Why was the Bank of England created in 1694 and what problems was it created to address? Essay

Why was the Bank of England created in 1694 and what problems was it created to address?

Bank of the England is one of the first banks to be established as a central bank of a nation in the history of the world. Since its founding in 1694 the Bank of England has been the central bank of the United Kingdom and is considered to be the heart of the financial and monetary system of the country. Also called the ‘Old Lady’ of Threadneedle Street, the Bank was nationalised on 1 March 1946. Like most of the central banks of nations all over the world, the Bank promotes and maintains the monetary and financial stability to keep the economy of the UK healthy and prospering.(Bank of England website, 2007)

The primary purpose behind the founding of The Bank of England was to advance money to the needs of the government at that time. In return for lending money, the parliament declared the bank as the sole institution with the right to issue banknotes. By the start of the 19th century the bank evolved into becoming the bankers’ bank when various other banks came forward to set up their accounts with the Bank of England. This facilitated the growth and development of a full fledged and far-reaching banking system in the country. The success of operations and functional excellence achieved by the bank encouraged the development of similar systems of central banking in various countries especially in Europe. Most of these new central banks followed a similar system of issuing bank notes in return for lending money to the government in their hours of need. Governments exercised their control to keep the banks under check. ( Reserve Bank of South Africa Website, 2007)

The founding of the bank in 1694 happened due to several factors. At that period of time the public finances of England was in rough weathers.  The then King William III needed funds to mobilise his army to fight the ongoing war with France. The King found it difficult to raise sufficient funds from the regular income sources such as taxes and levies from the public. The main reasons for this was that the King’s authority was limited and besides, introducing new taxes would need approval from the parliament and the same would have created strong protests from the public. So the only option left for the King to pursue was to raise funds by borrowing. When personal loans were found inadequate the King and the parliament accepted the proposal of William Paterson leading a group of goldsmiths, to create a financial institution to lend the King £1.2 million in gold towards his needs. (Money Reform Party, 2005)

At the time, there was no banking system in the country and “no authority was in place to manage the distribution of currency throughout the country, and there was no means of guaranteeing the integrity or value of money once in circulation” ( fxpedia.com, 2009)

William Paterson and his men raised the capital by issuing the shares of the new institution. The money so raised was given to the King. The government in return for the favor incorporated the investors of the Bank as the “Governor and Company of the Bank of England”. Thus formed the worlds’ first public limited company and was officially announced through Royal Charter and began operations on July 27, 1694. (Bank of England website)

The primary duty of the bank was to raise funds and lend it to the government in return of which it received certain rights to issue notes which later became the currency of the country. The awarding of this rights and privileges were done under the power of the Royal Charter and by several acts of the parliament. Since then, the duties and responsibilities of the bank have changed over the years and the bank assumed the position of being the central bank of the nation. Though in the initial years the bank was mainly catering to the needs of the government, later it started regular banking services for the public. When new banks began to be formed at various parts of the country the Bank of England became their banker. Soon the Bank of England became the sole manager of the country’s monetary system and its foreign exchange and gold reserves.

Background :

Founding of the bank of England was a direct result of a certain political situation prevailing in the country at that time and era. The reasons behind its creation is very closely connected to a series of political events such as war with neighboring countries, the suspension and reinstating of the governing powers and authorities of the parliament etc. (Andread?s, 1966)

At the beginning, the bank of England had 1268 shareholders. The loans given to the government were made at a nominal the interest rate of 8% and the bank used the security of the loan to negotiate with the government for rights. The bank of England evolved as the most powerful bank by servicing the needs of the government and more privileges were given to it by the British parliament.  The bank increased its capital by fresh infusion of shareholders and increasing the equity of its existing shareholders. Its influence on the government’s policies is evident from the fact that until 1826 the bank of England remained the only bank with a large number of shareholders.  The bank was a monopoly as far as financial power and sheer size were considered.  The government ensured that the bank did not have any competition in the country as other banks were prohibited from increasing the number of investors beyond a certain limit.
The administration of the bank of England is controlled by its Governor supported by a court of directors numbering 16 shareholders appointed by the Crown. Though the roles and responsibilities of the bank primarily remained as the banker to the government and as its agent in the issue of treasury bills. The functioning was later extended when it started servicing other smaller banks all over the country. It was the “lender of last resort” to the clearing banks. The bank controlled the currency circulation. The bank managed the Royal Mint which had the sole rights to issue the country’s currency notes. The bank was also acting as registrar for government stocks. And the Royal Treasury awarded the bank the entire range of operations of the money market and exchange equalization account. In 1997, the bank also finally got the ultimate financial responsibility of deciding the various changes in rate of interests of the economy.

Political and commercial events that led to the founding of the bank

The political situations that led to the creation of the Bank of England arose out of the stringent shortage of funds in the King’s treasury to finance the defense forces that were in battles with the likes of Scotland and France. In the 1640s the taxation was already criticized by the public as too high and ill affordable.  But even this heavy taxation was inadequate to fund the army to prepare them to repel any impending invasions. To tide over the situation borrowing was found as the only solution. But the government attempts to secure a sufficient loan was rejected by the king of Spain citing lack of resources to raise the 4 million pounds loan. The pope refused to help the government because King Charles was not a catholic. The city of London, the government last hope, rejected the proposal because most of its officials were opposed to the King. (Andread?s, 1966 p.17) The king managed to raise only close to £60,000 from individuals and friends but this was much too small an amount to survive the crisis.  With no other option in sight, the king seized £130,000 worth in bullion which was deposited by the merchants in the tower. Later he negotiated with the merchants to return the bullion in return for a loan of £40,000 giving the customs receipts as security for the same (Andread?s, 1966, p.19).

The merchants got together and decided that after such a bad experience as the seizure of the bullion, that it was not safe to entrust their assets with the tower. This led to the development of goldsmiths as the safe keepers of the merchants’ gold. They would accept the gold as a deposit and issue notes as proof of these deposits to merchants. Later these notes were used by the merchants and the public to exchange and transact business. This slowly replaced the coins which were issued by the government as the preferred method of payment. The goldsmiths’ notes so issued are considered as the first bank notes of its kind in the history of banking. With this power to issue notes the goldsmiths grew rich and powerful (Andread?s, 1966 p. 23). More and more people began to trust them with their money and could be termed as the first bankers. The goldsmiths even started issuing even more notes as loan to individual at exorbitant rates of interests. Lack of a proper system to assess the debtors and the indiscipline on the part of the goldsmiths and their clerks led to several problems in the position of this situation.

In 1659, Samuel Lamb proposed to the parliament that a bank be setup in England. Citing the examples of the Dutch and Swiss operations of such a bank in their respective countries, Lamb pointed out the benefits of such a bank would mean the setting up of a national capital and reduction of interest rates. (Andread?s, 1966, p.27) But his attempts failed to develop because of severe political issues of those times and were drowned in the problems relating to the treatment of merchant Jews living in England.

After the reign of King Charles II ended, the revolution of 1688 occurred resulting in a long and expensive war with France. The preceding government of William III was put in great financial struggle. William III decided that only the founding of national bank could improve the situation. He persuaded the parliament to accept the proposal made by William Paterson and the bank was finally founded.

The political and commercial reasons for founding the Bank of England

The reasons for founding the bank could be summarized as follows,

1.      A formal system for receiving of deposits, lending money and issue of bank notes was required. The new system had to eliminate the problems experienced earlier by the goldsmiths in doing the same functions.

2.      A disciplined system was required to fix the rate of interest which had always fluctuated wildly with the political situation.  The rate of interest had to be kept at low  and healthy levels to support trade and borrowing depended businesses.

3.      The issue of paper currency as opposed to the coinage which had several limitations in terms of denominations and comparisons with other prominent currencies of the era. The variations in value of metallic currency could be minimized with the use of paper notes.

4.      Traders and farmers would need advances from time to time to make transactions and they were depending on the private money lenders and goldsmiths for borrowing at very high interest rates. So there was a need of a systematic credit issuing system at reasonable interest rates that was also easily accessible that the public could use whenever there was a need.

5.      The state of the economy was extremely critical. Decades of different wars against the neighbors and the especially Louis XIV eroded the government’s resources and taxation alone was not adequate to fund the heavy expenses incurred.

6.      The returns from taxations were not sufficient. The establishment of a national bank would improve the collection of taxes and help eliminate the middlemen and corrupt tax officials who contributed to the poor tax collection.

7.      A national bank was needed to mobilise the nation’s resources and manage it for the maintenance and growth of its economy.

References

“Bank of England.” A Dictionary of World History. 2000. Retrieved March 01, 2009 from Encyclopedia.com: http://www.encyclopedia.com/doc/1O48-BankofEngland.html

Bank of England website, 2009  Retrieved March 01, 2009 from http://www.bankofengland.co.uk/about/parliament/index.htm

“Factors leading to the founding of the South African Reserve Bank”  July, 2007 Retrieved March 01, 2009 from  www.reservebank.co.za/internet/Publication.nsf/LADV/7EE59A82CC1F1E3742257337004640FF/$File/Fact+Sheet

Money Reform Party, 2005 Retrieved March 01, 2009 from http://www.moneyreformparty.org.uk/money/about_money/history_of_money.php)

“Bank of England”, fxpedia.com, 2009 Retrieved March 01, 2009 from http://www.fxpedia.com/Bank_of_England

Andread?s, A. M, ( 1966) History of the Bank of England, (pp. 17-57), Routledge

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