The India Council, for instance, lends large sums in the London short loan market. The numerous foreign and colonial banks in London do the same, and so, too, do many of the large insurance companies and merchants, while during slack times money finds its way from the Stock Exchange to the bill broking houses. At first sight it seems strange that bankers should advance money to the bill brokers, and so provide their rivals with capital with which to compete against them, especially as the banks have discount departments of their own.
Let us, however, consider the position of the bill broker in relation to the Bank of England and the money market.
Towards the beginning of the nineteenth century the broker acted as agent for the country bankers, but this connection was naturally severed when the country firms opened accounts with the London bankers, and the broker, whose knowledge of bills was extensive, then transacted business for himself. Through holding out for high rates, the London private bankers drove a large amount of business into the hands of the bill brokers, who, by confining their attention solely to this class of credit document, came to be largely trusted by the joint stock companies, which could not obtain servants with the special training of their rivals.
In no other country has the bill broker such influence as in England. In Paris, for instance, the customer discounts with his banker, who re-discounts with the Bank of France; but in London, for reasons already stated, bills find their way to the bill brokers, who re-discount either with the banks or with the Bank of England. Moreover, all the best bills get into the hands of the bill brokers, who, at one time, only discounted the acceptances of the banks and the larger houses; but they now take small trade bills, and, should the banking business grow less profitable, it is questionable whether the banks might not endeavour to dispense with the middleman whom they now encourage.
We next have to consider the London money market as a whole. First we find a system which comprises Lombard Street and Threadneedle Street. In other words, the London banks, by keeping accounts with the Bank of England (Threadneedle Street), have placed that institution in the centre of the system, and we know the Bank derives great power from this situation; but its power is not innate—it is derived through and is dependent upon Lombard Street. This group we will call "the money market" or "the market."
Then we have the bill brokers, of whom we will speak as "the outside market." Every morning the bill broker goes from bank to bank inquiring at what rates he can borrow; and if Lombard Street (the London banks) cannot supply him with all the capital he requires, then he is compelled to apply to the Bank of England, which, however, he always endeavours to avoid, because the Bank invariably charges him a higher rate than do the other banks.
The Bank of England is a great bank of discount: consequently, the brokers are its rivals; so it is hardly reasonable to expect the Bank to charge the same rates to them as to its own clients, seeing that the brokers, by their competition, reduce the Bank's business. When trade is brisk loanable capital is in considerable demand, and the banks, therefore, have less money to lend to the bill brokers, who consequently are then driven to the Bank, which holds the bankers' balances.
But the Bank of England's position is an extremely delicate one; and when the resources of Lombard Street are temporarily exhausted and demand centres upon itself, it has to take care that its ratio of reserve of notes and cash in the Banking Department does not sink too low in proportion to its liabilities. Should the demand upon its resources prove considerable, it raises its rate until the pressure is reduced. As a large part of the trade of this country is conducted through the medium of bills of exchange, it is absolutely essential that there should always be a market for good bills. Otherwise, panic and failures would be the result; so, were the Bank to refuse to take bills from the brokers at a price, our credit system would collapse at once, unless the banks themselves, determined to crush the brokers, offered to deal direct with the holders. But the experiment would be a most risky one to make. Moreover, it could not be attempted at a critical moment.
When Lombard Street is not lending freely, or cannot lend further with comparative safety, the Bank, by raising its rate of discount from time to time, reduces the merchant's profit on each transaction, until at last money becomes so dear that he finds that he is making little or no profit on his goods. He therefore produces less, and, consequently, discounts less, when the pressure upon the Bank relaxes.
So long as money may be obtained, let the price paid for it be what it may, a sense of security pervades the community; but were it whispered during a period of temporary tightness that the Bank refused to discount good bills at any price, our credit system would be in imminent danger, for the trade of the country would be at a standstill. Further, did such a state of affairs continue for many days, the crash would come, and the Bank of England would then be swept away with the rest of the market. Our present system is so delicately poised that the Bank simply dare not refuse to take good trade bills from the brokers.