As their name indicates, these institutions specialize in discounting bills of exchange, Treasury bills and other short-term securities. In other words, they provide short-term loans. They borrow from the banks for very short periods and use this money and use this money to discount bills. Much of the money they borrow from the banks is ‘at call’. This means that they undertake to repay these loans whenever the banks call upon them to do so. Like other banking institutions, the discount houses make a profit by borrowing at rates of interest lower than those they charge for discounting bills (i.e. lending). When all the banks are asking for repayment of the money they have loaned ‘at call’, the discount houses may not have the money to repay these loans because they have used the money to buy bills of exchange and Treasury bills. In this case, they will be able to borrow from the Bank of England, although they may find themselves having to pay relatively high rates of interest on these loans from the central bank.
3.7.3 The merchant banks
These banks specialize in wholesale banking. They deal with large deposits of money and handle large loans to industry, both at home and abroad. They also do a lot of business in foreign currencies. They act as accepting houses (explained opposite), and they also organize and manage share issues for the larger firms. Merchant banks also deal with the financial problems involved in large-scale takeovers and mergers.
3.7.4 Foreign banks
There are branches of more than 250 foreign banks in the City of London. They are important in the financing of overseas trade – making payments and arranging loans. They are also important in the operations of the London money market as providers of short-term loans.
3.7.5 The commercial banks
These are the familiar high street banks and include the Big Four – Barclays, Lloyds, Midland and National Westminster. Commercial banks tend to be large national banks, with a large number of local branches.
They provide a wide range of banking services – all those services, in fact, which were described in Section 3.5. Since they are public limited companies, they are in business to earn profits for their shareholders. This means that they must arrange their assets (i.e. their loans) so as to earn the highest possible rates of interest. On the other hand, they must look after the interests of their depositors. The bank must make sure that they can always meet their depositors’ demands for cash. The banks, therefore, have two main objectives, profitability and liquidity.
An asset is said to be liquid when it can easily and quickly be converted into cash. Notes, coins and bank deposits held in current accounts, therefore, are the most liquid of all assets. Time deposits in banks and building society deposits are not completely liquid, but they are still very liquid assets because they can be converted into cash fairly easily and with little delay. Houses and works of art, however, are illiquid assets. They could be converted into cash, but it could not be done quickly, and the selling of such assets can be a difficult and complicated process.
Although the bank have to hold some reserves of cash, they will tend to keep these reserves to a minimum because cash is an asset which earns no income. The banks’ other assets, which are loans, do earn them an income. To protect themselves against any unexpectedly high demands high demands for cash, therefore, the banks keep some assets which can easily and quickly be exchanged for cash. These assets consist of very-short-term loans. For example, some of their loans to the discount houses can be called back at any time. The banks also hold bills of exchange and Treasury bills which can always be sold (discounted) in the London money market. Cash plus very-short-term loans make up the banks’ liquid assets.
· Profitability and liquidity
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