-day and other bills, that is included in the calculation.
In its treatment of the liabilities side of its account we found that the Bank to this extent gives fuller information than other banks, in that it separates the Public from the Other Deposits ; but on the assets side its statement, which, be it remembered, was arranged for it by Parliament sixty odd years ago, is distinguished by obscurity. It makes no distinction between its investments, its loans and its discounts, all of which are stated under the heading of securities, these being distinguished as Government and Other. In this case again Government means only British Government, and the item Government securities covers the Bank's holding of Consols and other British Government stocks, Treasury bills, Exchequer bonds, and other short obligations of the Government, and any loans that it may have to make to the Treasury in the shape of Ways and Means or Deficiency advances, when the exigencies of "supply" or of dividend payments compel the Government to draw on its banker. As these temporary borrowing operations by the Treasury are indicated more or less by the weekly returns of public income and expenditure, published in the Gazette, it is possible with their assistance to get a dim glimpse of the meaning of the movements in the Government securities in the Bank return; but these Government returns are slow in appearance, inadequate in information, and obscure in expression, and any one who attempts to find his way with their help towards a comprehension of the relations between the Government and the money market is entering a path full of pitfalls. It is rather curious that the money market, which so often has to come to the assistance of the Government by subscribing to Treasury bills or otherwise, submits patiently to handing over its money to a borrower whose operations are veiled in so much mystery, and at the same time are of such great importance. Broadly, however, it may be stated that when the Government securities item rises, either the Bank has been increasing its, holding of Consols or other Government obligations, funded or unfunded, or else has been making some sort of an advance to the British Government ; and when it declines, it goes without saying that one of the contrary operations has taken place, that the Bank has been selling its Consols, etc., or having an advance repaid by the Government ; but there is yet another possibility, for the Bank may have been borrowing from the market and giving some of its Government stocks as security. When it borrows in order to curtail the supply of credit it is usual to see a decrease in the Government securities, and sometimes in the Other Securities likewise. But it is important to remember that when the Bank lends money to the market its holding of Government securities is not thereby affected ; very probably it lends on the security of Consols, but this security is only collateral and the borrowers' promise to pay is what it relies on first, and it therefore ineludes advances to any borrower but the British Government under Other Securities.
The Other Securities are thus already to a great extent explained. They include all investments held by the Bank, other than obligations of the British Government ; all advances to its private customers, or to bill-brokers, stockbrokers, municipalities, colonial Governments, accepting houses, colonial or foreign banks, or any one, except the British Government, who may have need of its services and possess the wherewithal to obtain them; all the bills that it has discounted, whether in order to provide credit for the London bill-brokers, when cash has been called in from them by the other banks, or in the ordinary course of trade. The comprehensive nature of this item thus entails much wariness in drawing conclusions from its movements, and it is often suggested that the Bank return would be a much more lucid statement of the position if its loans, discounts and investments were separately stated instead of being thus massed together. The gain in lucidity would certainly be enormous, and it is difficult to see that any valid objection can be raised against this step in the direction of publicity and clearness.
Finally, having thus arrayed the obscurities which clog any attempt to unravel the meaning of the Bank return and the movements in its various items without assistance from those who know what is behind the figures, we may arrive at the one broad and platitudinous conclusion that can invariably be drawn from a change in the Bank's holding of securities. It is safe to expect that any increase in the securities will protauto increase the supply of money, and any decrease will reduce it. For since every amount lent means a corresponding credit in the Bank's books, an increase in the securities causes a corresponding increase in the deposits, either Public or Other; and if the Public deposits have been increased by an advance from the Bank it may be assumed that this has been done because the Government has payments to make, and that the increase will shortly be transferred to the Other deposits, and so will be added to the " cash at the Bank of England" in the books of other banks, which is regarded as equivalent to gold as the basis of credit. Or the increased credit may be employed in the withdrawal of actual currency from the Bank, which will so be added to the cash in hand of the commercial community. At the same time it is equally true that an increase in the Bank's securities, though it tends to make money cheap, is generally accompanied, and caused, by dearness of money, which drives borrowers to the Bank in order to increase the supply.
And now we come to the last two items on the assets side of the account, which taken together constitute what is generally spoken of as the reserve of the Bank of England. It should be noted that this reserve is, in accordance with the confusing habit of economic phraseology, a reserve in quite a different sense from the reserve or reserve fund of another bank or company.
Ordinarily a company's reserve means an accumulation from profits which have not been distributed as dividend but kept in hand for use in case of need. The Bank of England, as we have seen, possesses a reserve of this kind, and calls it its Rest. But when we speak or write of the Bank's reserve we mean its holding of cash in the Banking Department. In the account before us it consists chiefly of notes with a comparatively small proportion of coin and bullion; the coin and bullion may be called the Bank's till money, the coin that it has in hand to meet cheques drawn on it, and for other ordinary banking business. Any more gold that comes into the Bank's hands goes into the Issue Department, and notes are issued against it and put into the assets of the Banking Department.
It is a confusing and complicated arrangement that makes the notes a liability of the Issue Department and an asset of the Banking Department, but we can simplify it a little by regarding the notes of which the reserve largely consists as bullion certificates representing gold in the vaults of the Issue Department.
For practical purposes we are justified in doing so, but it must not be forgotten that notes are not actually quite bullion certificates, since as we have seen they are to some extent based on securities and Government debt, and in the account before us about one-third of the backing of the notes is thus composed. And it thus appears that the liabilities of the Banking Department of the Bank of England, which are used as the basis of credit by the rest of the banking community, are represented as to one-half or rather more by securities, and as to most of the rest by notes, which are again represented as to about one-third by securities. It is a beautiful if rather complicated development of the use of credit, and economy of metal, but the attractiveness of the system, on paper, and its smooth working in practice, make it all the more essential to be sure that the solidity of the machine is carefully watched over, and :that metal is not economized to a dangerous extent.
This part of the Bank of England's task is the more difficult because it has no control over the extent to which its banking customers create credit.
All that it can do is to try to maintain its reserve by the use of its rate, when its rate is effective, but the quantity and quality of the credits that are given to the commercial community both local and foreign by the other bankers are matters which are necessarily in the hands of the latter. And the elasticity of the system, which is one of its chief attractions, thus results in the Bank's reserve being liable to be depleted by credits given by its customers, over which it can have no control. An advance given by one of the other banks to a foreign financier, in the shape of a loan against securities, or an acceptance or the discount of a bill, may mean that the foreigner takes advantage of the credit so given to demand gold; this demand will fall ultimately on the Bank of England, which will take the gold out of its vaults and cancel a corresponding number of notes. As it obviously cannot cancel notes in circulation it has to cancel those in its Banking Department, and so its reserve is thereby diminished by an operation of which it had no knowledge. And we so come back once more to the importance of the other banks, and see that the ' manner in which they conduct their business of credit-making has a very considerable bearing on the problem of the defence and maintenance of the Bank of England's reserve.