Despite the fact that modern central banking did not come about until the 19th century, the history of the Bank of England extends back far further. While its responsibilities have no doubt transformed over its three-century history, the Bank has always served a distinguished role in Britain’s system of public finance. Indeed, the institution has its origins, not in conducting monetary policy, but in providing loans for the state. It was in exchange for these services that the Bank was granted its extraordinary privileges despite being a private institution for most of its history.
These privileges allowed the Bank to eventually position itself to fulfill the role of a central bank. So significant was the Bank of England, and the advantages it was conferred, that the institution was the only incorporated bank in Britain for over a century. Only in 1826 was legislation passed allowing for the creation of new joint-stock banks, more than 130 years after the loan was raised that led to the creation of the Bank of England. That loan, needed to rebuild the English navy after a crushing defeat, turned out to have a profound significance in Britain’s economic history.
William and Mary
The creation of the Bank of England was in many ways enabled by the ‘Glorious Revolution’ of 1688. Late that year, the English king, James II, was overthrown and replaced by his daughter Mary and her husband William of Orange, who had ruled the Netherlands. The previous kings of the House of Stuart had steadily reduced England’s creditworthiness. This fiscal difficulty arose partially from wars against the Dutch but also from the unwillingness to raise taxes if it meant having to convene Parliament. The Stuart monarchs relied on loans forced from creditors and James II’s predecessor, Charles II, had defaulted on the Kingdom’s debts in 1672. When the English Bill of Rights was enacted after James II was replaced by William of Orange (William III), fiscal authority shifted to Parliament.
The Glorious Revolution also replaced a pro-French government with a strongly hostile one. To a large extent, William III saw his English kingdom as a new weapon against an old enemy, Louis XIV, the King of France. He had the opportunity to use it as such when the War of the Grand Alliance broke out. Louis XIV saw the English bogged down by revolution at home and the Austrians preoccupied by a war against the Turks and so used the opportunity to occupy territories on the eastern bank of the Rhine. However, William III quickly gained control of the British Isles and the Austrian Habsburg monarchy took on the prospect of a two-front war by raising an army against the French. For William III, this was a chance to exact revenge for the Dutch defeat in the Franco-Dutch War of the 1670s.
The 1694 Loan
In July 1690, a combined Anglo-Dutch fleet engaged the French Navy in the English Channel on orders from the government and against the best judgement of the local commander. The Battle of Beachy Head was a French victory, giving them temporary control over the English Channel. Three years later, a British convoy of hundreds of merchant ships in route to the Mediterranean was captured. These defeats at sea exposed English naval weakness and the need to rebuild its navy. This would be an expensive proposition however and more money was also needed to continue the war against France on the European mainland.
It was not an opportune time for the English state to be in need of money. The decades of fiscal mismanagement under the earlier Stuart monarchs, the Revolution, and the war against France made England a poor credit. However, the need to borrow under difficult circumstances transformed the way the country managed its state debts. For example, the most immediate task was the raising of a £1.2 million loan. Given the lack of investor appetite, the decision was made in advance to fund the repayment of the loan by enacting certain customs duties and excise taxes. This decision was made simultaneously with the loan being raised and marks the beginning of the increased reliance on ‘funded’ instead of ‘unfunded’ debt.
This commitment to hypothecate certain tax revenue for the expressed purpose of paying down the debt enabled the raising of the £1.2 million loan in 1694. Regardless, further concessions had to be made. For one, the interest rate on the loan was rather high by modern standards, at 8%. The legislation authorizing the loan, the Bank of England Act, also allowed those who invested to incorporate as a private bank. This was an unusual privilege in an era when one couldn’t simply incorporate a firm without obtaining a charter from Parliament or the King. Still better for investors, subscribers only needed to pay 25% of the amount of their subscription up front. All these provisions reveal just how desperate the state was for money.
Together though, these concessions were successful in raising the loan, which was syndicated out to some 1300 investors and was fully subscribed in under two weeks. The bank charter was crucial though; observers at the time believed that without it, the loan could not have been successfully syndicated, at least at a rate of 8%. Given the financial troubles facing the wartime government, this was cheap money; earlier long-term borrowings in the form of life annuities carried implied rates of as high as 14%. The approach of giving a charter to conduct business in exchange for cheaper financing was successful enough that it was used again in 1698 when a loan was raised allowing subscribers to incorporate a new East India Company.
It was the provision in the 1694 loan allowing the investors to incorporate a bank that was the genesis of the Bank of England. The institution, founded as the ‘Governor and Company of the Bank of England’ was only formally established once the loan was successfully funded. At that moment, the subscribers were made shareholders of the Bank, which held the loan and collected the 8% interest as well as a £4,000 fee for administering the debt. Regardless, though the original charter was for just eleven years, at which point the government could call the loan, it would be renewed continuously from then on.
Bank of England
In return for this and other loans, the Bank was conferred advantages and monopolies when its charter was renewed in 1697 and 1708. This preferential treatment was described by the economic and political science writer Walter Bagehot in his 1873 book, Lombard Street. First, the bank profited from being the place the Government would park surplus funds. Thus, though the bank lent to the state in 1694, thereafter it would occasionally be the state supplying credit to the bank. This was an even more valuable benefit than it may seem because it helped the bank raise money elsewhere. The Bank of England was essentially receiving the government’s seal of approval, an inestimable benefit when people would only know so much about the health of their bank.
Further, the Bank was given the advantage of limited liability. Seemingly unremarkable today, this was still a novel concept in the business world Bagehot lived in and wrote about, let alone a century and half earlier when the Bank was founded. As a general matter, limited liability companies didn’t take off in Britain until the 1850s and this wasn’t the last of the Bank of England’s notable privileges. In 1708, the Bank was given a near monopoly on printing banknotes. Because banknotes paid no interest, the issuance of these notes, in addition to serving as a useful medium of exchange for the public, was also a source of cheap capital to the Bank. In fact, at the time of the first renewal of the Bank of England’s charter, banknotes formed the largest of the Bank’s liabilities.
Of course, not all were pleased by the special treatment conferred on the Bank of England; complaints were registered in the public sphere long after the 1694 loan. Some took issue with the very existence of such a bank. For one, while there was a general consensus that the Bank led to lowered interest rates for both public and private debts alike, this was not universally popular. Its existence pitted creditors against debtors. Others argued against the monopoly on the printing of banknotes granted to the Bank, insisting the free printing of banknotes would increase the money supply. In later decades, foes of the Bank of England would point to Scotland, where there was no such monopoly and where money was believed to flow more liberally. To some extent, this distinction between Scottish and English money never died. Still to this very day, banknotes in Scotland and Northern Ireland are issued by private banks and not exclusively by the Bank of England.
Though at the moment of its founding, the Bank’s sole asset was the £1.2 million loan of 1694, the Bank of England grew from there. However, the state continued to be its main client. A balance sheet tabulated in 1697 reveals, unsurprisingly, that the 1694 loan remained the largest asset on its books. However, the Bank also held short term government notes, called ‘tallies’ in the financial parlance of the time, as well as private debt in the form of mortgages and other secured loans.
The liabilities side looks even more intriguing. By 1697, banknotes and bills outstanding made up the lion’s share of the Bank’s funding sources. As for the original £1.2 million of investor capital, the proceeds of which would have funded the loan, recall that only 25% had to be paid immediately. Another 35% of the committed amount was called on later in 1694. Following another call in 1697, intended to stop a bank run, perhaps 40% of the subscribed amount remained committed but not yet paid.
Making sense of late-17th century accounting, especially for a financial institution, is no easy task, even more so considering that the concept of shareholders equity as an accounting item was not yet in vogue. The historian William Arthur Shaw reckoned that the £720,000 in equity capital that was ‘paid in’ was treated as a deposit and therefore fell under the ‘Banknote’ heading. Considering the size of the balance sheet in relation to this equity, it is clear that the Bank of England was, like any bank, a levered institution. This enlarged the returns to the individual shareholders. Recall that the bank was paid 8% interest as well as a £4,000 fee for administering the £1.2 million loan. This £100,000-pound return, divided over an equity capital of £720,000 amounted to an almost 14% return. This yield was in line with other debt offerings made by the British state but was simply achieved by a very different manner via a bank, one with significance for the rest of Britain’s financial history.
Lesson
Regardless of how one should make sense of its own financing, the Bank of England certainly played a large role in the financing of the state debt during much of its 325-year existence. Indeed, from the moment of its founding in 1694, the Bank was meant to serve the state by ensuring its need for deficit financing was met. Along with lotteries and the sale of annuities, the Bank of England provided the extraordinary sums required to fund England’s military engagements abroad. Considering that the reconstruction of the English navy was enabled by the Bank of England, even the immediate historical significance of the Bank cannot be denied.
Further Reading
1. Bagehot, Walter. Lombard Street: a Description of the Money Market. Henry S. King & Co. 65 Cornhill & 12 Paternoster Row, London, 1873.
2. Britannica, The Editors of Encyclopaedia. War of the Grand Alliance. Encyclopædia Britannica, Inc.
3. Broz, J. Lawrence, and Richard S Grossman. “Paying for Privilege: the Political Economy of Bank of England Charters, 1694–1844.” Explorations in Economic History, vol. 41, no. 1, 2004, pp. 48–72.
4. First Report from the Select Committee on Nationalised Industries: Report, Minutes of Evidence and Appendices, Session 1969-1970, Bank of England. H.M.S.O., 1970.
5. Francis, John. History of the Bank of England, Its Times and Traditions. Willoughby, 1848.
6. Gordon, John Steele. “England’s ‘Secret Weapon’: How a Bank Laid the Groundwork for the British Empire.” ABA Banking Journal, 31 July 2019.
