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Dissertation on Banking

This is a dissertation chapter on “Comparison of the United Stated and United Kingdom
Banking Systems”
topic:

The Bank of England has had much success and as a result many nations have followed its lead in creating a central banking systems of their own. The United States is one of these nations. The two nations have many similar banking objective and strategies on how to best achieve the objectives. These nations also differ greatly in some aspects of their banking philosophies. The currencies of both nations are strongly held around the world. Their monetary policies and bank regulations differ in some aspects, but both nations banking systems are held to high esteem worldwide. The banking systems of the United States and the United Kingdom were born of the same origins but differ in some major aspects of practice.

The United States monetary system was greatly influenced by that of the United Kingdom. The United States Federal Reserve Board and the United Kingdoms Monetary Policy Committee are both used to regulate the economy and are similar to one another. The Federal Reserve System is the central bank of the United States and was established by Congress in 1913. The bank of England is the central Bank of the United Kingdom and plays the same role as the Federal Reserve. The main roles of the Federal Reserve is to influence the money and credit conditions to achieve stable prices, supervise and regulate banking institutions, maintain the stability of the financial system, and provide financial services to the US Government, the public, financial institutions, and foreign official institutions (Federal Reserve Board Homepage). Before the Bank of England Act of 1998, the United Kingdom and the United States were similar in that their central banking institutions were in charge of these same four objectives. Now the difference is that the Federal Reserve supervises open market operations, where the United Kingdom the Treasury supervises open market operations.

The Bank of England and The Federal Reserve’s main objective for monetary policy is price stability, while maintaining economic health. To maintain economic health they focus on maintaining low levels of unemployment and a high GDP. The Federal Reserve and The Bank of England aim to maintain confidence in the domestic financial markets and stability in the foreign exchange markets. To achieve this price stability, they are focusing on a monetary policy that targets the value, supply and cost of money in the economy. Both The Bank of England and The U.S. Federal Reserve use the interest rate to influence the economy and control price stability. The interest rate policy is formed through evaluation of many factors such as demand, output, employment, money and credit growth, asset prices and the exchange rate.

The Central Banks of the United States and United Kingdom take measures to prevent the collapse of their banking system. The Federal Reserve and The Bank of England protect themselves by functioning as a lender. They step in as a last resort option to prevent a financial institution from failing if the failure is expected to hurt the overall economy. Both systems also have a requirement for all commercial banks to ensure that the commercial banks will be capable of meeting their liabilities.

Along with protecting themselves the Central Banks also have interest in protecting, as well as maintaining confidence of their consumers. To gain confidence and insure their customers the United States and United Kingdom banking Systems are monitored and maintained by the American Federal Deposit Insurance Corporation and the United Kingdom’s Deposit Protection Fund. These organizations provide bank customers with insurance on their deposits in case of a bank failure. In this aspect the two countries differ because of the reserve requirement. In the United States, The Federal Reserve sets the reserve requirement through a legal process. However, in the UK, there is no legal limit to how low the reserve requirement may fall (The Federal Reserve).

The Bank of England and The Federal Reserve currently have similar policies and goals but different levels of independence. The United State’s Federal Reserve is much more independent and has more duties than the United Kingdom’s Bank of England. The Central Bank of England just gained the ability to raise or lower interest rates to maintain consistent price levels in 1997. The Bank of England is also less independent; in extreme circumstances the government of the United Kingdom reserves the right to overrule the actions taken by the bank.

The Federal Reserve and The Bank of England use different methods to achieve their financial goals. The Federal Reserve Bank relies on the monetary aggregates and interest rates to achieve goals. The Bank of England currently uses interest rates to control inflation. The United Kingdom heavily focuses on inflation targeting through interest rates. The interest rates are targeted through short-term treasury bills (because of their high level of liquidity) and the Bank Rate. The United Kingdom is much more quick to adjust interest rates in order to achieve their ideal level of inflation than the Federal Reserve.

Another function of the Federal Reserve and Bank of England is to raise funds for the Government. Both systems raise these funds in a similar fashion. The Bank of England sells “gilts” which are “marketable instruments denominated in sterling,” and The Federal Reserve sells Treasury bills in the form of bonds (Monetary Policy).

The United Kingdom has about twenty major banks. Like most of the nations with competitive markets, 5 banks control the industry due to economies of scale. The United Kingdom’s economy varies greatly from the United State’s. The United States has about 8,500 banks (Milgate 248). The ten largest banks in the United States hold just 36% of the assets in the banking industry (Milgate 251). The United States had many regulations limiting the geographic area that banks can serve and the services banks can offer. This was limited by the Glass-Steagall act, and resulted in banks in the United States remaining small. These constraints do not exist in the more competitive market setting of the United Kingdom. The banks in the United Kingdom were free to develop in order to maximize profits and shareholders wealth. Due to economies of scale larger banks are more profitable than smaller banks, larger money deposit creation, and geographic diversification, all the small banks were driven out of the market. Inefficient banks were allowed to remain in business in the United States because of government protection.

Recent bank deregulation and loophole mining in the United States has led to bank consolidation on a national level. This trend of bank merging is expected to continue since the super-regional banks are anticipated to continue to increase in size. The 1999 repeal of the Glass-Steagall Act, which prohibited commercial banks from selling corporate securities, allows financial institutions to expand their list of services. Today the United States greatly outnumber the United Kingdom in the number of commercial banks. This may change in the near future. With all the banks merging and creating larger banks the individual number of banks will diminish. The United States and United Kingdom commercial banks will still differ in that, in the United Kingdom commercial banks are allowed to hold corporate equities and in the United States they are not.

After the exceptionally successful integration of euro into circulation and a three and a half year stable exchange rate for the euro, the United Kingdom is now debating over its own switch over to using the euro. Sterling is now viewed as overvalued and thus foreigners are less likely to invest in the United Kingdom because the return on their investment will be smaller. Even if Sterling is depreciated to reflect its true value, foreign investors will still be less likely to invest in the United Kingdom due to the future uncertainty of the exchange rate. If the United Kingdom does decided to switch to the euro the currency will be more susceptible to damage by the actions of the other members of the euro state. The United Kingdom is still weighing the benefits and the disadvantages of the switch. The United Kingdom’s entry as a euro member is beginning to look more probable since the Bank of England has developed a plan to put the euro into circulation. The plan could be fully implemented within a year of the official announcement to change over to the euro.

While contrasting the banking system of the United Kingdom to the United States regarding the future of the currency, central banking, and commercial banking system we found many similarities as well as differences. When looking at the United States, we see one of the most powerful and independent central banks, that was influenced by the United Kingdom’s banking system. Although, the United Kingdom has less independence and a narrower level of authority they still maintain and effective banking system. Meanwhile the United States supports legislation to defend its citizens from the influential commercial banks. It was this legislation that barred economic efficiency form occurring in the United States. It was the United Kingdom who did not take responsibility to develop legislation to prevent the harmful effects of commercial banks on the public and yet they have the most efficient commercial banking system. Although the two countries banking systems differ both have proven to be effective.

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