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Banking and financial system of Great Britain
A financial system is composed of institutions and markets which fulfil a variety of economic functions. Central to all is arranging or facilitating the lending of funds from one economic agent to another. The lending of funds from one economic agent to another — from lender to borrower — can be accomplished in many different ways; but all can be classified into just two distinct approaches.
Firstly, the lender can lend direct to the borrower, albeit perhaps with the assistance of brokers who act in an agency capacity. This may be called direct finance.
The second approach, which may be called indirect finance, involves a financial intermediary standing between borrower and lender. This form of finance seems at first sight to be more roundabout, and to involve the use of more real resources of capital and labour than direct finance. But financial intermediaries are numerous and indirect finance more common than direct finance. What, then, are its advantages? They are many, and they derive from the ability of financial institutions to use their size and expertise to transform financial claims, so that they can offer savers a wider choice of assets than ultimate borrowers are able to do. At the same time, they can offer borrowers a more varied choice of credit terms than ultimate lenders are able to do. The law of averages, in normal circumstances, ensures that the total sum of money deposited does not vary greatly. In consequence, banks can allow depositors the freedom to withdraw funds at little or no notice, whilst at the same time making loans to borrowers which last for many years. The banks are said to engage in maturity transformation, that is," they borrow short and lend long.
Banks, like other economic institutions, have been created out of definite needs. The wide use of money and credit increased the importance of financial institutions, which do not serve only as depositories of funds, but also as sources of credit. Without the services of the banks it is unlikely that our modern industrial order could function efficiently.
The main functions of a bank are:
1 The provision of a safe deposit for money and valuables. This is the oldest banking function, but by no means the most important.
2 The lending of money. This is the most profitable banking activity and the major source of the bank's income.
3 The issuing of bank-notes. This, as we have noted, was one of the earliest functions of a bank. In England and Wales this right is now restricted to the Bank of England.
4 The provision, by means of bank deposits subject to movement by cheque, of a very efficient means of settling debts.
In addition to these basic functions, modern banks provide a wide range of financial services.
Most countries now have a central bank which stands at the apex of, and is responsible for, the operation of the banking system. In the UK the central bank is the Bank of England which was taken into public ownership in 1946. It has many responsibilities, the more important of which are:
• It is the government's bank. It handles the income and expenditure of the Exchequer and other government departments.
• It manages the National Debt.
• It is the bankers' bank. The clearing banks maintain accounts at the Bank of England and the balances they hold in these current accounts are counted as part of their cash reserves.
• It is the central note-issuing authority for the UK and the sole note-issuing authority for England and Wales.
• It is the lender of last resort.
• It acts as the government's agent in the foreign exchange market.
• It has the responsibility for carrying out the government's monetary policy.
The vast majority of ordinary banking business is handled by the clearing banks. The business is dominated by the London clearing banks, Barclays, Lloyds, Midland, National Westminster (the 'Big Four'), Coults and Co., and Williams and Glyn's together with three Scottish clearing banks, The Bank of Scotland, Clydesdale Bank, and the Royal Bank of Scotland. Between them these banks have some 12000 branches. The Bank of England, the Cooperative Bank and the Central Trustee Savings Bank are also members of the Clearing House. There is a large number of non-clearing banks in the money market. The strength of the large bank with numerous branches derives from its ability to obtain economies of scale.
Today the British banking is a complicated tripartite system like a three-layer cake. The system is headed by the Bank of England.
The other two layers are:
— the commercial or joint stock clearing banks
— specialized banking institutions such as the discount houses and merchant banks.
The commercial or joint-stock banks deal with the general public. Commercial banks are designed to make a profit for their stockholders. Commercial banks render various services to companies and individuals. Some of the services are:
— to receive or accept from their customers the deposit of money
— to collect and transfer money both at home and abroad against deposit and current accounts
— to provide overdrafts to both personal and business customers
— to lend loans to their customers
— to exchange money
— to supply economic information and to prepare economic reviews to be published
— to make foreign exchange transactions, including spot transactions, forward transactions and swap transactions
— to issue various banker's cards.
The banks attract deposits from the public in three main forms: current accounts, deposit accounts, large-term deposits
The Bankers' Clearing House. The procedure for making payments by cheque creates problems when the person making the payment keeps his account in a different bank from that which holds the account of the person receiving the payment. It is an obvious solution for each bank lo pay (or receive) the net amount owing after the banks have totalled their claims against each other. Cheques drawn on one bank but payable to another arc sent to the clearing house where the mutual claims are offset and the banks merely settle the outstanding amounts. These payments from one bank to another are carried out by means of cheques drawn on the bankers' deposits at the Bank of England. The merchant banks. The main activities of the merchant banks are: acceptance businesses, financial advice to companies, share issues, investment managers, wholesale banking.
The discount houses. The London discount market is an important part of the financial structure of the City of London and is basically concerned with dealings in short and very short-term loans. The business is in the hands of the members of the London Discount Market Association (12 disc. Houses). As the name implies, the main function of a discount house is to 'discount' a variety of lOU's or 'promises to pay' which are issued by the government, local authorities, banks, and industrial and commercial companies.
Foreign banks. The number of foreign banks in London has expanded rapidly in recent years and there are now more than 200 of them. United States and Japanese banks are the most numerous. One reason why banks establish foreign networks is to meet the requirements' of their customers' international operations and this is particularly important in these days of large multinational companies.
Finance houses operate in a similar manner to banks by taking deposits from the public and employing them in loans, but they tend to specialise in providing hire purchase and other types of instalment credit.
Savings banks and the National Giro There are two major savings banks, the National Savings Bank which is operated by the Post Office on behalf of the Department for National Savings and the Trustee Savings Dank. Both banks provide deposit facilities for small savers and these are collected at 21000 post offices (in the case of the NSB) and at I 500 branches of the Trustees Saving Bank. The Trustees Savings Bank now provides a current account service (i.e. payments may be made by cheque); the National Savings Bank does not provide such a service, but the National Giro provides money transmission services. People holding giro accounts are provided with three basic services: transfer to other account holders, deposits, payments.
The primary purpose of building societies has been to provide finance for residential housing, and as such they provide a large proportion of the finance for house purchase within the UK. As a consequence of the need to raise funds to do tills, they are also major participants in the market for savings, particularly retail savings. In more recent years, however, they have started to provide a range of other services, to make loans for purposes oilier than house purchase, and to reduce their dependence on the retail savings market by raising an increasing proportion of their funds from wholesale sources.
Unit trusts are long-term investment products sold by managers to investors, often with charges of up to 5 % of the purchase price. Investors in unit trusts are usually private. In many cases, these investments were in unit trusts which the companies managed. Managers of unit trusts are specialist companies, such as M & G or Save and Prosper, or banks and insurance companies: they play an active role in selling the units to investors, investing the proceeds and finding the cash to repay investors wishing to withdraw (sell their units back to the managers). In addition, there is always a second financial institution involved in a unit trust — acting as trustee and holding the investments (assets) on behalf of the unit-holders (as investors are called). The advantages of unit trusts are principally that risks are pooled and that specialist managers should enhance investors' returns.
Investment trusts have a similar name to unit trusts, and they also pool investments managed by specialists. However, the similarities end there. Investment trusts are subject to lower charges and they are 'closed ended' funds. This means that, if people want to buy more of them, and because their quantity is limited then their share prices can rise above the value of the assets they own.
In brief, investment trusts are limited companies which invest in other limited companies. Investment trusts can borrow long term so as to invest in more assets, rather than asking the shareholders for more money.
Credit unions are, in general, very small scale savings and lending societies. Members are usually linked by neighbourhood, religion or employment, with members saving regular amounts each week: interest is paid gross of tax. The other main activity is lending, with a statuary maximum interest rate of 1 % per month.
Insurance companies. The assets of all insurance companies are grater than those of pension funds, but for the purposes of the Insurance Companies a distinction is made between the short-term and long-term insurance business of insurance companies. Broadly, short-term business is renewable annually, e.g. house or motor insurance.
To some extent, classification of financial institutions is becoming progressively more difficult.
What is the difference between the retail and wholesale activities of financial institutions? The major distinction between retail and wholesale activities undertaken by financial institutions is in the size of transactions involved. Retail activities are concerned with deposits and loans that are of relatively low value, and wholesale activities are concerned with high-value deposits and loans. While no hard distinction between retail and wholesale is possible, a transaction of less than £1000,000 would usually be regarded as a retail transaction.
The distinction between retail and wholesale activities also retails to the type of customer involved. Predominantly, retail activities of banks will involve taking in deposits from and making loans to personal customers and small businesses.
A third aspect of the distinction between the retail and wholesale activities of financial institutions relates to the distribution system for the services provided. Included in this group there are (a) London clearing banks (National Westminster Bank, Lloyds Bank, Barclays Bank, Midland Bank, Courts & Co.), (b) Scottish clearing banks (Bank of Scotland, Clydesdale Bank. Royal Bank of Scotland), (c) Northern Ireland Banks (Allied Irish Banks, Bank of Ireland, Northern Bank, Ulster Bank), (d) Trustee Savings Banks (TSB Bank, TSB Northern Ireland TSB Bank Scotland), (e) Girobank, (f) other retail banks (Co- operative Bank, Abbey National, Abbey National Treasury Services Yorkshire Bank), and (g) the Bank of England Banking Department. All of the above are involved in retail deposit-taking business and have access to their local clearing system.
Wholesale activities, being concerned with high-value transactions, typically involve customers that are larger businesses or else other financial institutions. The wholesale banks represent a diverse group of institutions within the UK financial system. They comprise three broad groups:
— British merchant banks;
— Other British banks;
— Overseas banks, which in turn are divided into American, Japanese and «other overseas banks».
Although the distinction between retail and wholesale activities is a useful one, the distinction is in relation to activities rather than institutions. Many financial institutions will be engaged in both wholesale and retail activities.
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