3.1.6Manager of the foreign exchange reserves

Central banks frequently act as agents of their government in the management of

foreign exchange reserves. ‘Management’ is necessary since governments normally

have some policy towards the exchange rate. Even if they do not operate a xed

exchange rate policy, governments will normally want to prevent sharp day-to-day

uctuations in the exchange rate. Resisting a rise in the value of the domestic

currency means that the authorities have to enter the foreign exchange market and

sell the domestic currency for foreign currency. Resisting a fall in the value of the

domestic currency means selling foreign exchange.

In the UK, management of the foreign exchange reserves rests with the Bank of

England.

3.1.7Currency issue

Central banks are commonly responsible for the issue of some or all of a country’s

notes and coin. In the UK, for example, the Bank of England designs, prints and issues

the country’s banknotes. There is no policy to limit the note issue. Notes are issued

on demand to commercial banks, which pay for them by surrendering some of their

deposits at the Bank. The process is analogous to commercial bank customers with-

drawing deposits in the form of cash. Such constraints as there are on the note issue

are constraints upon the demandfor money as a whole, and as we have already seen,

deposits form a much larger proportion of the money stock as a whole than do

currency notes. Since the cost of producing a banknote is considerably less than its

face value, there is a substantial prot to be made from the printing and issue. This

known as ‘seignorage’ and is paid, in the UK, to the Treasury.

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3.2 Banks

Some central banks are responsible also for the issue of coins, but in the UK this

is the responsibility of the Royal Mint.

3.2Banks

As Table 3.1 shows, the term ‘banks’ covers a wide variety of institutions whose prin-

cipal function is to accept deposits and make loans. All deposit-taking institutions

require a licence which is granted by the FSA under the Financial Markets and Services

Act (FSMA), 2000. But not all deposit-taking institutions are ‘banks’. For example,

insurance companies often hold deposits on behalf of their clients in the course

of arranging cover and settling claims. These are excluded from the denition of

‘bank’, together with building societies, credit unions and friendly societies. The

banking department of the Bank of England is also excluded (a change since 2000).

The category does, though, include the supermarkets and other retail stores which

have started to offer basic banking services in recent years. Examples are Sainsbury’s

Bank plc and Marks and Spencer Financial Services plc. It also includes branches of

foreign banks whose licences are granted by regulators in their home countries but

which meet the terms of what is known as ‘schedule 3’ of the FSMA, 2000.

If we add building societies and the banking department of the Bank of England

to ‘banks’, we have a category known as ‘monetary nancial institutions’ (MFIs). These

are institutions whose deposits feature in ofcial measures of the country’s money

supply. If we then add to this category the credit unions and friendly societies men-

tioned earlier, we have ‘deposit-taking institutions’.

The FSA website (www.fsa.gov.uk/pubs/list_banks/2005/lob_apr05.pdf) maintains

a list of institutions making up the category of ‘banks’. The constituents are grouped

together by nationality of the head ofce. The list numbers approximately 500.

Table 3.3 shows the consolidated balance sheet of banks operating in the UK.

In years gone by, it used to be possible (and useful) to classify banking rms by the

kind of banking business that they did. Thus we used to speak of ‘clearing banks’.

These contrasted with ‘merchant banks’, ‘discount houses’ and so on. However, since

the 1980s there has been a remarkable trend towards merger and the globalisation of

banking activity, with the result that the major retail banking rms now include not

just a retail banking division but also divisions specialising in other forms of banking

(and even divisions specialising in non-banking activity, as we saw in Box 3.1).

In Figure 3.1, we have divided banking activities into four main groups. Retail

bankinginvolves the provision of loan and deposits facilities to the personal or

household sector. It also includes banks which provide similar services to small and

medium-sized rms. Both types of activity include payment services, and so banks

operating in both parts of the retail sector are heavily involved in the payments

mechanism. Under the heading of wholesale bankingwe have ‘corporate banks’ which

provide loan and deposits facilities to large corporate clients and also a large range

of fee-based nancial advice of relevance to the major plcs. In addition, we have a

range of institutions, known as ‘investment banks’, whose principal activities have

little direct contact with conventional banking activity at all (loans and deposits)

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Chapter 3

• Deposit-taking institutions Table 3.3Banks in the UK – assets and liabilities (£m, end-December 2005)

Assets	% of	Liabilities and capital	% of
	total		total

Notes and coin	9,501	0.17	Deposits	3,465,7041
					62.70
			CDs	507,959	9.19
Operational deposits at	1,388	0.035	Repurchase	1,008,858	18.25
the Bank of England			agreements
Cash ratio deposits	1,949	0.025	Other	205,505	3.72
Market loans and CDs	960,085	17.37	Capital etc.	338,835	6.13
Bills	41,831	0.75
Acceptances	1,774	0.32
Repurchase	1,245,043	22.53
agreements
Investments	722,053	13.06
Advances	2,324,241	42.05
Other	218,996	3.96
	5,526,861	100.02			2
				5,526,861	100.0

¹Includes sterling sight deposits of £883,315 equal to 16% of total liabilities.

²Percentages may not sum to 100 owing to rounding.

Source:Adapted from ONS, Financial Statistics February 2006,table 4.3A

Retail banking	Wholesale banking
PersonalSmall business	CorporateInvestment

Retail banks
– the ‘Big Five’	ll	ll
– others	l
Wholesale banks
– UK ‘merchant banks’		ll
– Foreign banks		ll

Key: lheavily involved; limited involvement

Figure 3.1A taxonomy of banking

but are concerned mainly with the operation of security markets. Neither category

of wholesale bank is involved in the operation of the payments mechanism.

What Figure 3.1 also shows is that retail banking is dominated by the so-called

‘Big Five’: HSBC, LloydsTSB, Royal Bank of Scotland, Barclays and HBOS. It also shows

that these major banking groups are heavily involved in all four types of banking

activity (remember that Box 3.1 showed the structure of RBS). The ‘other’ retail banks

include the Abbey and other former building societies, and some Scottish banks.

These too are engaged in business and corporate banking, though only on a limited

scale and none plays any role in investment banking.

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