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Banking in Scotland
Chapter VII - Control of the Banking System


Britain in general but Scotland in particular was remarkably fortunate in the extent to which Governments left the banking system free to develop its structures and functions in line with the growth requirements of the economy. Throughout much of the history of Scottish banking the only effective monetary control on the banks was the Bank Rate. When the Bank of England put up its rate this was interpreted as a signal to the money market to put up their rates and so control the demand for credit. Open market operations in the sale of Government securities were also devised in such a way as to influence the banks' reserve ratios. Sales of these securities had the effect of reducing banks' reserves with the result that credit contraction would result.

Since the nationalisation of the Bank of England in 1946, however, the range and extent of Government's intervention in the money market has increased markedly. In the 1950s bank rate and open market operations were used extensively as a part of monetary policy. It also became practice from time to time for the Bank of England to issue directives to the banks indicating that they should either expand or contract credit to certain sectors of the economy.

In 1960 Special Deposits were introduced whereby banks were required to deposit a certain percentage of their deposits with the Bank of England. The placing of these deposits then obliged the banks to control their lending in order to bring their reserve ratios back to the required levels. The 1960s was a difficult time for the economy and all forms of credit control were used regularly but this merely gave a stimulus to other financial institutions which the Bank of England found more difficult to control than the banks. The latter were losing business to the secondary banks and finance houses.

So when Competition and Credit Control was introduced in 1971, minimum reserve requirements were stipulated for virtually all financial institutions and all were encouraged to compete for business. This led to some ill-considered business by some of the secondary banks and in 1974 the financial collapse led to the Bank of England together with the Scottish banks and London Clearing Banks setting up a "lifeboat" scheme to prevent these concerns from collapsing.

As part of the 1971 package the efforts by the Bank of England to enforce quantitative controls, i.e., lending ceilings, on the banks were abandoned but the authorities retained the right to provide banks with qualitative guidance when certain priority categories were defined during credit restraint. For example, in 1972 they were advised by the Bank of England to restrict lending to property companies and for financial transactions and to concentrate their advances more on manufacturing industry especially those with export potential. This request was repeated and re-enforced throughout the 1970s.

Other types of Government controls on the ability of banks to lend have remained in force although seldom in their original form. Notably the special deposits scheme underwent several variations in the 1970s ending with a "corset" scheme in 1978. Under this if deposits increased by 4 per cent over six months then further special deposits were required. In this way the Government hoped to choke off the growth of the money supply (deposits) and so restrict the banks' ability to lend.

Experimentation was also made with the role of Bank Rate as a leader of market interest rates and as a controller of lending but this new method in which the Bank Rate's name was changed to Minimum Lending Rate was not a success and the scheme was abandoned in 1978 in favour of the old system although the name Minimum Lending Rate remained. This too was abandoned in 1981 when interest rates ceased to be an instrument of monetary policy.

Many of the changes introduced in the 1970s were intended to increase the degree of competitiveness in the British banking system and to increase the efficiency of Government control. In retrospect it must be argued that much more success was achieved with the former objective than the latter, although the degree of this success is to be seen in the range of services offered rather than in the structure of interest rates and charges.

The extent of Government surveillance and control of the banking system in the 1980s is in very marked contrast to the free enterprise days of the Industrial Revolution.


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