THE CENTRAL FUND
What I call the Central loanable fund is the fund in what financial
journalists call the Central Institution. This is not to be regarded as
an institution standing in the centre of a great circle of banks, with
directing chords, as it were, radiating from this governing centre.
Why it is called the Central Institution I do not know, except it
be a birth of the mother of invention, or a need arising out of the
limitations of the English language.
But the origins are unimportant. The Bank of England, let us say,
stands in an unique position, and it is a banking institution that
possesses great, but not absolute, autocratic powers. The public
attribute to it greater powers, and surround it with a greater glory
and majesty than it probably possesses. This is a psychological fact of
significance. It is the Bank _of England_. That is _the_ Bank; the Bank
that props up the nation, and which the nation in its turn props up.
It is a mutual propping up. The one cannot fall headlong and leave the
other standing erect. Both must stand or fall together. As, however,
in the consciousness of the community the nation is unshakable--then it
follows that the Bank of England is in the nation’s view unshakable.
Let me say, before I proceed further, that there is no delusion in
this. It is a fact of tremendous import.
Where a delusion does exist is in the belief or consciousness that
the Bank of England is a State bank and not a private bank like other
banks. It is, however, a private bank, like other banks, performs
similar functions, earns its profits in the same way and distributes
its dividends to its shareholders in the same fashion. It is a
proprietary establishment, run by the directors for the benefit
primarily of its shareholders.
It is only a State Bank in that the Government deposits its funds with
it alone, borrows from it now and then, and employs the Bank as its
medium for issuing loans, paying interest on the funds and performing
many other functions on its behalf. These functions, it need scarcely
be said, are not performed gratuitously. They provide a source of
income for the Bank.
The Bank of England is also a banker for the private individual in the
same way as an ordinary joint stock bank is.
It is also the banker’s bank. It may seem strange to some people to
learn that the banks themselves have a common bank. This common bank is
the Bank of England. But they bank with it in a strictly limited way.
They do not borrow from it, nor discount or, rather, re-discount bills
of exchange there. The Bank of England is to the joint stock banks a
limited convenience.
They deposit what is called their reserve funds there. In the balance
sheet we have examined we see that that particular joint stock bank
possessed in coin in hand and at the Bank of England a sum aggregating
£5,996,668. How much it had in its own safes and how much at the Bank
of England, no outsider can divine. At any rate, we learn that a
portion of it was in the keeping of the Bank of England.
This reserve performs two functions. It acts as a part reserve against
deposits, or liabilities, and it helps in adjusting the balances
between the various banks, the adjustment being made in the books of
the Bank of England.
I need not describe here the methods of the bankers’ clearing house,
how each day the cheques are cleared, and how each bank at the close of
each day finds out how it stands in relation to the other banks. Debits
are settled, not by a direct transfer of cash, but by drawing a cheque
upon the Bank of England, just as an ordinary individual redeems his
liability by handing to his creditor a draft on his bank. If they both
bank at the same bank the necessary adjustments are made in the books
of that bank. The aggregate deposits of the bank are unaffected, and
the reserve is unaffected.
All the joint stock banks, then, have accounts with the Bank of
England, and the deposits of the Bank of England include reserves of
the joint stock banks. The Bank of England pays no interest on its
deposits.
Let us now analyse a Bank of England return, which we may call a Bank
of England balance sheet. The following return is a post-war return,
issued some months after the outbreak of the war:--
BANK OF ENGLAND.
ISSUE DEPARTMENT.
£ | £
Notes issued 86,802,605 | Government debt 11,015,100
| Other securities 7,434,900
| Gold coin and bullion 68,352,605
| Silver bullion
---------- | ----------
86,802,605 | 86,802,605
========== | ==========
BANKING DEPARTMENT.
£ | £
Proprietors’ capital 14,553,000 | Government securities 21,824,358
Rest 3,499,722 | Other securities 108,836,570
Public deposits 47,393,479 | Notes 52,098,065
Other deposits 117,593,833 | Gold and silver coin 813,512
Seven day and other |
bills 32,471 |
----------- | -----------
183,072,505 | 183,072,505
=========== | ===========
We must leave out of consideration for the present the Issue
Department. This is quite distinct from the Banking Department, and
so far as the Banking Department is concerned, its working is as
independent as though it were merely a Treasury Office in Whitehall.
The Proprietors’ Capital explains itself. It represents the amount of
capital subscribed by the shareholders. The Rest may be regarded as the
Bank’s accumulated profits, and ordinary reserve fund. It is the fund
into which the profits flow and the funds out of which the dividends
are paid. It is not allowed, however, to run below £3,000,000.
The Public Deposits are the Treasury deposits, and it will be observed
that these are kept distinct from the Other Deposits. As every return
explains, these deposits include Exchequer, Saving Banks, Commissioners
of National Debt, and Dividend accounts. When we pay our income tax
to the Government it is paid into the Bank of England and swells the
Public Deposits, and the Government uses them in the same way as the
private individual uses his deposits in his own bank.
The Other Deposits are the aggregate deposits of all the Bank of
England’s depositors except the Government. They include the Reserves
of the banks of the Kingdom and the loans the Bank has made to its
various customers. As they include loans they are a composite account.
The Seven Day and Other Bills is an item of no importance.
On the other side are the assets the Bank holds against these varied
liabilities. Government Securities are securities lodged by the
Government as a security for loans, and they also include the Bank’s
own investments. The Other Securities include bills of discount, and
securities of the highest class lodged with the Bank as security for
the loan-deposits.
The notes are the ordinary Bank of England legal tender notes, and
constitute, with the small amount of gold and silver coin, the Reserve
of the Bank against its liabilities. In this particular week the ratio
of the Reserve to the liabilities was 32⅛ per cent.
It will be noted that the Reserve does not consist of coin, but
almost entirely of notes. But the notes can be exchanged at the Issue
Department for gold, so that they are equivalent to a holding of gold.
On the asset side of the return, then, we see the character of the
wealth the Bank possesses. This wealth represents the loanable fund of
the Bank and totals a huge sum. The deposits are, of course, merely
book entries, or book liabilities, or credits, as most call them, and
what I call the liquefied form of the wealth held against them.
Those who borrow the most extensively from the Bank are bill brokers,
and they only borrow in those seasons when the joint stock banks have
reached the limit imposed by their reserves and cease lending. Having
need of liquid capital and not being in a position to wait until
the joint stock banks can lend again, it is with great reluctance
the bill brokers borrow from the Bank of England. The reluctance is
most natural, because the Bank of England charges higher rates for
discounting bills and for lending money on security than the joint
stock banks charge. And it also discounts and lends for much shorter
periods. This explains the Bank rate, which is of such great importance
in the economic life of the nation. It is the minimum rate at which it
will discount bills for customers and the brokers, while it will lend
only at half per cent. above its minimum rate for discounting.
The rates charged by the joint stock banks are always well below Bank
rates, except on the rarest of occasions, and therefore bill brokers
and borrowers of money generally naturally go to the cheapest market,
and when they are forced to go into the dearest market in Threadneedle
Street they go there from necessity and not from choice.
We are able now to grasp in some measure what the Central Fund is. The
Bank of England, when other sources are dried up, is always able and
willing to lend _at a price_. This price is regulated by the calls
upon it, by the state of its reserve, by the condition of the foreign
exchanges, and by a general survey of financial conditions.
The rate is an instrument for limiting borrowing, for correcting the
foreign exchange, for drawing gold to England, and for replenishing
its reserve, if the proportion has fallen to what is considered below
the average ratio of prudence, or safety.
The loanable fund of the Bank of England, therefore, is identical with
the loanable fund of what is called the outside market. It is the
highest class of wealth liquefied, but to the Bank is given the sole
power of attracting gold from abroad as a basis to this fund when that
gold is needed.