The London Money Market.
It is usual, when describing the Money Market, to assert that it
consists of the numerous banks in the City of London; but it seems to
me that, in reality, the money market extends throughout the United
Kingdom, for wherever there is a bank or a branch bank there is a
market for money. Moreover, the demand arising for loanable capital
in the provinces largely influences the rates of interest ruling from
time to time in London, because, if demand is brisk in the country, the
banks have less to lend in London, consequently the rate advances there.
When reference is made to the money market the London short loan
fund is invariably meant, and we now have to consider how this fund
is formed. The banks, which are liable to the public for huge sums
of money at call and short notice, are obliged to keep a certain
proportion of cash in their tills and strong rooms and with the Bank of
England in order to be prepared for any sudden demand that may be made
upon them.
Their cash in hand is, of course, required to meet the ordinary demands
of a banking business, and that deposited with the Bank of England is
held as a reserve fund against those risks of withdrawal from which a
credit institution owing immense sums at call is never free. Roughly
speaking, a well-managed bank would keep, say, six per cent. of its
public liabilities in legal tender on the premises, and a further ten
to twelve per cent. at its credit in the books of the Bank of England.
The latter accumulation might be called the bank's _real_ reserve, for
it is upon this that it would have to rely during a run.
Secondly, from eighteen to thirty per cent. of its liabilities to
the public would be invested in first class securities. Those of and
guaranteed by the British Government are in great request for this
purpose, as the Bank of England would not hesitate to advance against
such investments should a company find itself compelled to meet a
sudden drain upon its resources. Every prudent banker therefore takes
care that a large proportion of these securities is included in his
list, which would also contain Metropolitan and other Corporation
Stocks, English Railway Debentures, Colonial Government Securities, and
so on. A banker's list, in short, should be a so-called "gilt-edged"
one.
Thirdly, a banker lends a certain proportion of his deposits in the
London money market. Some banks have eight per cent. there, some
fourteen per cent., and others from fifteen to twenty per cent., though
the larger and better managed companies generally employ from seven
to fourteen per cent. therein. A certain amount of this "call money,"
however, represents money which has been lent to jobbers and brokers
on the Stock Exchange for "carrying over" purposes at the various
settlements, but by far the larger part of it is money which has been
lent to the bill brokers and discount houses.
In no sense can this asset in the balance sheets of the banks be looked
upon as a reserve. It is money invested in the London short loan
market--money lent to the bill brokers, who, in times of bad credit,
might not be able to repay it on demand. Just at the very moment
when bankers are most in need, this asset is the least available;
therefore, it is about the worst possible form in which the reserve of
a credit institution, owing large sums at call, can be invested.
As a credit bank's debts are due at call and short notice, a true
reserve can only consist of legal tender, and the till money, which
is required in the ordinary course of business during normal times,
certainly cannot be classed with that reserve. When considering what
is a bank's real cash reserve, we ought to deduct from four to five
per cent. from the ratio of cash in hand and with the Bank of England
to liabilities, for a trader would not include the cash required from
day to day in his business with any reserve he might accumulate against
accidents.
Reverting to investments, we might take Consols as an illustration of
their liquidity. During normal times Consols can be sold for cash at
any moment, but it is otherwise in a time of panic, when practically
everybody wants either to sell them or to borrow upon them. The market
is then disorganised, and people require either gold or large credits
at their bankers--not securities. Hence, even Consols are unsaleable
when a panic develops into a crisis.
As the Bank of England holds the cash reserve of the nation, it alone
can advance against securities in the midst of a crisis, and those
banks which were caught short would then have to apply to the Bank
for help. The Bank certainly would not lend upon any but gilt-edged
securities during a time of stress, and if their customers then made a
call upon them those companies which held second-rate investments would
have to close their doors, as they could not obtain assistance from any
other source. A strong list of securities is, therefore, essential to
every bank that is anxious to protect its customers against disaster.
These three assets (cash in hand and at the Bank of England, money at
call and notice, and investments) constitute a bank's so-called liquid
assets. The ratio of total liquid assets to liabilities maintained by
the best English banks ranges from 43 to 78 per cent. The last-named
figures, which are quite exceptional in their strength, were published
by Stuckey's Banking Company. The remainder of a bank's resources is
employed in making advances and loans, and in discounting bills for its
clients, whilst a small proportion is locked up in premises.
We can now form some idea as to what the short loan fund of the London
money market really is. Immense sums are collected at the head offices
of the banks in London through their metropolitan and provincial
branches; and, as the demands of trade are always uncertain--now brisk,
then slack--it is impossible for them to invest all their surplus
capital in securities; consequently, a certain portion of it finds
remunerative employment in this channel.
A huge stream of credit is constantly circulating through the three
kingdoms, and London, so to speak, is the heart of the system. In years
of active or good trade this stream increases in volume, and during
years of depression it contracts; yet it is difficult to say whether or
not the resources of the banks (the floating capital of the country)
are appreciably lessened during a period of temporary depression,
although the national turnover unquestionably is, as may be seen by the
Clearing House returns. During years of rising prices and increasing
trade activity profits are augmented, and, consequently, the resources
of the banks are swollen; but when the profits are invested within the
country, a similar amount of credit is returned to the banks by those
who have sold their securities, and though less capital is created
when trade is dull, it is questionable whether the resources of the
banks then shrink very greatly, unless foreign securities are largely
purchased.
We have seen that this stream of credit flows to London, and as demand
throughout the country is not sufficiently strong to attract it all
back again, a large fund of loanable capital accumulates in the hands
of the London banks, and flows from them to the bill brokers, who
employ it in discounting bills of exchange. But though by far the
greater part of the London short loan fund is accumulated in this
manner by the banks, other firms and companies also discharge their
surplus capital into it. The pool, of course, is not a stagnant one,
for capital is constantly flowing in and out.
The India Council, for instance, lends large sums in the London short
loan market. The numerous foreign and colonial banks in London do
the same, and so, too, do many of the large insurance companies and
merchants, while during slack times money finds its way from the
Stock Exchange to the bill broking houses. At first sight it seems
strange that bankers should advance money to the bill brokers, and so
provide their rivals with capital with which to compete against them,
especially as the banks have discount departments of their own.
Let us, however, consider the position of the bill broker in relation
to the Bank of England and the money market.
Towards the beginning of the nineteenth century the broker acted as
agent for the country bankers, but this connection was naturally
severed when the country firms opened accounts with the London bankers,
and the broker, whose knowledge of bills was extensive, then transacted
business for himself. Through holding out for high rates, the London
private bankers drove a large amount of business into the hands of the
bill brokers, who, by confining their attention solely to this class
of credit document, came to be largely trusted by the joint stock
companies, which could not obtain servants with the special training of
their rivals.
In no other country has the bill broker such influence as in
England. In Paris, for instance, the customer discounts with his
banker, who re-discounts with the Bank of France; but in London, for
reasons already stated, bills find their way to the bill brokers,
who re-discount either with the banks or with the Bank of England.
Moreover, all the best bills get into the hands of the bill brokers,
who, at one time, only discounted the acceptances of the banks and the
larger houses; but they now take small trade bills, and, should the
banking business grow less profitable, it is questionable whether the
banks might not endeavour to dispense with the middleman whom they now
encourage.
We next have to consider the London money market as a whole. First we
find a system which comprises Lombard Street and Threadneedle Street.
In other words, the London banks, by keeping accounts with the Bank
of England (Threadneedle Street), have placed that institution in the
centre of the system, and we know the Bank derives great power from
this situation; but its power is not innate--it is derived through and
is dependent upon Lombard Street. This group we will call "the money
market" or "the market."
Then we have the bill brokers, of whom we will speak as "the outside
market." Every morning the bill broker goes from bank to bank inquiring
at what rates he can borrow; and if Lombard Street (the London banks)
cannot supply him with all the capital he requires, then he is
compelled to apply to the Bank of England, which, however, he always
endeavours to avoid, because the Bank invariably charges him a higher
rate than do the other banks.
The Bank of England is a great bank of discount: consequently, the
brokers are its rivals; so it is hardly reasonable to expect the Bank
to charge the same rates to them as to its own clients, seeing that
the brokers, by their competition, reduce the Bank's business. When
trade is brisk loanable capital is in considerable demand, and the
banks, therefore, have less money to lend to the bill brokers, who
consequently are then driven to the Bank, which holds the bankers'
balances.
But the Bank of England's position is an extremely delicate one; and
when the resources of Lombard Street are temporarily exhausted and
demand centres upon itself, it has to take care that its ratio of
reserve of notes and cash in the Banking Department does not sink
too low in proportion to its liabilities. Should the demand upon its
resources prove considerable, it raises its rate until the pressure
is reduced. As a large part of the trade of this country is conducted
through the medium of bills of exchange, it is absolutely essential
that there should always be a market for good bills. Otherwise, panic
and failures would be the result; so, were the Bank to refuse to take
bills from the brokers at a price, our credit system would collapse at
once, unless the banks themselves, determined to crush the brokers,
offered to deal direct with the holders. But the experiment would be
a most risky one to make. Moreover, it could not be attempted at a
critical moment.
When Lombard Street is not lending freely, or cannot lend further with
comparative safety, the Bank, by raising its rate of discount from time
to time, reduces the merchant's profit on each transaction, until at
last money becomes so dear that he finds that he is making little or
no profit on his goods. He therefore produces less, and, consequently,
discounts less, when the pressure upon the Bank relaxes.
So long as money may be obtained, let the price paid for it be what
it may, a sense of security pervades the community; but were it
whispered during a period of temporary tightness that the Bank refused
to discount good bills at any price, our credit system would be in
imminent danger, for the trade of the country would be at a standstill.
Further, did such a state of affairs continue for many days, the crash
would come, and the Bank of England would then be swept away with the
rest of the market. Our present system is so delicately poised that the
Bank simply dare not refuse to take good trade bills from the brokers.
We next come to the other side of the picture. The broker, when he goes
his rounds, sometimes finds that the surplus resources of the banks
are abundant, and that they are ready to let him have even more than
he requires. When he makes this discovery, he begins to higgle, to try
to ascertain the lowest rate certain banks are prepared to accept; for
the difference between the rate at which he discounts bills for his
own customers and the rate at which he re-discounts or borrows, is
his margin of profit, and he is naturally anxious to make it as wide
as possible. (The poor man, be it remembered, does not visit Lombard
Street simply because he finds the air pure and the society of bank
officials congenial.) He therefore does his best to discover those
banks which are in funds, and, having found them, to induce them to
lend as cheaply as possible. This he can do when loanable capital is
cheap and abundant, and the Bank of England probably doing but little
business. Possibly, though the Bank rate is at two and a half, bills
are being taken by the brokers at one and a half. Then the Bank, in
order to get business, either lowers its rate of discount or else, by
selling stock, endeavours to lessen the resources of Lombard Street.
If the Bank adopt the latter expedient, it usually sells Consols for
cash, and buys them back for the account, thereby temporarily reducing
"bankers' balances," and attracting business to itself. The banks,
having less to lend, raise their rates, which then approximate more
closely to the Bank rate.
The brokers often complain bitterly of this interference by the Bank
of England with the market's supply of loanable capital, asserting
that this artificial enhancement of rates by the reduction of bankers'
balances through the sale of stock affects their business injuriously,
and benefits the Bank but little; and it certainly is difficult to see
how the Bank of England can make a profit out of the transaction.
On the other hand, when the market rate is appreciably below the Bank
rate, it is impossible to attract foreign gold to London; and the Bank,
by borrowing on Consols, and making its rate representative, is acting
in the public interest, should it be desirable either to attract gold
to this country or to prevent its leaving these shores.
We can now see that the Bank of England, though it states its minimum
rate, is often powerless to transact business thereat; and, recognising
that its own rate is out of touch with the market rate, the Bank often
discounts bills for its own customers at the rates ruling in the open
market, as, were it to refuse to do so, its clients would naturally
take their bills to the cheapest house. When, however, Lombard Street
is empty, and the bill brokers are compelled to approach the Bank
which holds the final reserve, the Bank of England is frequently in a
position to charge its rivals one per cent. above its declared minimum,
and the bill brokers quite naturally feel a little sore. For this
reason they try every source of supply before making application to the
Bank.
As security against loans made to them the brokers usually deposit
either bills which they have discounted in the ordinary course of their
business or gilt-edged securities, but sometimes the bill broker's
credit is so good that the banks lend him money at call practically
without security. When securities are deposited they are of course
returned directly the loan is paid off.
There is also another little point to which attention may be drawn: to
wit--that, although the market we are discussing is a special market,
yet if a borrower's credit be good it is generally possible to obtain
an advance either at or about Bank rate.