The Bank of England: Its journey as the pillar of financial stability

By Saswathi Suresh

Edited By Avani Pandith

In this article we are going to be exploring the dynamic role of the Bank of England, as a financial institution, as a pillar of financial stability from the 17th century (when it was first inaugurated) to the 21st century. In particular, we analyse the 3 main ways in which the Bank supported long-term financial health over time:

• Determining monetary policy

• Regulating the economy

• Issuing banknotes [1]

• Lender of Last Resort

Determining Monetary Policy

Throughout history, the UK has experienced has been exposed to varying currency regimes, including fixed rate regimes and floating rate regimes . Regardless of the regime, the Bank of England has played a pivotal role in setting monetary policy to ensure that the economy adheres to the respective regime, therefore, maintaining financial stability. Although the fixed rate regimes did eventually collapse, creating uncertainty (although the bank mitigated this through their role as lender of last resort, which will be discussed later), the Bank was able to adapt their mechanisms in response to changing economic and political landscapes. 

Pre-1930s, at the height of the gold standard, where the pound sterling was convertible to gold at a fixed ratio, the Bank’s goal was to maintain the gold standard, therefore monitoring and adjusting interest rates appropriately to prevent too much money entering into the economy, threatening the sustainability of the gold standard. This, as a result, would keep prices in rein, fulfilling price and financial stability.

After the collapse of the global standard, in 1944, the British government decided to peg the value of the pound to the dollar, and implemented 3 defence mechanisms:

 - Interest rates - Interest rates varied to influence domestic demand, by either encouraging or discouraging spending. This would effect the money supply, therefore allowing the bank to maintain financial stability.

 - Buying and Selling Foreign Reserves - The Bank of England would either purchase or sell their foreign exchange reserves to either create artificial demand or increase/decrease the supply of pounds to preserve its value against the dollar. 

 - Capital controls - Limits were introduced on the capital that could be invested abroad or domestically in the UK, to prevent speculative investments in the USD or pound which would threaten the peg(i.e sudden capital flight)

These mechanisms ensured that the conversion rate from the pound sterling to the USD remained insured against external shocks. This therefore, prevented any mass conversions from the USD to the pound or vice versa, which would have threatened financial stability in the UK. 

Following the collapse of the Bretton Woods System, UK adopted a monetary aggregate target (M3), which attempted to measure the total circulation of money in the economy. 

Although the economic outcomes during this period were favourable, many people were skeptical of the ability of the M3 target as a suitable target for the Bank. It was incredibly difficult to track, leading to speculation, as to what the true value of M3 was. 

As a result, the UK returned to a fixed exchange rate regime, as it joined the Exchange Rate Mechanism, and implemented the defence mechanisms mentioned beforehand. This shift in objective demonstrated how the Bank of England adapted its strategy to maximise financial stability, by scrapping their monetary target. 

In 1992, a more appropriate aggregate target was introduced: an inflation target. Inflation measures the increases in prices of goods and services, year on year. [2].  The inflation target was set at 2% (as a benchmark for all central banks to meet), and since then has formed the foundations for the Bank of England’s monetary policy. This was supported by the founding of the Monetary Policy Committee (MPC), under the bank, which is ‘responsible for maintaining price stability and, subject to that, supporting for the economic policy of the government, including its objectives for growth and employment’ [3] . The formalisation of the bank’s objective for price stability (therefore financial stability), instills confidence in the public, as they are legally required to ‘maintain price stability’. This highlights their continued emphasis on financial stability for the last century. 

However, the continuing failure for central banks to meet their inflation target in recent years has raised questions as to whether the target effectively aids the bank in stabilisation of the economy, or if its down to poor fiscal policy.

Issuing Banknotes

The development of the bank as the chief note issuer in the United Kingdom, has shaped the trend of growing confidence in the value of money (although the government’s backing is responsible for the extrinsic value of the note), and naturally, has shaped the robustness of our financial system. The Bank’s monopoly of note issuance reduces the risk of potential counterfeiting notes, and allows more control over the total money supply in the UK.

The Bank’s significance in this role was recognised early on by surrounding London commercial banks, as by 1770, most London banks ceased the issuing of notes. 

However due to no legal restrictions, many country banks continued the issuing of notes, leading to difficulties in controlling monetary supply and growth.

Therefore opposition to the issuance of notes by country banks, resulted in the Bank Charter Act of 1844 placing restrictions on other commercial banks issuing notes [4], as detailed below:

“That from and after the Thirty-first Day of August One thousand eight hundred and forty-four the Issue of Promissory Notes of the Governor and Company of the Bank of England, payable on Demand…..shall be thenceforth conducted and carried on by the said Governor and Company in a separate Department to be called " The Issue Department of the Bank of England” [5]

Moreover, the bank has adapted the anti-counterfeit features of its notes, in response to technological developments over time that have threatened the credibility of the bank note. From guilloche patterns, to ‘windowed’ metallic threads and to the introduction of modern security features in polymer notes, including holograms, and see-through windows, are indicative of the consistent measures the Bank takes to secure the credibility of the notes issues, contributing to the stability of the financial system. 

Regulating the economy

In the early years of the Bank of England’s establishment, no official regulatory framework within the bank existed to regulate the activities of other commercial banks, and firms within the economy.

Although no organised system was present, there were instances which demonstrated the Bank’s regulation and management of the economy.

The bank received formal supervisory powers in the Banking Act 1979, including the ability to withdraw a bank’s authorisation to conduct business [6]. However, there was no guidance as to how this was to be determined, making it a difficult task for the Bank to perform. In 1996, the Bank introduced the RTGS system, which settled payments, and nowadays settles around £500bn a day on average. This showed how the Bank was an early facilitator of payments.

There were other organisations, such as the Securities and Investment Board and the  Self-Regulating Organisation, which merged into the Financial Services Authority, but these were not operated by the bank. 

Therefore, in this respect, the Bank of England made incredible progress to establish a regulatory framework in the Financial Services Act of 2012, coming into force in 2013. Through the regulation of the economy, the Bank of England identifies risks and mitigates them with appropriate macroprudential tools, thereby reinforcing financial stability.

In 2013, The Bank of England underwent major statutory changes, and welcomed more responsibilities, of which include the formation of the PRA (Prudential Regulation Authority), and the amendment to the FPC (Financial Policy Committee), which are branches of the bank, and include the close monitoring and supervision of post-trade financial market infrastructure providers (FMIs).

The PRA monitors the activities of individual firms (hence microprudential regulation), and aims to act preemptively to mitigate the potential risks said firms may pose on the financial stability of UK’s economy. As outlined in Figure 1, there is a specific focus on insurance policyholders to ensure they receive an appropriate degree of protection. 

In total the PRA supervises about 1400 financial groups.

The PRA’s approach is judgement-based, forward-looking, and focused. The PRA’s emphasis on prescience stems from the mistakes made during the 2008/09 crisis, exemplifying how the PRA focuses on insuring the market from firms that are risky in the future. Its focused approach enables the PRA to maximise its efficiency, by channelling resources into the firms that pose the most risk to the financial state of the UK. This, therefore, ensures the long-term financial health of the UK.

The Financial Policy Committee will also be able to recommend and direct other financial regulators to specific macroprudential tools, specifically consisting of:

• Countercyclical capital buffer - The FPC ensures that other commercial banks and investment firms hold a sufficient amount of capital to insure against external shocks (additional loss absorbing capital). 

• Sectoral capital requirements - Each sector has individual capital requirements dependent on the level of risk they pose to the financial system, and is subject to the FPC’s discretion

A further change in the 1998 Bank Charter Act granted the Bank the responsibility to oversee and facilitate the supervision of FMIs, through the creation of the FMIC.  Post-trade financial market infrastructure aids in the transferral of securities from the seller to the buyer, while simultaneously transferring payment from the buyer to the seller. Therefore, the increased role of the Bank in the implementation of FMIs in the financial market, solidifies financial stability. 

Lender of Last Resort

The role of the bank during times of panic as a lender of last resort, coining the nickname LOLR for the bank, is arguably, the most significant role of the bank, as it enables the economy to maintain a level of stability through turbulent periods, when all other measures fail.

The role of the Bank of England as a lender of last resort was seen early on, notably during the financial panics of 1847, 1857 and 1866 in London. In 1873, Bagehot argued that a lender of last resort should increase the rate of lending during times of crisis, provided that there is good collateral for the loans. He proposed that loans should be provided for illiquid firms, but not insolvent firms. The Bank of England’s provision of liquidity to firms during these crises, and their judgement of which firms were more deserving than others became better, over the period of the 19th century. This was evident in the 1866 crisis, when the Bank provided liquidity to Overend and Gurney, after they collapsed [7], containing the panic that arose from this. This emphasises their role in maintaining financial stability.

During the GFC, the Bank of England provided emergency liquidity to a number of institutions,in combination with the government, including:

• Royal Bank of Scotland

• Lloyds Banking Group

• Northern Rock - In September 2007, the Bank of England provided an emergency load to Northern Rock, as they had struggles borrowing in the money market (although this responsibility was transferred to the government in August 2008)

• Bradford and Bingley 

In particular, the special liquidity scheme, The Special Liquidity Scheme (SLS) was introduced in April 2008 to improve the liquidity of the banking system by allowing banks and building societies to exchange their securities for UK Treasury Bills for up to 3 years [8]. This mean that businesses were able to sell the treasury bills, and increase their liquidity more quickly, in comparison to their illiquid assets, which were taken on by the banks. This boosted the growth of banks and building societies, instilling financial stability in the broken economy.

The Bank also adopted a new measure to boost economic growth, when interest rates fail to stimulate significant economic growth, due to short term interest rates are reducing to 0. Quantitative easing is the purchase of securities, such as assets, in the long term, to provide the economy with capital, to stimulate investment and economic growth, purchasing £60bn of government bonds [9].

During the COVID pandemic, the Bank of England, along with the HM treasury, established the CCFF scheme (COVID corporate financing facility). This scheme was introduced to help firms deal with cash flow issues, where the Bank would take on short-term debt of the business (i.e a maturity of between 1 week to 12 months) ,buying the firm time to fix necessary financial issues, fostering financial stability.

Though these examples demonstrate how the Bank of England’s role as the lender of last resort sustains financial stability, there have been criticisms in the way the Bank of England and the government bail out banks, as this involves the use of taxpayer’s money to finance this. It can be argued that in the long run, the continuous use of the taxpayer’s money in the long run to do this is unsustainable, as it encourages firms to take on more risks, and borrow more, which would counterintuitively decrease financial stability (moral hazard argument). 

However, due to increased financial liquidity requirements, it would be incredibly rare for a financial firm to be bailed out. Moreover, this practice only occurs during crisis periods (rarely), which may not be enough of an incentive for firms to act in a financially irresponsible manner. 

Conclusion

By stepping through the worn pages of the Bank of England’s history, it is evident that the role of the Bank of England in ensuring financial stability is ever-changing, and dynamic, and is shaped by the social, economic, technological and even political landscapes of the time. 

Although it is unclear what the potential future role of the Bank may be, it is undeniable that the Bank will continue to keep our economy growing and in check when necessary.

References:

1. Bank of England, ‘About Us

2. Oner, Ceyda. 2025. “Inflation: Prices on the Rise.” International Monetary Fund. 2025. https://www.imf.org/en/Publications/fandd/issues/Series/Back-to-Basics/Inflation.

3. Murphy, Emma, and Stephen Senior. "Changes to the Bank of England." Bank of England Quarterly Bulletin (2013): Q1.

4. Bank of England, ‘Our History’, 

5. Bank Charter Act 1844.” 2011. Legislation.gov.uk. 2011. https://www.legislation.gov.uk/ukpga/Vict/7-8/32/enacted.

6. Smith, Chris. 2020. “Library Briefing.” https://researchbriefings.files.parliament.uk/documents/LLN-2020-0006/LLN-2020-0006.pdf.

7. Jones, Brad. 2023. “” https://www.rba.  gov.au/speeches/2023/Speech Bagehot and the Lender of Last Resort - 150 Years On.pdf/sp-ag-2023-12-14.pdf.

8. Ons.gov.uk. (2016). UK Government interventions in the financial sector 2007 to 2016 - Office for National Statistics. [online] Available at: https://www.ons.gov.uk/methodology/methodologicalpublications/specificmethodology/economy/articles/ukgovernmentinterventionsinthefinancialsector2007to2016.

9. https://www.tutor2u.net/economics/reference/2-6-2-role-of-the-bank-of-england-monetary-policy

10. Goodhart, Charles AE, R. Edvinsson, T. Jacobson, and D. Waldenström. "The Bank of England, 1694-2017." Sveriges Riksbank and the history of central banking (2018): 143-71.

11. Goodman, Halley. "The formation of the Bank of England: a response to changing political and economic climate, 1694." (2009).

12. https://www.tutor2u.net/economics/reference/2-6-2-role-of-the-bank-of-england-monetary-policy