Chapter XXII: The English Banking System (2)

Some of the banks include under the heading "cash at call and short notice" advances which they make to the Stock Exchange for the fortnightly periods that elapse between its settlements. The funds that they so use obviously have an important effect upon the marketability and price of securities in London. On the first day of every settlement it is usual to see rates quoted as those at which the banks are lending to their stock exchange clients for the financing of speculative commitments. In the arrangement of these rates a certain amount of combination and co-operation among the banks, or some of them, has grown up as a matter of custom, but since for this class of accommodation the bankers are subject to competition on the part of the agencies of the foreign banks and the big finance houses it is often found difficult to maintain even this amount of harmonious working among the bankers.

It has been shown that the rate at which the banks make advances to the discount houses has an important effect upon the market rate of discount in London, but the banks exercise a still more important and direct effect upon this discount by being themselves large buyers of bills. It is impossible to gauge exactly the extent to which they hold bills among their assets, since many of them in their balance sheets include their discounts along with their loans and advances. Among the many suggestions that reformers have put forward in the matter of English banking, one is that this item of the banks' holding of bills should be separately stated. But though this obscurity in the statements of the English banks makes it impossible to know the precise extent to which they hold bills, there is no doubt their purchases of them are on the whole the most important influence upon the market rate of discount in London. Nearly all the discount houses, whose functions will be described later, buy bills, largely with the intention of reselling them to customers, among whom the joint-stock banks are the largest and most important and most regular buyers, and it is contended by the discount houses that the market rate of discount, for which they themselves are generally supposed to be responsible, is really and in fact regulated by the price at which the big joint-stock banks are prepared to buy. This being so, since the market rate of discount is perhaps the most important influence on the foreign exchanges and so on the inward and outward movements of gold, it will be seen that this function of the bankers is one of the greatest possible importance from the point of view of London's free market in gold.

Besides thus regulating the price at which bills of exchange can be discounted in London, the banks have in recent years taken an increasingly large and important part in the creation of bills of exchange by placing their acceptances at the disposal of their customers. The increasing extent to which the bankers have in recent years intruded into this class of business is a grievance that is resented rather keenly by the merchant firms, or accepting houses, as they are often called. It is contended by the latter that the business of acceptance is a special function for which special training is required, and that the joint-stock banks rarely have available the special abilities that make for its proper conduct. On the other hand, the high standing of the joint-stock banks and their big reserve resource in the shape of their uncalled capital makes their acceptances an exceptionally fine credit instrument, and it seems natural enough that they should, to a certain extent and within moderate limits, place these facilities at the service of their customers.

Finally it may be added that the English joint-stock banks are now showing a disposition to engage to some extent in the business of dealing in foreign exchange which has hitherto been left to the finance houses and foreign firms established in London. The London and County and the London City and Midland banks have now established regular foreign exchange departments. This development is generally welcomed as a sign of a desire on the part of the banks to widen their horizon and to come into closer touch with the affairs of the financial world at large, but, as in the case of the banks' increasing interest in acceptance, there are some critics who consider that it is better for the bankers to stick to their obvious and highly important function of providing the community with credit and currency, and taking care of the money of their customers.

THE PRIVATE BANKS

Any differences that exist between the private and joint-stock banks of England lie in their ownership rather than in their functions. Their functions are the same, but the manner in which they carry them out is perhaps influenced to a slight extent by the fact, which really distinguishes them, that the private banks are owned by a few partners who generally conduct the business for themselves or exert more or less influence on it, while the joint-stock banks are managed by salaried directors and officials on behalf of a large body of shareholders formed into a public company, the shares in which can as a rule be bought and sold on the London Stock Exchange.

Since private enterprise naturally precedes joint-stock institutions, it goes without saying that the private banks of England were the pioneers of the banking business. There are still in existence private firms which were founded before the Bank of England. A goldsmith called Child was doing business of a banking character soon after 1660, and Child's Bank still exists. Hoare's Bank was instituted in about 1680, fourteen years before the Bank of England received its charter. Modern developments have almost driven them out of the field, and among the leading banks in the city of London only two are left which can still be called private in the old sense of the word. There are one or two other institutions which are on the borderland: and at the west end of the town several old firms, including Child's and Hoare's, have retained their old constitutions.

THE MERCHANT BANKERS AND ACCEPTING HOUSES

The most important function of the merchant bankers is not that of banking, but of accepting. Banking, in the strict sense of the term, they do not engage in--that is to say, they are not prepared to meet claims upon them by an immediate payment of cash or legal tender over the counter, but by payment of a cheque on one of the banks in the stricter sense of the term. The function of the London accepting houses, though of enormous importance, is still to a certain extent subordinate to the judgment of the English banks. They finally decide whose paper is most readily negotiable, and, in times when the credit machine is felt to be somewhat out of gear, the bankers occasionally discriminate against the paper of firms which they consider to have been giving their acceptance too freely. In this respect, as in so many others, the Bank of England remains the final arbiter, since the paper of an accepting house which is questioned by the other banks can be negotiated at the Bank of England through a discount house, and the Bank of England has before now intervened with effect when it considered that questions raised concerning certain acceptances have been without justification.

This business of acceptance is one into which the other banks have themselves recently intruded with considerable effect, accepting bills for their customers, home and foreign, for a commission; and there is a certain apparent anomaly in the position which makes them guardians of the volume of acceptance created by the private firms and acceptors themselves on a steadily increasing scale. Nevertheless, this anomaly has little or no untoward effect in practice. The bankers are naturally extremely cautious in raising any question as to the security of general credit in London, and they are in many ways closely connected with the private accepting houses, so that the system, which appears to be full of uncomfortable possibilities on paper, works easily enough in practice.

Other functions of the merchant firms and accepting houses are their activity in general finance and in exchange business. Both these functions arise out of their old business as merchants, which gave them close connection both with the governments and the business communities of foreign countries.

THE DISCOUNT HOUSES

The great volume and diversity of the bills of exchange which come into the London market to be melted and turned into present cash before their date of maturity has caused the existence of a class of dealers in bills (bill brokers) who specialise in handling them and may be regarded as intermediaries between the holders of the bills--that is to say, originally, the drawers of them, or their representatives, or any one else into whose hands they may have passed them on--and the bankers, who are the ultimate buyers and hold them as investments until maturity. It is the business of the discount houses to buy these bills on a wholesale scale, using for this purpose funds largely lent them by the banks, and to meet the requirements of the bankers with regard to the date named and quality of the bill, providing them out of the store that they keep constantly replenished.

We have also seen that the discount houses fulfill a very important function by borrowing funds from the bankers at call and short notice. These funds are regarded by the bankers, and actually described in their balance sheets, as cash, cash at call, and short notice. It is a somewhat elastic extension of the term "cash" to apply it to money that is being lent to any borrower, even of the highest credit and against the most liquid possible collateral. But it is always assumed by the bankers that these funds placed in the discount market can be called in readily at any moment. That they can be called in is practically a fact; but it arises chiefly from the ability of the discount houses when pressed for repayment of these loans by the bankers to fill the gap in credit by an appeal to the Bank of England and the production of fresh cash, as it is called, by borrowing from it. The discount houses take security to the Bank of England and raise with it the right to draw cheques. These cheques they pay to their bankers, whose cash at the Bank of England, which we have already seen to be regularly used as a part of the basis of credit in England, is thus increased.

Besides the money that they habitually borrow for short periods from bankers, the discount houses also have considerable amounts placed on deposit with them by other lenders, some of which they employ, especially in times when the volume of bills is comparatively small, by loans to the Stock Exchange for financing the speculative commitments of the public, and by holding or carrying securities of a reasonably liquid character. They also take some part in the underwriting of new loans and in the general financial business of the London market.

[154]It is impossible to exaggerate the importance of the functions which the bill brokers discharge in the London money market. They are only about twenty in number, including three joint stock companies. One or two of the brokers work on commission, as your brokers do, but the majority are really dealers in bills. That is, they buy or discount, and sell, or rediscount, bills of exchange.

Let me illustrate their method of working: A bank in New York may buy $1,000,000 worth of sterling bills drawn on England and send them forward to its London agent to be discounted with the bill broker. The bill broker will discount these bills at, say, 4 per cent. If he thinks rates are likely to fall, he will hold the bills; if he thinks them likely to rise, he will try to sell the bills at about 3-3/4 per cent. or 3-7/8 per cent. discount, thus making a profit on the transaction of 1/4 per cent. or 1/8 per cent. per annum. Similarly he may discount large parcels of bills for Eastern and South American banks. Many of these bills will be bills drawn on and accepted by banks and finance houses. These are known as "bank bills." But on the other hand, the bill brokers are free buyers of "trade bills." The trade bill in England arises in the following way: Trader A sells goods to trader B. He will draw a draft on trader B at, say, three months date. Trader B will accept the draft and return it to trader A, who will discount it with his banker or with the bill broker. The rate of discount for trade bills is usually 1/2 per cent. per annum higher than the rate for bank bills.

The essential feature of almost all the bills on the market is that they represent a commercial transaction, such as a sale of goods, where value passes. It is this that lends them their self-liquidating quality; for they are usually liquidated by the acceptor out of the proceeds of the resale of the goods during the currency of the bill.

The bill broker not only employs his own capital in buying bills, but also money which he borrows from the banks and others at call or at short notice. Enormous sums are employed in this way.

INTERVIEW WITH THE GOVERNOR AND DIRECTORS OF THE BANK OF ENGLAND

[155]Q. When does your present charter expire?

A. The bank's exclusive privileges of banking continue subject to one year's notice and to repayment by the Government of the debt of L11,015,100 and of all other public debt held by the bank at the time.

Q. What is the par value and present selling price of your shares?

A. The bank's capital is in the form of stock, L100 of which is at present quoted at about L267.

Q. How many stockholders have you?

A. There are at present over 10,000 accounts.

Q. Is the stock fully paid?

A. Yes.

Q. Have your shareholders any liabilities in addition to the ownership of shares?

A. Legal opinion is to the effect that there is no further liability on bank stock.

Q. Is there any limit to the number of shares which may be held by any one person, and is your approval required before a transfer of your stock can be made?

A. There is no limit--the bank's approval is not required.

Q. Does every share have a vote at shareholders' meetings?

A. To have a vote a proprietor must hold L500 of stock, but no matter how much additional stock a proprietor may hold he can not have more than one vote.

Q. Is there any custom restricting the class from which the directors may be selected?

A. There is no legal restriction as to the class from which directors may be selected, except that they must be "natural-born subjects of England, or naturalized," but in actual practice the selection is confined to those who are, or have been, members of mercantile or financial houses, excluding bankers, brokers, bill discounters, or directors of other banks operating in the United Kingdom.

Q. How many branches have you?

A. There are eleven branches--two in London and nine in the provinces.

Q. Is the business conducted at your branches of the same class as at your main office in London?

A. Yes.

Q. Do your branches have business relations with merchants, farmers, and all classes of people in their respective localities?

A. There are no restrictions of any kind as to the class of people with whom the bank has business relations.

Q. Is the Bank of England a member of the London Clearing House?

A. Yes; but "on one side only," as it is termed. The Bank of England presents, through the clearing house, all drafts drawn on clearing bankers paid in to it by its customers; but the clearing bankers do not present, through the clearing house, drafts on the Bank of England paid in to them by their customers. Such drafts are paid direct to the credit of their accounts at the Bank of England.

Q. Do you at any time allow interest on special deposits?

A. It is not the practice of the bank to allow interest on any deposit.

Q. Can you state approximately the average length of time and the average size of bills discounted by you?

A. Time, forty to fifty days; size, probably about L1,000.

Q. What is the distinction between what are known as "prime bills" and other bills?

A. A "prime" bill we should define as a bill accepted by a London or provincial bank in first-class credit or a merchant or merchant banker of the first class whose business it is to grant credits.

Q. Do you discount any prime bills?

A. Yes.

Q. Do you discount to any considerable amount for individuals and merchants?

A. The bank discounts all approved bills offered to it by persons or firms having properly constituted accounts.

Q. Is it your custom to employ surplus funds in purchase of bills from discount houses?

A. No.

Q. Do you rediscount bills for the joint stock or other banks?

A. The bank is always prepared to rediscount for other banks at its official rate, and does a large business from time to time with the colonial and foreign exchange banks who are from the nature of their business always sellers of bills.

Q. Would you charge a merchant house having a good account with you the bank rate or the market rate for prime bills?

A. The market rate.

Q. To what extent does bank rate govern your discount and loan transactions?

A. The rates for discount and loan transactions at the bank usually approximate more or less closely to the bank rate.

Q. Do you at times discount bills for parties having no account with you?

A. No.

Q. Are a considerable number of your loans on call?

A. None.

Q. When and under what conditions is the bank rate changed?

A. The bank rate is raised with the object either of preventing gold from leaving the country, and lowered when it is completely out of touch with the market rate and circumstances do not render it necessary to induce the import of gold.

Q. Does the bank sometimes borrow money in the open market for the purpose of raising the market rate?

A. Yes.

Q. Do you sometimes sell consols for the same purpose?

A. Yes; on rare occasions.

INTERVIEW WITH SIR FELIX SCHUSTER, GOVERNOR OF THE UNION OF LONDON AND SMITH'S BANK LIMITED

[156]Q. Your bank is organised under the General Companies Acts as are all joint stock banks in England?

A. Yes.

Q. You are not under government supervision or examination?

A. No.

Q. The authorised par of your stock is L100, and L15 10_s._ have been paid on each?

A. Yes.

Q. Are your shares held by individuals and corporations?

A. By individuals, not by corporations. There are upwards of 8,600 different shareholders.

Q. In the transfer of shares, do you require the name of the transferee to be submitted and approved before the transfer is made?

A. Yes.

Q. That of course is in order to insure the responsibility of your stockholder?

A. This is in order to insure the responsibility of our stockholder, and to prevent one holder from securing too large a holding. Furthermore we give no single proprietor more than 20 votes, however large his holding may be. Every 10 shares carry one vote, so the holder of 200 shares has a maximum number of votes.

Q. Is that the usual custom with the joint-stock banks of England?

A. I am afraid I cannot answer offhand. I suppose it is so in some cases, but the practice varies.

Q. In London there is usually a difference between the rates charged on loans and bills in favor of bills, is there not?

A. Yes.

Q. Would you say that that difference is perhaps from one-half to 1 per cent. in favor of the bill?

A. It depends so very much on the circumstances of the moment that it is very difficult to generalise. At the present moment I would say a three months' bill is worth 1-7/8, and a three months' loan would be worth perhaps 3-1/2.

Q. Were most of your branches organised by you or were most of them other institutions purchased by you?

A. Some of them were other institutions; some of them were organised by us; most of them were those old banking firms which were carried on as private businesses and have since become branches of our bank.

Q. The tendency is for the consolidation of banking in Great Britain, is it not?

A. Yes.

Q. Very strongly in that direction?

A. Very strongly in that direction, yes.

Q. As a matter of fact, a large part of the commercial banking in England is done by about a dozen institutions, is it not?

A. In Liverpool and Manchester there are very important local banks. However, it is no doubt the fact that four or five banks do about half the banking business.

Q. In the main you believe that the banking situation is stronger and better and the country is better served through the system of branches than through the independent banks?

A. I am quite convinced of that, if only for one reason, that I do believe the indiscriminate granting of credits to the individual is injurious to himself, the private bankers being too much in the habit of regarding old family associations and not so careful as the joint-stock company would be, and he has accustomed people to trade on the credit that they get from the banker. I do not think that is banking business. The bank ought never to supply the trader with working capital. I think it is bad for the trader.

Q. Is it not quite essential to the success of a financial institution doing a commercial business to become a member of the Clearing House if it is to meet with a large degree of success?

A. No. After all, there are only seventeen banks, I believe, now in the Clearing House, but there are a great many other institutions who are not members of the Clearing House and who do not suffer from that fact. Scotch banks with branches here who do a large banking business are not members of the Clearing House. There are all the colonial banks with head offices or branches in London and other large institutions; those are not members of the Clearing House. There are Barings and Rothschilds; they are not members of the Clearing House.

Q. Would you say the Bank of England is in any way a competitor of the other banks in England?

A. Yes. That is a source of very grave complaint by the other banks.

Q. The Bank of England do not pay interest on any accounts?

A. No; but in some cases they act as intermediaries for lending money. It is a very subtle distinction.

Q. While the bank rate is fixed and is to-day, say 2-1/2 per cent., is it not a fact that the Bank of England does some business for its customers and also purchases bills for their account at a lower rate?

A. That is so, and that is one of the matters of complaint. By fixing the rate at 2-1/2 per cent., or 3 per cent., or 4 per cent., they can regulate the rate we fix for our own customers. We regulate our deposit rate in accordance with the bank rate. We also regulate the rate we charge for our loans in accordance with the bank rate, and we are bound by it to a certain extent, and they themselves feel at liberty to depart from it.

Q. What does the bank rate mean; what does it govern in fact?

A. It means the general charge to the trade of the country, because although we say that bills in the market are discounted at a lower rate than bank rate, yet there is a vast number of trade bills which are purely governed by the bank rate.

Q. We found both in Germany and in France the question of the amount of reserves, either in specie or in bank, was regarded as of little importance by the bankers. They depend on the Reichsbank and the Bank of France for rediscount in times of need.

A. Both in France and in Germany banks are much more dependent on the central institution than we are here. They lean on their central institution to a very great extent; for instance, the rediscounting of bills and borrowing from the central institution is, I believe, quite a usual occurrence. Here it is an occurrence which would only take place in the last resort. As far as I am aware this bank has never as long as it has been in existence had one penny from the Bank of England, whether by way of advance or by way of a discounted bill. We do not rediscount our bills in the market either; so every transaction we enter into we have to see through to the very end.

INTERVIEW WITH MR. CHARLES GOW, GENERAL MANAGER OF THE LONDON JOINT STOCK BANK, LIMITED

[157]Q. Your capital stock is L100 authorised, L15 paid?

A. Yes.

Q. Does your board pass upon a new stockholder?

A. Yes.

Q. Who really conducts the business of the bank?

A. The managers, who are appointed by the directors; that is to say, myself and all those belonging to me.

Q. Are most of your acceptances secured?

A. Every one.

Q. How are they secured, generally speaking?

A. They are secured in the great majority of cases by bills of exchange, by first-class securities with plenty of margin, even by cash in hand to a moderate extent, and to a very small extent by bills of lading for produce shipped. That is a very small item.

Q. Can you state the reason for accepting bills instead of furnishing the cash?

A. We accept those bills because it happens to be the custom of the particular banks to draw a long bill. The customer himself who buys cotton in Bombay, or wherever it may be, acts according to the custom there to draw a bill to a certain usance. Now, for instance, with regard to an inland bill, we would not give credit of that sort to a man in London, but wherever there is a regular course of business abroad to draw at long usance we comply with it.

Q. What is the character of your bills discounted?

A. Those are all marketable bills, trade bills; you know what they are; they are between the manufacturer and the man to whom he sells.

Q. You always require two names?

A. Always.

Q. What does the form of obligation by the borrowers upon collateral take?

A. Just the same form as your promissory note.

Q. You have branches, have you not?

A. We have about forty-odd branches all in London and close to London.

Q. You do not then endeavor to acquire a country business through your branches?

A. For this reason, that we commenced as a purely London bank, and we have so far kept to that original determination of not launching out into country business, because, as I say, it differs from the ordinary London business. Country business is not quite so liquid, and can not be.

Q. If you had an account of a man running, say, a hat store, his account was satisfactory in character and had been carried with you for several years, and he wanted to stock up on hats, there would be no way in which he could go to you and borrow the money with which to buy those goods unless it was through a guarantor?

A. No. He would go then to the wholesaler from whom he would buy the goods, and give that wholesaler his bill, and that bill would be a discountable article, and that is how the money would be raised.

Q. Do you ever allow overdrafts, as they do in Scotland?

A. They are not unheard of, but not a principle of our business. Overdraft is a principle of country banking.

Q. My observation leads me to believe that the banking situation in London is practically controlled by twelve or fourteen of what are known as the London joint-stock banks, through their offices and through their branches?

A. Yes; I think that is right. However, there are still independent banks in the country, and I doubt whether amalgamation will go very much farther than it has gone. You see, these amalgamated banks have already become so large that they begin to get a little unwieldy. Lloyds Bank is an enormous thing, with $350,000,000 of current and deposit accounts.

Q. Would you say that the public are better served through these branches than they were through the independent banks?

A. Some say that they are not so well served, that accommodations are curtailed now as compared with what they used to be, and that I can understand to some extent, because, working a very large concern from one centre, you see, fiats will go forth, "Cut that man's credit off," and not listen to taking a large view. They say, "I have enough of that kind of accommodation; I have 100 shipbuilders or shipowners; I am not going to give out more than a proportion of my money into that particular trade; therefore, I will not have any more," whereas the independent banks would be perhaps a little more accommodating.

Q. If I were to go to you to-day with a ninety-day trade bill, the acceptor known to you as good, and also with a loan secured by Pennsylvania Railroad bonds, my loan to mature in ninety days, what rate would you charge me on those separate items?

A. The bank rate to-day is 2-1/2 per cent. You are a good customer, and I should charge you 2-1/2 per cent. for discounting that trade bill, and I might charge you 3 per cent., or even perhaps 3-1/2 per cent. on the Pennsylvania Railroad collateral for this reason, that one is not as realisable as the other. When the bill becomes due it has to be paid, or I give it back to my customer, and say "Give me the money for that." I can not quite say the same to him about his collateral.

Q. What per cent. of earnings on your capital did you show last year?

A. Roughly, our net earnings were 20 per cent. It cost us 50 per cent. of our gross earnings to run the business.

Q. What taxes do you have to pay?

A. We pay income tax on all our earnings, and deduct from our gross profits. We are entitled to deduct, roughly speaking, our expenses, and then upon the remainder we have to pay the income tax, or whatever it is, at 1 shilling in the pound, for instance, now.

Q. Would you say that the Bank of England is a popular banking institution among other banks in England?

A. Yes, I should say so decidedly. Its popularity goes to this extent, that it is absolutely indispensable to them. Some of them may grumble at this proceeding or that proceeding, but they have one and all to own that the Bank of England is indispensable to them.

Q. As a matter of fact, if you had presented to the Bank of England last fall some bills which had been negotiated through you which appeared to be finance bills, do you not think they might have gently hinted that it was not agreeable to them to have you negotiate any more finance bills?

A. I may say they have that recourse, and they might say to me if I gave them any just cause for doing it, just the same as anybody else.

Q. In other words, the Bank of England has such a commanding position here among the financial institutions which control all the finances of Great Britain that they dominate it when they choose to?

A. When they choose.

Q. It is the custom of the bank to co-operate very cordially with the other banks, is it not?

A. Oh, yes; we are as free as free can be. There is very little conference, or anything of the kind; we are all pretty good friends all round.

FOOTNOTES:

[150] F. Straker, _The Money Market_, pp. 7-16. Methuen and Company. London. 1904.

[151] _Ibid._, pp. 28-40.

[152] [The fourth suspension occurred August 6, 1914.]

[153] Adapted from Hartley Withers, _The English Banking System_, Publications of the National Monetary Commission, Senate Document No. 492, 61st Congress, _2nd Session_, pp. 3-64.

[154] James H. Simpson, _Some Leading Features of the London Money and Discount Markets_, an address delivered at the annual banquet of the bankers of the city of New York, Jan. 19, 1914. (In Banking and Currency at Home and Abroad, Distributed with the Compliments of the National City Bank.)

[155] Adapted from _Interviews on Banking and Currency Systems of England, Scotland, France, Germany, Switzerland, and Italy_, Publications of the National Monetary Commission, Senate Document No. 492, 61st Congress, _2nd Session_, pp. 7-29.

[156] _Ibid._, pp. 34-55.

[157] _Ibid._, pp. 60-91.