We are all familiar with high street banks, such as Lloyds, HSBC and so on but what is a Central Bank and how is it different?

What is a Central Bank?

In a nutshell, Central Banks, such as the Bank of England, Federal Reserve and European Central Bank, are financial institutions with responsibility for the supply of money to a nation or group of nations. Other responsibilities of a Central Bank include managing the money within an economy via monetary policy and regulation of financial institutions. Central Banks may or may not be owned by the state in which they operate and may or may not be government departments.

What is the Bank of England?

Known as “the Old Lady of Threadneedle Street”, the Bank of England (“BoE” or “the Bank”) was originally established in 1694 to raise funds for war with France by issuing ‘Bank Stock’. In excess of 1,200 individuals purchased this ‘Bank Stock’ (shares) and they raised a total of £1.2 million. King William and Queen Mary purchased £10,000 of stock, but many other buyers were everyday working people. As time passed, more money was raised from an increasing number of shareholders, including private banks, and dividends were paid to shareholders from profits. The bank of England also operated as a deposit-taking commercial bank.

In these early years, the Bank of England functioned like a private company does today, with those owning more than £500 of Bank Stock (the equivalent of almost £70,000 in 2021) eligible to vote at Annual General Meetings (AGMS). Those serving as Directors needed to own at least £2,000 of stock (the equivalent of almost £272,000 in 2021) and the Governor needed to own at least £4,000 (the equivalent of almost £450,000 in 2021).

In 1844, the Bank of England started to act more like a Central bank than a Private Company as it was granted a monopoly to issue banknotes and protect the financial system. Finally, in 1946, the BoE was nationalised due to its importance to the UK economy (being owned by the public, rather than private individuals). The same was happening to other Central banks across Europe at this time. Shareholders were compensated by being given Treasury 3% Stock in exchange for their shares.

Since 1997, the BoE has been responsible for setting the UK base interest rate when the Government transferred the responsibility for monetary policy to the Bank.

Today, the Bank continues to be owned by the UK Government and the funds are held by the Treasury but are supposed to be free from political influence and the Bank able to carry out their duties independently.

What are the Bank of England’s Responsibilities?

The Bank of England is responsible for:

Setting Monetary Policy, mainly via the base rate of interest.
Issue of currency.
Regulation of financial institutions via the Prudential Regulation Authority.
Acting as a lender of last resort in a crisis.
Providing economic stimulus via Quantitative Easing.

What issues do Central Banks face?

One of the biggest issues facing Central banks today is the pressure being put on them to reduce their balance sheets after the large positions they accumulated following the 2008 crisis, mainly in bonds. However, given the sheer volume of the assets purchased, it’s unclear whether or not there are other buyers available to buy the assets at a fair value and, it’s likely that a measured selloff over time would also affect the value. As a result, many are taking the approach of letting the bonds mature and not replacing them with new ones.

Central banks’ balance sheet growth — *Central banks balance sheet growth.*

Another of the major challenges affecting Central Banks, and the Bank of England in particular, is to control inflation via monetary policy. In a Pre-2008 world, monetary policy was fairly one-dimensional and mainly focused on adjusting the base rate. However, the BoE now wants to have a range of tools in its toolbox such as communicating a change is imminent and seeing how the markets adapt, before actually making any changes to the base rate.

Another factor for Central banks to consider is how they are going to handle digital currencies and how they may produce a digital asset that is less risky than traditional cryptocurrencies, retain its value and be reliable over time. The Bank of England suggests that ‘Digital Sterling’ or ‘Britcoin’ would be for everyone to use and will be in denominations of pounds sterling; essentially a digital banknote that works alongside cash, which is much less in demand than it used to be.

Conclusion.

Understanding what a Central Bank is and what the Bank of England’s responsibilities are should be an essential part of everyone’s financial toolkit. Inflation affects all of our investments and, in order to not only maintain the value of assets as a minimum, but seek to grow the value of investments over time, knowing the responsibilities, capabilities and challenges that Central Banks face should facilitate better decision-making and long term planning.

What’s next?

If you need help or advice on your personal or business finances or if you want to consider investing to make your money work harder, you can get in touch with one of our advisors for independent financial advice. We offer a free initial consultation and although we are based in Tunbridge Wells, we advise clients across the UK.

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Don’t forget, this article offers information about investing and should not be taken as personal advice. Remember that investments and pensions can go up and down in value, so you could get back less than you put in. Tax rules can change and the benefits depend on individual circumstances.

What is a Central Bank and what is the Bank of England?