Banks and Their Customers / A practical guide for all who keep banking accounts from the customers' point of view

by Henry Warren

We need not, in a small book of this description, enter into the mysteries of the foreign exchanges, or discuss internal and external drains of gold, but the Bank, in order to arrest a drain of gold outwards, raises its rate, when the other banking companies, equally anxious to stop the efflux, raise their rates too, with the result that borrowers, whether upon bills or securities, have to pay more. Conversely, when the Bank’s reserve is high and the political horizon unclouded this nervous feeling no longer exists. The Bank, we will assume, then lowers its rate, and the other banks follow suit, when the borrower pays less.

When speaking of the money-market, the London money-market is always implied, and here we encounter the bill-brokers to whom the banks advance their surplus funds. The banks, that is to say, finance their rivals, who make bills a speciality, and whose knowledge of bills of exchange is doubtless both extensive and peculiar. Seeing that the banks themselves discount trade-bills for their customers, the necessity of a middleman or bill-broker between the person who discounts a bill and the banker who supplies the capital is not very apparent, but the broker’s “turn,” when he re-discounts with the banks, is extremely small; so it is quite possible that were the banks to establish special departments to deal with this business, the slight increase in their rates would not compensate them sufficiently for the troubles of management. As, under this system, the brokers’ rate of discount is below that of the banks, it follows that all the bank-bills and most of the best trade-bills pass through the hands of the bill-brokers, while bills are also sent to them from all the great cities. The bankers, consequently, discount inferior paper at higher rates for their own customers.

But the Bank of England is a great bank of discount. Moreover, it pays a dividend like any other bank, and, as the bill-brokers are its rivals, it follows that it cannot afford to allow all the business to drift into their hands. When, therefore, the brokers’ rate (the market rate) is below its own, it either takes steps to make its own rate of discount, as the saying is, “effective,” or else it reduces its advertised rate of discount (the Bank rate). The Bank makes its rate representative or effective by selling Consols, and thereby reducing “bankers’ balances.” The banks in consequence have less to lend to the brokers, who are then bound to apply to the Bank of England, which compels them to discount their bills at its own terms, and the rate in the outside market, of course, advances.

We can see, therefore, that though the Bank rate is sometimes either above or below the market rate, it is necessarily never out of touch with it for any very considerable length of time; so now, perhaps, it will be understood why the banks allow 1½ below Bank rate on deposit; and their reason for basing their rate for loans and advances upon the Bank of England’s advertised rate of discount will also be apparent.

Of course, the demand for, and the supply of, loanable capital decides the rate of interest, and as demand and supply are never equal, the rate is always fluctuating, but we might just remember that our artificial banking system “influences” the rate from time to time. During periods of dull trade, when loanable capital accumulates in the hands of the banking companies, we should expect to see a low Bank rate, because, prices of commodities having fallen, people are less anxious to borrow, while fewer bills are on offer, and, the demand for those bills having increased proportionately, it follows that the holders can discount them at a cheap rate. But when business is brisk and the prices of commodities are rising, more bills are drawn, and as the fund with which they are discounted is not limitless, it follows that the increasing demand upon that fund sends up the rate. Bankers, consequently, who have also to meet the requirements of their current-account customers, are sometimes obliged to administer a salutary check to speculation by making the rate almost prohibitive in order to protect their reserves of cash, as if they then lent to all and sundry even Lombard Street would collapse.

Now the Bank of England, we have seen, holds the national reserve, as it were, and is, in consequence, the pillar upon which the money-market rests. Threadneedle Street (the Bank) is, therefore, the centre of the money-market (hence the description “central institution”) into which Lombard Street (the rest of the banks in the United Kingdom) pours its reserve and surplus cash. We might describe the Bank as the heart of the money-market, through which a stream of cash and credit-documents is continually flowing. The brokers (the outside market), who practically keep no reserves of cash, are largely financed by Lombard Street, which, however, calls in its advances to them during certain conditions of the market; and the bill-brokers are then compelled to fall back upon the Bank of England which holds the bankers’ reserves. In assisting the brokers the Bank is also supporting the credit of Lombard Street; so, clearly, the interests of each division are identical; and the closer and more friendly the relations between them the smoother will be the surface of the money-market.

But we have to consider the Bank rate in relation to bankers’ charges; and here another factor must be introduced, to wit, the nature of the securities deposited by the customer. The business man’s favourite investments are English railways, Corporation Stocks, Industrial Companies, and so on, whilst occasionally, endowed with imagination, and recognizing how erratically the earth dispenses her favours, the blessed uncertainty of mines appeals to his gambling instinct. As a rule, a banker’s loans and advances are not covered by Consols, because it would pay the borrower better to sell out and place the sum they realized to his credit. Advances against Consols would be made principally to stockbrokers and to speculators who had bought them largely in the hope of a rise in price.

Competition for an advance, which is covered by tangible securities, is keen both in London and the provinces, and competition, we must remember, tends to reduce the rate. Then, again, assuming that the Bank rate be 3 per cent., and that a banker suggests 4 per cent. on an advance covered by railway debentures, the customer may not see the force of maintaining a margin of 10 per cent. between the market-price of his stock for the protection of his banker, and paying him, say, ¾ per cent. more than his securities return on his purchase-money. As the customer’s loan or advance is well secured, and as the banker will only advance to the extent of 90 per cent. of the market-price on the condition aforesaid, he is only willing to pay Bank rate upon the sum he borrows.

We next have to consider the amount of pressure the customer can bring to bear on his banker, of whom his securities make him practically independent. He may, in the first place, threaten to remove his account unless his banker grant him a loan at 3½. Secondly, he may decide that it will pay him better to sell his debentures at the market-price. Again he may only require the loan for a few months or even weeks; and as, in his opinion, the debentures will probably appreciate in value, he may decide to pay 4 per cent. for a short period to either selling out or troubling to find a cheaper market. Obviously, the higher the Bank rate advances the less disposed is this class of customer to pay ½ per cent. above it; so, when the official minimum is at 5 and 6, he can often arrange for an advance at Bank rate or even at a ½ below it. On the other hand, the banker, when Bank rate is at 2 or 2½, generally refuses to lend at less than 3 per cent. per annum. The rate, therefore, upon a secured advance is influenced by the nature of the cover deposited as well as by the state of the money-market.