The Bank of England was founded in 1694 to act as the Government’s banker and debt manager. Since then it’s role has developed and evolved.
The beginnings of the Bank
The revolution of 1688, which brought William and Mary to the throne, gave England political stability for the first time in nearly a century.
Businesses flourished, but the public finances were weak and the system of money and credit was in disarray. The goldsmith bankers, who had begun to develop the basic principles of banks as deposit-takers and lenders, had been damaged by the lax financial management of the Stuart kings.
There were calls for a national or public bank to mobilise the nation’s resources, largely inspired by the Dutch example of the Amsterdam Wisselbank. Many schemes were proposed. The successful one, from Scottish entrepreneur William Paterson, invited the public to invest in a new project. The public subscriptions raised £1.2 million in a few weeks, which formed the initial capital stock of the Bank of England and was lent to Government in return for a Royal Charter. The Royal Charter was sealed on 27 July 1694, and the Bank started its role as the Government’s banker and debt manager.
Open for business
The Bank opened for business a few days later in temporary accommodation in the Mercers’ Hall in Cheapside. It had a staff of seventeen clerks and two gatekeepers. Later in the same year, it moved to the Grocers’ Hall in Princes Street, which became its home until 1734 when it acquired premises in Threadneedle Street. Over the next 100 years, the Bank gradually acquired adjacent premises until the present three-acre island site was secured. Sir John Soane’s massive curtain wall was erected round it, and this still forms the outer wall of the Bank today.
Early business – the Bank move
The first Governor of the Bank of England was Sir John Houblon, grandson of a French Huguenot refugee and a prominent city merchant. The Bank’s early years were dominated by the Government’s pressing demands for finance and the issue of a new coinage. The Bank also started a conventional banking business, accepting deposits. As evidence of deposits placed with it, the Bank issued banknotes, initially in odd sums, with pounds, shilling and pence, but later in round amounts.
The Bank’s notes became a widely accepted currency. At the time they could be redeemed at the Bank for gold or coins. People seldom doubted that the ‘promise to pay’ written on the notes would be honoured. The Bank’s connection with the Government, the scale of its private banking business, and its position at the heart of the growing financial system of the City of London made it the leading commercial bank of the day.
In 1780 the Bank was threatened by a mob during the Gordon Riots, and the Government agreed to provide an overnight military guard or ‘picquet’ for the Bank. This continued until 1973.
Debt and inflation in the nineteenth century
The national debt increased steadily during the eighteenth century, from £12 million in 1700 to £850 million by the end of the Napoleonic wars in 1815. The Napoleonic wars put a strain on the nation’s finances, and in 1797 the drain on the Bank’s gold reserves made it necessary to stop paying out gold in exchange for notes. This ‘”Restriction Period’ lasted until 1821, and during it the Bank issued £1 and £2 notes for the first time to compensate for the shortage of coins. The wider availability of notes contributed to a general increase in prices, and there was a severe slump after the wars. The low denomination notes also proved extremely tempting to counterfeiters, and over 300 people were hanged during the Restriction Period for counterfeiting Bank of England notes.
The Bank was not the only note issuer at the time. Many country banks, as well as banks in Scotland and Ireland, issued their own banknotes. But these country banks were prone to failure, especially in the difficult trading conditions in the 1820s and 1830s, and to meet the demand for a sound currency the Bank began, from 1828 onwards, to open its own branches in provincial towns.
The Bank Charter Act 1844
In 1844 – 150 years after the Bank was founded – a major step was taken to put the currency on a sound footing. The Bank Charter Act of 1844 gave the Bank a formal monopoly on issuing notes in England and Wales. A related measure required the Scottish banks, which continued to issue their own notes, to back these with holdings of Bank of England notes. As this measure took effect, the Bank became the sole monetary authority for the United Kingdom, and this arrangement is still in place today.
However, there was an important condition on the Bank’s monopoly. Mindful of the inflation that could result from the unrestrained issue of banknotes – the Restriction Period was still fresh in people’s minds – the Act prevented the Bank from issuing new notes that were not matched by an increase in its gold reserve. The fiduciary issue – that is, the part of the note issue not backed by gold – was frozen at its 1844 level. And to make the status of the currency more visible, the Bank was required to publish a separate balance sheet for its note-issuing activities. This separation of issue from banking continues in the Bank’s accounts to the present day. The profits of the note issue were to be paid direct to the Treasury.
The nineteenth century – banker to the banks
The 1844 Act gave the Bank the note issue and the nation a sound currency. But it placed, in effect, a limitation on the Bank’s ability to develop its commercial business, and during the nineteenth century it was overtaken in size by the great joint-stock deposit banks which emerged from a series of mergers. The Bank chose not to compete directly with these banks, but to develop its role as the central bank: the guardian of the gold reserve, the lender of last resort. In a succession of banking crises – notably those involving Overend and Gurney in 1866 and Barings in 1890 – the Bank established the concept of lender of last resort – the ultimate reserve of the banking system. It would mobilise its own resources – and those of the City – and step in when a financial crisis at a single bank threatened to spill over into the financial system as a whole.
It would routinely use this leverage over the banking system’s liquidity – the ability to supply money to the banks when no-one else could – to set interest rates in London at what it judged to be the right level. While the gold standard was in place, the choice of interest rate was constrained – the Bank had to set rates high enough to maintain its gold holdings. Later, the choice of rate would become more a matter of the Bank’s discretion, and so the two main elements of modern central banking were in place.
The twentieth century – the gold standard abandoned
The First World War saw the link with the gold reserves broken again, and there another increase in the issue of unbacked or fiduciary currency. On this occasion the low denomination notes were issued by the Treasury rather than by the Bank. After the war, in 1925, an attempt was made to return to the discipline of the gold standard, but this proved unsustainable and the gold standard was finally abandoned for good in 1931. The gold and foreign exchange reserves were transferred to the Treasury (although they are still managed by the Bank) and banknotes became entirely fiduciary, or based on trust. Now the only official constraint on issuing notes is the need to obtain a Parliamentary resolution approving an increase in the number issued.
During the 1920s and 1930s, the Bank was rebuilt. Sir John Soane’s buildings within the curtain wall were replaced by a single structure designed by Sir Herbert Baker, extending to seven stories above ground and three stories below. The buildings were completed just before the Second World War and survived several bombs during the Blitz.
The Bank acquired new responsibilities during the war, notably foreign exchange controls, which required a large staff to administer and which continued until 1979. The enlarged Threadneedle Street building could not contain them all, and a new purpose-built block was constructed at nearby New Change, near St Paul’s. This building has since been demolished.
Nationalising the Bank of England
Throughout its history, the Bank has always seen itself as a public institution, acting in the national interest. Although privately owned for much of its life, its activities were determined the Government and legislation. The Bank was nationalised in 1946, meaning that it was now owned by the Government rather than by private stockholders. This gave the Government the power to appoint the Bank’s Governors and Directors, and to issue directions to the Bank. To date, the Government’s power to issue directions has not been used.
In 1997, the Government announced that it would transfer full operational responsibility for monetary policy to the Bank of England. The Bank thus rejoined the ranks of the world’s independent central banks. However, debt management on behalf of the Government was transferred to HM Treasury, and the Bank’s regulatory functions passed to the newly created Financial Services Authority.
Major regulatory reforms
The 2007 to 2008 global financial crisis demonstrated the need for a new approach to financial regulation, and major changes to the Bank of
England came into force on 1 April 2013. The Financial Services Act 2012 made the following changes:
- an independent Financial Policy Committee (FPC) was created at the Bank of England
- a new prudential regulator, the Prudential Regulation Authority, was created as a subsidiary of the Bank
- the Bank acquired new responsibilities for supervising financial market infrastructure providers.
The Prudential Regulation Authority integrates into the Bank
In May 2016, the Bank of England and Financial Services Act was passed by Parliament. The new legislation integrated the Prudential Regulation Authority (PRA), which was formerly a subsidiary, fully into the Bank of England.