VII. Complete the sentences using your own words:

1. The first objective of any central bank is ……

2. Monetary policy operates in the UK mainly through …..

3. Setting monetary policy - deciding on the level of interest rates necessary to meet the inflation target - ……

4. As part of the Government's move to increase public scrutiny of policy making, ………

5. The minutes, which include the Governor's advice, are now …….

6. Although the decision on whether, and by how much, to change interest rates is the Chancellor's, ……..

7. When more money flows from the banks to the government than vice versa, the banks' holdings of liquid assets are run down and ……….

8. Interest rates affect ………….

9. The reserves are held in a government account called the Exchange Equalization Account, which was set up in ………….

10. Short-term interest rates and foreign exchange market intervention are ……

Unit II

The uk money and banking markets

TEXT A

The uk banking market

The banking and money markets in the UK, like their respective markets in the United States, are not two distinctive mutually exclusive markets. Rather, they overlap each other substantially. We define the banking market in terms of major market participants — banks in this case — whereas we define the money market in terms of financial instruments traded. Since banks are also important dealers of money market instruments, it is natural that the two markets overlap.

First we examine the characteristics of the British banking market, focusing our attention on the type of banks and their major activities. We will also point out the mode of operation should it be significantly different from those in other markets.

The British banking market structure

Banks in the UK are a diverse group of financial institutions which are characterized by the fact that on the liabilities side they take deposits with relatively short maturity and that on the assets side they make loans for a variety of purposes with longer maturity, longer than the deposit maturity. In addition, many banks provide ancillary services, such as payment guarantee facilities, corporate financial advice, and investment management.

At present, banks in the UK are classified into eight groups for statistical reporting purposes: (1) retail banks, (2) British merchant banks, (3) other British banks, (4) American banks, (5) Japanese banks, (6) other overseas banks, (7) other (quarterly reporting small) banks, and (8) discount houses. Except for the first group of banks, all others are by and large engaged in wholesale banking, which involves relatively large-sum deposit taking and lending with narrow interest rate margins.

This classification of banks, as announced in August 1989 by the Bank of England, is based partly on functions, partly on ownership and partly on data-gathering convenience. Therefore each group does not necessarily represent banks with distinctive functions. Rather, many different groups of banks perform similar functions. The major function of financial intermediaries is to acquire "illiquid primary securities" while issuing "liquid indirect securities" to the nonfinancial sector. It is therefore easy for each type of financial institutions, particu­larly larger ones, to extend their services into areas previously specific to a particular type of banks, thereby blurring the grouping boundaries. In effect, as early as 1959, such possibilities were clearly noted in the Radcliffe Report because of the similarity of liabilities of financial institutions.

Table 1 shows major changes in the classification of banks in recent years. Prior to the enactment of the Banking Act 1979, financial institutions recognized as banks were the so-called "listed banks," which were under the Bank of England credit control scheme and submitted their returns to the Bank. In a sense, at that time banks were defined by the regulatory relation­ship with the Bank of England rather than by a formal charter. These banks were collectively known as the "UK banking sector." But there were a number of banks falling outside the Bank's control, yet performing similar functions to those of the listed banks.

Table 1. Changing UK banking sector

UK banking sector		Institutions forming the monetary sector		Institutions included within UK banks
London clearing banks	6	Retail banks	19	Retail banks	21
Scottish clearing banks	3
Northern Ireland banks	4
Accepting houses	35	Accepting houses	35	British merchant banks	36
Other British banks	70	Other British banks	241	Other British banks	150
Overseas banks	201	American banks	63	American banks	42
		Japanese banks	25	Japanese banks	31
		Other overseas banks	227	Other overseas banks	277
Consortium banks	29	Consortium banks	23
Bank of England Banking Department	1
Discount houses	18	Discount houses	10	Discount houses	8
	367		644		557

After the enactment of the Banking Act 1979, all recognized banks and licensed deposit-takers were brought under the control of the Bank of England so that the reported number of banks increased substantially. In addition, some banks established by special legislation, known as Schedule 1 banks, were also brought under the new retail banks group largely on the basis of their retail banking functions. Since the liabilities of these banks constituted a bulk of certain monetary aggregates, the name "banking sector" was replaced by the term "monetary sector."

However, in 1989 the conversion of a large building society into bank status brought about a major break in monetary aggregate data series, making the use of the term monetary sector inappropriate. The liabilities of banks in these remaining monetary aggregates are no longer so predominant as to call the group of banks the monetary sector. The institutions in the monetary sector were renamed "banks in the United Kingdom."

As shown in Tables 1 and 2, as of the end of 2000 there were 557 banks with total assets of £1,258.5 billion. The market share of the foreign banks as a whole in terms of asset size was 56.4 percent, while that of the retail banks was 33.1 percent. Therefore the combined share of all other banks was only 10.5 percent. Now let us take a brief look at individual groups of banks.

Table 2 British banking market structure (as of December 31, 2000) (in

billions of pounds)

Type of banks	Liabilities and capital		Assets		Total liabilities/total assets
	Sterling	Foreign currencies	Sterling	Foreign currencies
Retail banks	364.8	61.3 (14.4)	355.0	71.1 (16.7)	426.1	(33.1)
Merchant banks	42.6	16.8 (28.3)	40.8	18.6 (31.3)	59.4	(4.6)
Other British banks	48.9	7.6 (13.5)	46.1	10.4 (18.5)	56.5	(4.4)
American banks	21.3	89.0 (80.7)	20.2	90.1 (81.7)	110.3	(8.6)
Japanese banks	43.1	211.4 (83.1)	40.5	214.0 (84.1)	254.5	(19.8)
Other foreign banks	108.2	251.4 (69.9)	109.3	250.3 (69.6)	339.6	(28.0)
Other banks	2.5	1.7 (33.3)	2.3	1.9 (36.4)	4.2	(0.3)
Discount houses	14.7	0.5 (3.2)	14.7	0.5 (3.2)	15.2	(1.2)
Total					1,285.8	(100.0)