Building societies are not banks – they do not create deposits. Nevertheless, a large number of people use them as a form of saving bank.
They were established to help people to buy houses by providing them with loans. These loans take the form of mortgages because the building society holds the title deeds to the property as a security until the loan is repaid.
The societies attract savings by offering a variety of savings schemes, many of which allow cash to be withdrawn on demand.
They do not make a profit but they cover their costs by charging higher rates of interest to borrowers than those which they pay to savers. They can only continue to provide loans if they maintain a steady inward flow of savings. This is why they have to charge their rates of interest from time to time: if the flow of savings begins to decline, buildings societies may have to offer higher rates of interest to saver, and this means that they would have to charge higher rates to borrowers.
In recent years, the building societies have begun to compete strongly with the banks. They now offer current accounts with cheque books, credit cards, travellers’ cheques and other services similar to those offered by the banks.
3.8 The Bank of England and the control of the money supply
The government tries to control the money supply for several reasons. If prices are rising and the government fears an increase in the rate of inflation, it will try to reduce the money supply or slow down the rate at which it is increasing. If there is a serious slump, it might try to increase total spending by allowing the money supply to increase. The measures used for these purpose are described as monetary policy. The Bank of England is responsible for carrying out the government’s monetary policy.
Since the greater part of the money supply consists of bank deposits, monetary policy must try to control the level of these deposits. The extent to which they are created depends upon
- the banks’ customers’ willingness and ability to borrow (the demand for loans), and
- the banks’ ability to lend (the supply of loans).
The Bank of England, therefore, must be able to influence the behavior of both the banks and their customers.
3.8.1 Changes in the rate of interest
The price of a loan is the rate of interest one has to pay for it. Any changes in the rate of interest, therefore, will affect people’s willingness to borrow from the banks.
The Bank of England is able to operate in the money market as a major borrowed and lender. It can, therefore, have a direct effect on the demand for and supply of loans. In other words, it can influence the price of loans – the rate of interest. A rise in the rate of interest raises the cost of borrowing. The demand for bank loans may fall or, more likely, grow more slowly. The rate at which total bank deposits are growing will slow down. A fall in the rate of interest will reduce the cost of borrowing and increase the demand for bank loans. Total bank deposits will tend to grow more rapidly.
3.8.2 Changes in the banks’ reserves of cash
· Open-market operations
The commercial banks hold deposits at the Bank of England in current accounts. These deposits are counted as part of the banks’ cash reserves because cash can be withdrawn from them at any time. Any change in the level of these deposits at the Bank of England will change the level of the banks’ cash reserves, and hence affect their ability make loans and create bank deposits.
If the Bank of England sells securities in the open market to households and firms, the buyers will pay for them with cheques drawn on their accounts at the commercial banks. These banks, therefore, will now owe money to the Bank of England. This debt will be settled by taking money out of the commercial banks’ deposits at the Bank of England. This will reduce the commercial banks’ cash reserves, so their ability to create deposits will be reduced.
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