FINANCIAL INSTITUTIONS
The Bank of England is the central bank of the United Kingdom. It was established in 1694 and nationalised in 1946.
Functions of the Bank of England
The Bank of England is the sole issuer of notes and coins through the Royal Mint.
The Bank of England is the government's banker.
The Bank of England is the banker for commercial banks.
The Bank of England has close links with foreign central banks and the IMF.
The Bank of England holds the UK gold and foreign currency reserves in the exchange equalisation account which it uses to help stabilise sterling.
Since the election of the Labour government in 1997, the Bank of England has been given operational independence. This means that they set interest rates through a Monetary Policy Committee that meets monthly. This takes the setting of interest rates out of the hands of politicians. The Bank of England set them at a level appropriate to meet the governments inflation targets.
The Money Market
The money market arranges large-scale short-term loans (up to three months) and is mainly used by commercial banks and discount houses.
The Stock Exchange
The London stock exchange is the centre of the capital market and provides large-scale long-term loans for companies and the government.
New Share Issues
Firms can raise money for expansion by reinvesting profits or arranging a loan through a bank. However, a company wanting to raise millions of pounds' worth of capital may consider going public, ie becoming a public limited company. The firm prepares a prospectus stating the history and aims of the company and inviting the public to buy shares.
A public limited company can raise further capital through a rights issue when shareholders are invited to buy new shares at a discount on the current stock market price.
An alternative method of raising money is to issue debentures. A debenture is a loan to a company paying a fixed rate of interest. Second-hand debentures can be bought and sold on the stock exchange.
Table 12.1 Types of share
Type |
Dividend |
Vote |
Order of dividend payment |
Ordinary or equities |
Depends on size of profits |
1 per share |
Paid last |
Preference |
Fixed but no profit means no dividend |
None |
Paid first |
Cumulative preference |
Fixed but lost dividends made up |
None |
Paid first |
Organisation of the Stock Exchange
In 1986 the stock exchange underwent a radical change in organisation (the 'big bang'):
Market makers buy and sell shares.
Brokers or dealers represent the client but may be part of the same firm as the market maker.
Market makers and brokers are linked by a new computer system, SEAQS (Stock Exchange Automated Quotation System).
The stock exchange has been enlarged to include a number of high street banks and foreign financial institutions.
The Stock Exchange Council (a committee of elected dealers) is directly responsible for policing the market. The council itself is under the supervision of the Securities and Investment Board.
Changes in Share Prices
An increase in the demand for a share will raise its price. This may be the result of a possible takeover bid, increased profits or because the economy is booming.
A speculator buys or sells shares hoping to make a quick profit. There are three sorts:
A bull buys shares now expecting share prices to rise.
A bear sells shares now expecting share prices to fall.
A stag buys new share issues expecting their price to rise.
Functions of the Stock Exchange
An organised market for the purchase and sale of second-hand shares.
The stock exchange gives people confidence to buy new shares issued by companies since they know there is an organised market for their resale.
The stock exchange allows institutions collecting money for small investors such as trade unions, insurance and pension funds to make large purchases of shares in UK companies.
Other Financial Institutions
A number of specialist institutions lend for special purposes:
Building societies assist house buyers by collecting money from many small savers and lending large long-term loans.
Merchant banks specialise in lending directly to firms, and in giving advice to companies involved in takeover deals.
Discount houses borrow money from commercial banks and buy treasury bills.
Finance houses specialise in leasing and hire purchase agreements.
Pension funds collect contributions which are then used to buy stocks and shares.
Unit trusts allow small investors to buy a spread of shares in different companies. The money raised from selling units is used to buy stocks and shares in a large number of companies. Units can only be bought and sold from the trust.
Insurance companies collect premiums from policy holders. Some of this money is used to buy stocks and shares.
There is an increasing trend for financial institutions to extend the scope of their business. As a result of the Building Societies Act (1986) they are now able to offer a wide range of financial services. However, many Building Societies have converted to Plcs as they feel that they are unable to compete fully if they retain their mutual status. This process was started with the conversion of the Abbey National to a Plc. These conversions have resulted in substantial windfall payments during the 1990s and helped contribute to the recovery in retail sales in the middle of the 1990s.