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Pounds are the money that people use in England and the English monetary system is built around using money instead of barter to settle debts and for purchasing purposes. Monetary system has become very complicated and is supervised by the Bank of England founded in 1694. Its current role is to carry out the monetary policy while also regulating and supporting the banking system. It is also the government's banker and manages the national debt, the lender of last resort to LDMA(London Discount Market Association) and the issuer of notes. It also carries out foreign exchange transaction and gives statistical information about the country.
Monetary policy was previously mainly the control of money supply, but interest rates have gained more importance nowadays. It is basically the direction of Economy through the price and availability of money. The Bank has recently adopted a medium term financial strategy for directing the economy in order to break down the stop-go cycle. Money supply control was abandoned because it was not easy to measure. We now have two different measures: broad or secondary money being M4 for the store of value, and narrow or primary money M0 being for the medium of exchange. First includes notes and coins in circulation and commercial banks cash deposits in the Bank and the latter includes M0 plus all deposits, certificates of deposits and building society deposits.
Interest rates can only be influences by the Bank by changing the rate at which it buys Treasury Bills, seven or fourteen days from maturity, and also marginally by setting the rate that it lends as a last resort to the LDMA. LDMA discounts the bills of banks and the banks can call money from it with very short notice. LDMA is unique to Britain. The Bank could in theory, although not used recently in the UK, change the liquidity ratios (amount of deposits that banks must keep in cash) or use moral suasion or funding (selling national debt to general public) to affect the interest rate. The final decision as to the level of interest rates lies with the Chancellor, Kenneth Clarke, but the Governor of the Bank of England, Eddie George's, views are becoming increasingly important and there is much debate at present whether the responsibility of setting their level should be completely handled by the Bank to reduce political bias. When the level of interest has been decided it is up to the Governor to decide when the new rate should be introduced. Interest rate setting is not perfect to reach the policy objectives. It is said to be less inflationary than fiscal policy, but hot money will flow in from abroad causing problems, and people will borrow and firms invest regardless of high interest rates. Changes in interest rates are a medium target of government policy. They will affect the aggregate demand and this ultimately leads to the major targets: lower inflation, steady self-sustained growth and low unemployment.
Banking system in England has become one of the least regulated in the whole world, but it is very profitable to England, maybe because its high liquidity. This has attracted many foreign banks to England. Control of the banking system must still exist to avoid liquidations, like Barings, and to make sure banks are not operating against the Bank's policy. One of the regulations is for the commercial banks to keep a small percentage of their eligible liabilities in cash. The bank also monitors the growth of M0 to be in the range of 1-4%. The Bank must be careful with the control as otherwise the protection that the Bank offers may lead to banks adopting careless or very risky strategies.
There are obviously other banks besides the Bank in the UK. Their duty is to create credit - relend the money that had been deposited with them. They are thus financial intermediaries and their assets form part of the money supply. There are two types of banks existing. Primary banks deal with the transmission of money, advisory services and sale of financial products such as mortgages and insurance. They are the commercial banks on high street, LDMA and clearing banks. Secondary banks deal with other financial intermediates like bills and provide services other than money transmission like floating. They are the wholesalers in banking. Merchant banks are a main example of them. They are also involved in intermediation - bridging the financial needs of companies when they are not able to borrow themselves.
Money moves and is exchanged on two types of money markets in the UK. The transmission in classical markets starts with the Bank lending to LDMA. They then lend on to commercial banks who pass it to general public. Parallel markets are much newer invention. They include the local authorities' market, finance houses' market for hire purchase, interbank market for dealings between banks, certificate of deposits' market and eurocurrencies' market. Large companies also participate here.
Due to the complexity of the monetary and banking system there are several Acts regulating it. The Banking Act 1979 defined the licensing of banks and introduced a deposit protection scheme. Monetary control provisions were founded in 1981. The Banking act 1987 set out a stricter supervision including the increase of minimum capital to £5m. The Building Societies Act 1986 was issued to regulated building societies.