Since 1844 this power has, of course, been taken out of the hands of the Bank; but it is evident that, even before that date, the Bank of England could not fix the rate of discount, for whenever it made the attempt it failed signally. The above illustration fully explains the reason why. Both before and after the Act the Bank of England would have suspended payment upon more than one occasion, when it neglected to keep an adequate reserve, but for Government intervention; and it will be in the same plight again if it trade with too large a proportion of its resources.
The Bank was then by far the largest dealer in credit, and from time to time it stated the minimum rate at which it would lend or discount. But the private bankers were at liberty to underbid it; and although it could, by making sudden advances, cause money to fall in value, its power was not of a lasting character, and the rise which followed was quite beyond its control. Its rivals are now much more powerful, and the Bank is only one large dealer among many—therefore it has to either raise or lower its rate according to the demands made upon its resources; but from its position in the centre of the money market it still possesses a latent power for possible evil, which appears to have escaped the attention it deserves.
This brings us to the vexed question of the creation of credit by a bank, and though it is stoutly maintained that an ordinary banking company cannot create credit, I venture to think that, given certain conditions, it does. But perhaps, before proceeding further, it will be better to briefly discuss the Clearing House system.
Cheques and bills, we all know, pour up to London in a constant stream to the numerous banks, and are presented by them either to the firms upon whom they are drawn or to their agents at the Lombard Street Clearing House. As every bank which is a member of the Clearing House keeps an account with the Bank of England, the debit and credit balances (the result of this exchange) are adjusted in the books of the Bank at the end of each day, and so, though the balances standing to the credit of the various banks are diminished or increased, the total sum to the credit of all the clearing bankers remains unaltered. In other words, the balances, which are the outcome of the exchange of credit documents at the Clearing House, are finally arranged by transfer entries in the books of the Bank of England.
Every cheque presented in the House is debited to one bank and credited by another, therefore the totals of the debit and credit entries must agree; and if the totals are the same, then the debit and credit balances must agree also. In the smaller towns the banks exchange the local cheques between themselves, and settle the balances in cash or by payments through London. But Birmingham, Bristol, Leeds, Leicester, Liverpool, Manchester, and Newcastle-on-Tyne have Clearing Houses of their own at which local cheques and bills are presented.
We can now approach the question of the creation of credit by a bank. Suppose a bank suddenly increases its advances to its customers by £1,000,000, and that the customers pay away the whole sum by cheques. The said cheques are, say, paid by the recipients to the credit of their accounts with other banks, which present them at the London Clearing House. The balance of the bank which made the advance is thereby reduced £1,000,000 at the Bank, and the accounts of other banks are credited to the same extent; so the deposits at the Bank of England are not reduced one penny by the transfer. But £1,000,000 has been added to the working resources of the other banks; and as the liabilities of the bank that made the advance have not been reduced, surely this is a creation of credit? Of course, the bank which made the loan has lost £1,000,000 in "cash" at the Bank of England, and that asset would then be merged in "advances," which are up £1,000,000; and though the bank has not created credit in its own books, it has in those of its rivals. Surely, then, every bank which makes a new advance to a customer, who employs the sum placed to his credit to cancel certain debts of his own, creates credit in the books of other institutions. But the Bank of England can also create credit in its own.
On the other hand, say, Bank A calls in £1,000,000 from the bill brokers, who obtain credit to the extent of £1,000,000 from, say, Bank C, and draw cheques thereupon, and hand them to Bank A, which takes them to the Clearing House. C's balance at the Bank is reduced by £1,000,000, and A's is increased by a like sum; but in neither case is the "liabilities" side of the balance sheet affected. It is a mere transfer of credit from one account on the "assets" side to another on the same side, while the bankers' balances at the Bank of England remain the same. However, should Bank A advance £1,000,000 to a customer, who draws cheques against it, then the creation of credit in the books of other banks begins, as illustrated by our first example.
Again, take the case of a bank which sells securities, say Consols, to the amount of £1,000,000. It receives cheques upon other banks for a like sum; and these it takes to the Clearing House, where it presents them to those banks upon which they are drawn. The result is that the selling bank's balance at the Bank is up £1,000,000, and that the accounts of the other banks are down £1,000,000; but their liabilities also are down £1,000,000, whereas the liabilities of the selling bank are precisely the same. It has simply transferred £1,000,000 from Consols to "cash" at the Bank of England on the "assets" side of its balance sheet. Such a sale has reduced the floating capital of the banks by £1,000,000. Further, could not a little "window dressing" be done in this manner were a bank to find itself short of "cash" at the end of the half-year? By lending the sum so obtained the selling bank could create an amount of credit in the books of its rivals similar to that which it had previously destroyed. By buying stock back, too, it would produce exactly the same effect as if it made a loan.