1.1.3 Cheques and the emergence of modern banking
As early as the late seventeenth century, some bank customers were settling debts by writing letters to their banks requesting them to pay money to the person stated in the letter (the payee), with this being financed by funds being debited from the account of the person making the payment (the drawer). This means of settling debts was convenient not only for the customers (because it reduced the need for them to carry money around), but also for the banks. If both payee and drawer were their customers, the likelihood was that no actual funds would be withdrawn and that all that would be needed was for one account to be credited and the other debited. Given these advantages, those banks without note-issuing rights encouraged the use of cheques by their customers and began issuing cheque books.
Clearly the situation was more complicated if the two customers used different banks: funds would then have to pass from one bank to another, which was a cumbersome and often dangerous activity. To get around this problem, bank clerks started to meet at various venues, such as coffee houses, to set off the required cash movements relating to each cheque against each other, with only the balance having to be paid in actual funds from one bank to another.
These meeting places for bank clerks were the precursors of the clearing houses. In 1773, such a clearing house was set up in Lombard Street in London. In time, the member banks of the clearing house – that is, the clearing banks – kept their accounts at the Bank of England. This made the making of daily settlements between the clearing banks a simple process of book adjustments to each bank’s account. The consequence of the development of the cheque system was a vast reduction in the volume of cash required to settle debts. With greater capacity to hold cash as a reserve to meet unexpected demands from their customers, banks now had the capacity to create credit by granting loans to customers simply by crediting the customers’ accounts, as opposed to the old process of issuing and distributing their own bank notes. With the account credited, the customer could draw on the loan by writing cheques in favour of third parties to be drawn against their bank account.
The cheque system developed quickly in the nineteenth century, particularly as many banks lost their note-issuing rights through mergers and changes to their corporate status. The pattern of banking with which we are now familiar was thus established by the mid-nineteenth century. The subsequent century saw mergers and takeovers further reduce the number of banks in England and elsewhere in the UK, with the industry becoming centralised in London and Edinburgh. In England, by the second half of the twentieth century the banking sector was dominated by Lloyds, Barclays, Midland, Westminster and National banks – the original ‘big five’. The merger of the National and Westminster banks in 1968, to form the National Westminster Bank (in due course known as the NatWest) reduced the ‘big five’ to the ‘big four’.
Further material developments in the UK banking sector late in the twentieth century and early in the twenty-first included:
- Midland Bank being acquired by HSBC in 1992
- Lloyds Bank merging with the Trustees Savings Bank (TSB) in 1995 to become Lloyds TSB
- NatWest being acquired by the Royal Bank of Scotland (RBS) in 2000
- the Bank of Scotland merging with Halifax Bank (which had previously been a building society; see the next section) to become Halifax Bank of Scotland (HBOS) in 2001.
- Santander, the Spanish banking group, acquired the Abbey National Bank in 2004 and created Santander UK. Abbey National had previously been a building society but had converted to being a bank in 1989. We look at building societies in the next section.
So in the first years of the twenty-first century, the new ‘big six’ UK banks comprised Barclays, Lloyds TSB, HBOS, HSBC, RBS and Santander UK.
As regards the UK’s central bank, the position of the Bank of England as the central bank and the government’s banker was confirmed by its nationalisation in 1946 by the Labour government. The Bank still acts as banker to the banks, as the lender of the last resort and as the government’s banker.