Origin of the Central Bank of England and Its Changes - Case Study Example

Central Bank of England Introduction The Bank of England is a leading financial institute that has a rich heritage spanning over 300 years. This organization’s role has placed England in a focal point, in international finance. This means that a lot of countries have severally relied on the Bank of England for support. The United States, for example, did this during the Post-1929 depression. At that time, the Bank of England acted as a last resort lender to several countries (Eichengreen 1992). Origin of the Central Bank of England The Central Bank of England or much more famously the Bank of England has the enviable reputation of being the oldest Central Bank having being established in 1694 (Andreades 1966). Andreades 1966 argues that the bank played a central role in making sure that England regained and kept her important position among the European nations through the loans advanced to both William III and Queen Anne as well as financing all the wars that England was party to throughout the eighteenth century (Heffernan 2005). There is also the reputation that it holds as being the most original bank in Europe having seen the collapse of several well established banks that existed before and even after its own establishment (Andreades 1966). Before the coming of the Old Lady of Threadneedle Street, which is the nickname given to the bank on account of its location; the financial scene was quite chaotic with the users taking advantage of the disarray to profit greatly (Andreades 1966). Before 1640, there was no existence of banks as merchants usually deposited their bullion and coin at the Tower of London a fortified (Heffernan 2005). The goldsmiths were in charge of the flow of currency valued in gold as a lot of people from the noblemen to merchants all felt that the stability that the gold standard offered to their investments. The goldsmiths are, therefore, easily the first bankers (Andreades 1966). The goldsmiths were not without their faults, something, which gave their enemies reasons to attack them frequently. One of these faults was debasing the coin so that they could make profits from this situation. There was also the issue of interest that they charged on their loans. In most cases, it was way higher than the rate set by the law, for example, 33% or even more when the legal rate was 6% (Andreades 1966). There was also the matter of the losses they made and what these losses cost the government when they made poor investments. There was generally a big mess that the goldsmiths created coupled by the fact that they were too influential and thus a threat especially to the to the firmness of the country currency. Therefore, at that time, there is need for an institution that would be able to stabilise the financial scene. At that time, also was the reign of William III who was involved in wars and there was a need to raise funds to support this cause while, at the same time, the level of corruption meant that there was very little money getting to the required recipients (Heffernan 2005). The soldiers, for example, had at some time gone without shoes as well as the crown having to make concessions during wartime. All this pointed to the need to have a bank that could then allow the crown raise the much needed loans, as well as catering for other financial needs of the country such as the issue of currency in notes and coins among other needs. Changes affecting the Bank of England In the autumn of 1997, there were reforms in the banking sector and one of the beneficiaries was the Bank of England. It, however, lost some of its traditionally held privileges. Among these changes was the independence to set interest rates (Buckle et al. 2005). This will be discussed further at the point of describing the roles of the Bank of England. This was one of the new changes that took place as a result of the reforms. Another change was that prudential control of banks was withdrawn from the Bank of England and relocated to Financial Services Authority (FSA). This thus meant that the Bank of England was not in charge of the financial services industry (Buckle et al. 2005). By all means, this was a demotion of the Bank of England as it lost this authority. The other change was that the management of the government’s debt was transferred to the Debt Management Office (DMO) (Buckle et al. 2005). Reforms meant that the daily running of affairs in the Bank was placed under the governor and two deputies (Buckle et al. 2005). According to the arrangement, one deputy governor is in charge of monetary stability while the other is in charge of financial stability. To further safeguard transparency, the Bank is accountable to a court comprising the governor, his two deputies and 16 non-executive members appointed from a myriad of interests (Buckle et al. 2005). Role of the Bank of England The banking sector comprises of commercial banks, which comprise the four major banks that is: HSBC (Hong Kong and Shanghai Banking Corporation), the Royal Bank of Scotland Group, HBOS (Halifax-Bank of Scotland) and Barclays among other banks (Heffernan 2005). There is also the category of building societies, and there is the category of deposit taking firms. Following the Building Societies Act, 1986, effective January 1987, Building societies had the option of converting into banks, an option that a number of them took up (Heffernan 2005). The Bank of England played the vital role of overseeing this transition. The Bank of England also plays a protective role. This implies that it is mandated ensuring that weak financial institutions. During the transition period for the building societies, the Bank of England ensured that the building societies were amply protected from hostile takeovers (Heffernan 2005). The Bank, therefore, ensures that it has a fair deal in the financial sector. The Bank of England is the gold reserver, which is the basis of the British commercial credit (Andreades 1966). Ordinarily, the amount of money in circulation from coins, notes or cheques is backed by the gold reserves (Bayoumi et al. 1996). The Rational for this is to ensure stability of the economy since the backing of the currency in circulation with gold means that the value is consistent. The Bank also sets the interest rate caps that all financial institutions must uphold (Anderton 2000).The aim of this is to ensure that inflation is controlled at a low position (between 1-4 per cent this is subsequently modified to 2 ½ per cent and/or below annually (Anderton 2000). It also allows the bank to regulate the economy. If it observes that the economy is slowing down, it will respond in kind by lowering the base lending rate which should be charged by commercial banks (Buckle et al. 2005). This will thus encourage borrowing which then helps in a sense “pull up” the economy. The Currency and Bank Notes Act 1928 gives the Bank of England the sole responsibility of issuing currency. This currency as per Section six of the Bank of England Act, 1833 shall have effect as legal tender, and this will be reflected on the face of the currency (Sayers 1976). The Bank, therefore, has authority over the issue of money within the realm of England, Scotland and Northern Ireland. This sole responsibility ensures that the Bank retains a hold of the financial activities which in return ensure that the people of England, Scotland and Northern Ireland have a stable economy (Singh 2007). The Bank of England, as stated above, does not have the supervisory role anymore. This role was handed over to the FSA. The Bank, however, still participates in this regulatory role through its responsibility in ensuring a stable financial system (Buckle et al. 2005). This is a role according to Buckle et al. is bound to place the Bank in a collision with the FSA jurisdiction wise since there is a very limited disparity between what these two institutions are charged with. The disparities, however, will and continue to be resolved as they come up. The Bank has an integral role in securing future markets, which will ensure that London still has her prestigious position at the head of global financial markets (Buckle et al. 2005). The bank plays the role of banker to all commercial banks. This role means that it is a lender of last resort to commercial banks. This happens when the said commercial bank experiences short term liquidity problems(Buckle et al. 2005). The drive towards doing this is to ensure that the banking sector remains stable. As seen above, the Bank protected building societies during the period of their transitioning into banks. This is the same idea behind giving commercial banks a lifeline because failure to secure the banks would cause a bank to collapse and this may precipitate chaos in the country (Singh 2007). Relevance of the Bank of England There are several reforms that have changed the financial scene in England. As seen above, the regulatory role of the bank was taken and handed over to the FSA. There is also the big bang in the 1980s (Singh 2007). All these changes indicate an eroded position of the Bank of England. It is an indication that allowing a single organization to regulate the financial industry is not feasible. This, however, does not imply that the Bank is irrelevant. The separation of roles has had the effect of allows for effectiveness of the Bank in duties specified. As the lender of last resort, the Bank’s relevance is still intact. The Bank cannot be disregarded as far as the crucial role of keeping banks afloat (Singh 2007). The commercial banks can always rely on the Bank of England when they face short term liability problems. The Bank also has the role of supervising the financial system is paramount. This is seen in the fact that this supervision extends even into the capital markets all in the need to safeguard monetary stability (Singh 2007). This was seen in the key role it played during the dismantling of the restrictive practices in the London Stock Exchange in the 1980s (Singh 2007). This role is vital as it shows confidentiality in the Bank. Influence of the Bank of England is seen in the control of the Financial Services Authority (FSA). The FSA was placed under the Securities Investment Board (SIB). The appointment and removal of the chairman and other members of the SIB lies with the Treasury and Governor of the Bank of England (Singh 2007). This shows that although the FSA while having a free hand to regulatethe finance sector, its reference point is the Bank of England. During the reforms that followed the succession of the Labour Party into power in 1997, the Bank played a central role in the reforms that came up (Heffernan 2005). The Bank’s role was enhanced by the Chancellor of the Exchequer who placed the bank at the forefront indeed even placing Howard Davis a deputy governor of the Bank of England as the chairman of the FSA points to the relevance of the Bank in England (Singh 2007). According to the Section six of the Bank of England Act, 1833, the Bank of England is the only organization with the authority to issue new currency (Sayers 1976). Being the sole issuer of currency, the Bank is in a position to regulate the flow of currency and check inflation. This task is important to the economy as it is the Bank’s onus to ensure that the economy is stable. Conclusion All the above reasons point to the important role that the Bank plays in the financial sector. Though some of the roles that had traditionally been under the Bank have been taken, this is not to mean that the Bank has lost its lustre. History has proven that there must be an institution that is charged with regulating the industry. To this end, the Bank of England will continue to exist. Bibliography: Andreades, A., 1966. History of the Bank of England 1640-1903. Oxon: Routledge Taylor and Francis Group. Anderton, A., 2000. Economics. Essex: Pearson Education Ltd and London: Dorling Kindersley Ltd. Bayoumi, T., Eichengreen, B and Taylor, M. P., 1996. Modern Perspectives on the Gold Standard. Cambridge: Cambridge University Press. Buckle, M and Thompson, J., 2005. The UK Financial System: Fourth Edition. Manchester: Manchester University Press. Eichengreen, B., 1992. Golden Fetters: The Gold Standard and the Great Depression, 1919-1939.New York: Oxford University Press, Inc. Heffernan, S., 2005.Modern Banking. West Sussex: John Wiley and Sons Ltd. Sayers, R. S., 1976. The Bank of England 1891-1944. Cambridge: Cambridge University Press. Singh, D., 2007. Banking Regulations of UK and US Markets. Hampshire: Ashgate Publishing Limited. Read More