Review: Making a Modern Central Bank–The Bank of England 1979–2003 (Studies in Macroeconomic History) by Harold James,

Kofi Adjepong-Boateng

Cambridge: Cambridge University Press, 543 pages.

 The Conduct of Our Financial Affairs by: Kofi Adjepong-Boateng

 Harold James’s new history of the Bank of England was probably written for a general audience: it lacks the academic apparatus of other bank histories. The book describes the changes made by the Bank of England (‘the Bank’) between 1973 and 2003 to accommodate its changing role in British monetary affairs. Anyone interested in African central banking could usefully study these changes because most central banks in Britain’s former African colonies were modelled on it, including Bank of Ghana, the first post-Independence example. Two parts of this book are directly relevant here: the Bank’s support in the reform of industry and its experience with bank supervision.

The Bank was established by Parliament in 1694. The Peel Act (1844) defined its current form and reconciled its two functions: issuing banknotes and conducting general banking business.

Its interventions in British industry followed severe economic downturn. The 1930s Depression impelled the Bank to help create the Bankers Industrial Development Co., which it owned jointly with British clearing banks, to finance industrial rationalization. Through its branches, the Bank concurrently learned about business conditions in Britain and gained access to intelligence about likely financial problems. Subsequent Bank creations included the Industrial and Commercial Finance Corporation (ICFC), and produced ‘Investors in Industry’, now 3i, nowadays one of Europe’s largest venture capital investors.

Credit assessment policies among British banks were undeveloped at this time. This, coupled with bad industrial management, underlay many bad debts. The Bank had to help identify new managers to rescue vulnerable companies and improve corporate governance by appointing non-executive directors to industrial boards. It even developed guidelines for its financial support, known as the ‘London approach’, coordinating the orderly approach to industrial intervention in industries at critical moments.

Ghanaian readers will see the relevance of another area covered by James: bank supervision. First, the Bank was mandated to police individual financial institutions. The 1987 Act required reports of significant exposure to risk: the Bank must investigate whatever might jeopardise deposits. It also accepted “a mandate for extensive microprudential surveillance” whereby it ensured that other banks’ management and board were ”fit and proper”.

Second, several banks operating in Britain also worked extensively abroad, had foreign owners or headquarters elsewhere; they could not be regulated unless a college of banking supervisors in other jurisdictions cooperated (one of the first instances of this practice, which proliferated from the 1990s onwards). The Bank’s need for cross-border information during the BCCI collapse resemble problems faced by regulators in Ghana and elsewhere in Africa: how best to supervise cross-border banking activities.

The collapse in Britain of British and Commonwealth Merchant Bank (1990) and BCCI (1991), and the near-collapse of Midland Bank, all persuaded Bank officials to overhaul the approach to supervision. At one stage, market capitalization had made B&C the UK’s second-largest non-banking financial institution. Midland, at this point, held 17% of clearing bank deposits. The Bank’s intervention led to changes of both boards; indeed, full nationalisation was considered for Midland until HSBC acquired it. These problems were followed by the collapse of Barings, the private bank, in 1995.

James describes a 1996 report on the state of the Bank’s supervisory work, which recommended replacing the rather unstructured SWOT process by an evaluation tool that covered both qualitative and quantitative assessment and expanded the role of accountants.

In the mid-1990s, some Bank non-executive directors, faced with an enlarged UK financial sector, wanted its regulatory power extended to cover Lloyds insurance and the stock exchange. But this was resisted. Such debate over the responsibility for overseeing the British financial sector and its stability extends past James’ survey period; changes to Britain’s financial oversight architecture have continued since 1970.

James sees the difficulties of determining how successfully a regulator ensures financial stability: “It is harder to assess the effectiveness of financial surveillance than of monetary policy, [which] is designed to be forward-looking, and is regularly tested against the outcome in a particular time frame [whereas] financial stability policy has to be backward-looking, but … tested against surprise [future] events that are necessarily very rare”.  While inflation establishes the success or failure of monetary policies, “we do not … know what financial stability is”.

The banking and financial sector crisis in Ghana which began in 2017 has reduced the number of functioning banks and of fund managers. Several insolvent savings and loans companies and non-bank financial institutions have closed. In the Budget Statement of November 2019, government bailouts seemed to have totalled about 5% of GDP. Comparing this to other financial bailouts: in 1991, Norway’s was 2.7% of GDP, Sweden’s 3.6% and Finland’s 12.8%. Japan’s banking problems in 1997 are estimated at 14% of GDP, and the 1988 US savings and loans problem apparently cost 3.7%. In 2010, two years into the global financial crisis, the cost of bailouts was below 1% of GDP. Direct fiscal costs in the US and Germany were thought unlikely to exceed 2% and 1% respectively, while those in France and UK were expected to gain income. Aside from the financial cost to taxpayers, there is also the unemployment associated with corporate distress and hardship caused by frozen deposits, particularly when these affect low income households. The high fiscal cost of bailouts is partly why financial institutions should be incentivised to improve governance and any slack or fraudulent behaviour should be identified before disorderly bailouts are needed.

Improving the stress testing capacity of supervisory bodies within central banks and in regulated financial institutions is recommended, as is allowing “Living Wills” for banks to be introduced. This concept, sometimes known as bank resolution planning, refers to the rule that regulators should require financial institutions to submit “credible” plans for being quickly and methodically wound up under national bankruptcy laws or other applicable insolvency regimes following material financial distress. These resolution plans are essential because they can soften the impact of bank failures and limit the size of taxpayers’ bailouts.

For banks to successfully allocate a country’s savings, they need to take risks. Risks entail failure. Risk is acceptable if properly assessed, but some forms of risk, like related party lending, can be criminally negligent. Appointing individuals and chairs to boards who are ignorant of the industry is equally negligent.  Eliminating risk entirely merely reduces the efficiency of the banking sector which is why regulation is necessary for efficiency. This book captures a point in history when the Bank of England went through significant challenges to its regulatory model in ways that are directly relevant today to Ghana and other African countries.

In an article in The Daily Echo on 29th September 1952, J.B. Danquah expressed the wish that a new “National Bank of Ghana” would “stimulate the development of local industries and identify the people of the Gold Coast more closely with the conduct of their own financial affairs”. This must remain the guiding principle that robust regulation continues to make possible.

[1]The author holds a research position at the Centre for Financial History at Cambridge University.  He is a previous chair of the Policy Committee of the Centre for the Study of African Economies at Oxford University and was on the Board of Trustees of SOAS, University of London. He writes in a personal capacity.

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