The Bank of England located in London with its eleven branches in the principal cities of the country is the center of the banking system of England. It acts as banker to the British Government, being its fiscal agent and the sole depository of government funds. It is the chief- factor in controlling the flow of gold and in effecting international exchange. It has a practical monopoly of legal-tender note issues in England, and through its relations with the other banks it is able to provide emergency currency, in the form of deposits, which is remarkably elastic. It is banker to the joint stock and private banks, holding a large proportion of their reserves and rediscounting their paper to some extent. Its position as the government bank gives it great prestige in the eyes of the public which it passes on to the other banks dealing with it.
In the strict sense, however, the Bank of England is not a government bank; it is a private corporation owned and controlled by its stockholders. They elect a board of twenty-four directors, a portion of whom are practically life members, but none of whom, curiously enough, may be bankers. The directors choose from their own members a governor and a deputy governor to serve for two years. The deputy governor regularly succeeds to the office of governor, and the ex-governors constitute a kind of advisory council to the governor, known as the Board of Treasury.
The British law does not require any bank to hold a prescribed percentage of cash reserve. The joint stock and private banks generally carry only enough cash to meet the needs of current business, but keep a regular balance in the Bank of England. This makes of the Bank of England a bankers' bank and the gold reservoir for the whole kingdom. It rarely allows its gold reserve to fall below 33 per cent and generally the proportion is between 40 and 50 per cent. The Bank of England not only carries the responsibility of keeping an adequate supply of cash for home purposes, but it also acts as custodian of the gold store for international banking. London is the financial center of the world and the only center always prepared to honor its draffs in gold to any amount. To protect its gold reserve the bank resorts to the very clumsy and expensive device of raising its discount rate when the reserve is too heavily drawn upon, thus raising the general level of money rates in London and restricting loans. On the other hand, when the reserve rises above the normal level the bank lowers its rate. When the Bank of England raises its discount rate other banks raise theirs, and borrowers are obliged to pay higher rates for money in order that the reserve may be protected. If the raising of the rate does not check the withdrawal of gold or cause it to flow into the bank's vaults, the bank is obliged to go into the open market and borrow funds, thus lessening the supply and forcing up the rate of money. The high interest rates then attract capital, foreign exchange moves in favor of London, and the tide of gold sets in toward the Bank of England, enabling it to replenish its reserve or check the drain upon it.
That the Bank of England is obliged periodically to go through this clumsy process of borrowing money that it does not want to protect its gold reserve arises from the connection or lack of connection between its discount rate, known as the "bank rate," and the market rate. The market rates are established in the open market by the competition of all banks and other investors; they vary with the different classes of bills and fluctuate in accordance with the demand and supply of bills, on the one hand, and of funds on the other. The bank-rate is fixed by the central bank and is much more stable. The official bank rate in England is set each Thursday at the weekly meeting of the board of directors. In all countries having a central bank it is common to find the bank rate remaining unchanged for months at a time. Because of the branch bank system the rate is also uniform throughout the country.
The banking business has passed so largely to the other banks that the official bank rate may differ considerably from the rates quoted by other dealers in credit. Currency in England consists largely of checks drawn against deposits which arise largely from loans and discounts of other banks. There is no legal limit upon the amount of these loans and discounts and competition among the banks frequently leads them to loan at rates which may endanger the public interest by turning the foreign exchanges against London and so causing a demand for gold. It becomes necessary, therefore, for the Bank of England, occupying a commanding position at the head of the system, to intervene and regulate credit operations in the way described.