A comparative examination of the retail banking sectors of the United States and the United

Kingdom, with reference to their historical evolution and the structure and role of their central
banks.

This essay will seek to document the development and composition of the United States' retail
banking system and examine its current form, whilst noting its similarities and differences with the
UK retail banking system. Additionally it will outline the formation, structure and remit of the
country's central bank: The Federal Reserve, and contrast its responsibilities with those of The Bank
of England.
The commercial banking sector in the United States is unique, in that it has something in the
order of 7500 banks, many more than any other country. Remarkably, 43.5% of the banks hold less
than $100 million in assets.1 This level of extreme diversification is a legacy of the political and
historical factors that have influenced the development of the American banking system. Until 1863
all commercial banks in the U.S. were awarded charters by the state in which they operated. No
national currency existed and banking regulations imposed by the state were often very lax. As a
result, banks regularly failed due to lack of bank capital or fraudulent activities.2 The National Bank
Act of 1863 created a new system of federally chartered banks under the supervision of the Office
of the Comptroller of the Currency (a department of the U.S. Treasury).3 This resulted in a dual
banking system in which 'State Banks' (supervised only on a state level) and 'National Banks'
(regulated on a federal level) operate side by side.4
The Federal Reserve System was instituted in 1913 to improve the safety of the banking
system. All national banks were required to become members of the Federal Reserve System and
had to abide by regulations laid down by the new body. State banks were not forced to join the
system but could opt in. Most chose not to because of the high costs associated with complying
with the Fed's regulations.5
The Great Depression of 1930-1933 saw the failure of some 9000 banks, wiping out the
savings of many thousands of depositors. In an aim to protect depositors from such failures in the
future 1933 saw the establishment of the Federal Deposit Insurance Corporation (FDIC), to provide
federal insurance on bank deposits.6 Purchase of FDIC insurance was mandatory for national banks
and most state banks availed of it too. 1933 also saw the passing of a law (The Glass-Stegall Act)
which prevented retail banks from dealing in corporate securities and barred investment banks from

1 Mishkin Eakins pg 467

2 Ibid pg 451
3 Ibid
4 Ibid
5 Ibid
6 Ibid
in engaging in commercial banking activities.7 This law ensured the division of retail and
investment banking in the U.S. market for most of the 20th Century until its repeal in 1999.
The past decade has seen a high level of merger activity in the U.S. banking sector as a
result of the progressive deregulation of the industry. Banks have exploited loopholes in state
regulations regarding the type and number of branches that a bank may open in a given area.8 The
advent of bank holding companies (which now own over 90% of U.S. banks) has helped further
circumvent the restrictive branching regulations.9 It is worth noting that these seemingly anti-
competitive restrictions were set in place as a response to popular anti-bank sentiment in the 19th
and 20th century; which was in turn caused by the irresponsible behaviour of many banks during
that period.10 This phenomenon goes a long way toward explaining the fragmented nature of the
American banking system that persists, to a lesser extent, today.
The U.K. in contrast, has one of the most highly consolidated commercial banking sectors in
the world. The 'Big Four' banks (HSBC, Barclays, Lloyds, RBS) dominate the retail sector. A raft of
demutualizations (when building societies convert into banks) in the 1980s and 1990s along with a
numerous mergers and takeovers goes some way to accounting for the highly concentrated nature of
the U.K. Market. Another factor is the absence of any legislative restrictions on branch expansion or
the nature of business that the banks could conduct.
The Bank of England was founded in 1694, making it one of the oldest central banks in the
world.11 In 1844 the bank took on the status of 'Lender of last resort' (see below). Burgeoning
government debt accrued by the First and Second World Wars increased the importance of the Bank
of England and in 1946 the bank was nationalised.12
The Federal Reserve and Bank of England share many of the core purposes and functions
which are common to the majority of central banks world-wide. Both institutions are responsible for
the conduct of monetary policy with the aim of promoting maximum employment and stable prices.
They both act as government banker and as banker to the commercial banking system. The Fed and
the Bank of England are responsible for the issuing of currency, however in the U.K the Royal Mint
is responsible for the issuing of coin. Both take responsibility for the management of foreign
exchange reserves (which are held in order to manage the exchange rate of the domestic currency).
Additionally both institutions serve as a lender of last resort – providing emergency funds during
periods of crisis to ensure the stability of the financial system as a whole. The most recent example
being the interventions made (in the form of 'bail-outs' and quantitative easing) during and after the

7 Ibid
8 Ibid pg 468
9 Ibid pg 469
10 Ibid
11 http://www.bankofengland.co.uk/about/history/index.htm#1
12 Ibid
financial crisis of 2008. Indeed the process of quantitative easing continues into the present day.
Several relatively recent structural changes made to the Bank of England have resulted in
some significant differences in the remit and scope of the two institutions. When the Labour
government came to power in the U.K. in May 1997 then Chancellor Gordon Brown announced
that the Monetary Policy Committee of the Bank of England had been given the authority to set
interest rates with the aim of meeting the governments inflation target (then set at 2.5%).13 The
motivation for this move was to remove political influence from monetary policy decision making
with the aim of increasing economic stability. Thus the Bank of England was granted what is know
as Instrumental Independence – the freedom of a central bank to take the steps it believes are
necessary to reach a particular goal determined by the government.14 However, the Federal Reserve
has an even greater level of autonomy than the Bank of England: it is able to identify and set its
own monetary policy objectives. Thus the Federal Reserve may be classified as a Fully Independent
central bank, in that the government does not set its policy goals or limit the instruments it may
utilise to achieve them.
One significant difference between the two institutions, and indeed the two banking systems
as a whole, is in the area of reserve requirements. The Federal Reserve operates a mandatory
reserve ratio. This refers to the “amount of funds that a depository institution must hold in reserve
against specified deposit liabilities” and is a legal obligation. Currently banks with liabilities of
between $10.7 million and $58.8 million are required to hold a reserve of 3%, whilst those with
liabilities above the $58.8 million threshold are required to hold a reserve of at least 10%. 15 In the
U.K. however, the reserve ratio is a matter of choice for the banks themselves, informed by their
past experience. This is referred to as a prudential reserve ratio.
One area where there is significant difference in the roles of the two institutions is the area
of regulation. Prior to the granting of instrumental independence in 1997 the Bank of England had
full responsibility for the regulation of banks and non deposit taking institutions in the United
Kingdom. However, post 1997 the government believed there was a potential conflict of interests
between the bank's new role in setting interest rates and the potential disruption this may cause to
the markets and institutions it was charged with regulating. Thus the 1998 Banking Act saw the
formation of the Financial Services Authority, a non-governmental, fully independent body with a
remit that covers the whole of the U.K financial sector.16 The Bank of England retained its
responsibility of guarding against systemic risk to the U.K (as demonstrated by its actions in the
aftermath of the 2008 crisis). The duel nature and dispersed structure of the American banking

13 Howells and Bain, pg 69

14 Ibid, pg 70
15 http://www.federalreserve.gov/monetarypolicy/reservereq.htm
16 Howells and Bain, pg 74
system led to the development of what Mishkin and Eakins call “a crazy quilt of multiple regulatory
agencies with overlapping jurisdictions”.17 The Federal Reserve and state authorities share primary
regulatory responsibility for the 900 state banks that are members of the Federal Reserve system.
The Office of the Comptroller of Currency has primary supervisor responsibility over the 1,850
national banks which control over 50% of the assets of the commercial banking system. The FDIC
and state banking authorities jointly regulate the 4,800 banks that have FDIC insurance but are not
members of the Federal reserve system. Several attempts by legislators in Congress to pass bills to
reform this archaic system and consolidate the patchwork of regulatory bodies responsible for the
regulation of the banking industry into one independent body have failed to garner the requisite
support to become law.
Another area of variation is the function of managing the national debt (or deficit). The
Federal Reserve continues to preform this function in the United States. Prior to 1998 it had been
the responsibility of the Bank of England to manage government debt in the U.K. However, in light
of the devolution of interest rate setting powers to the Monetary Policy Committee and the bank's
role in administering the sale of government bonds there was a perceived conflict of interests. If the
bank suddenly raised interest rates this could adversely affect the bond market, potentially making
the bank more cautious in its pursuit of its anti-inflationary targets. Thus the 1998 Banking Act
transferred the function of debt management to a newly created department within the Treasury:
The Debt Management Office.
In conclusion it may be stated that although significant differences in the nature of the U.S.
and U.K. Retail banking sectors still exist, they are gradually diminishing, and will continue to do
so as the financial system becomes evermore globalized. The role of the Bank of England has
moved closer to that of the Federal Reserve as a result of the changes wrought by the 1998 banking
act, and it could be argues that greater independence from government is a health attribute for a
central bank.

17 Mishkin and Eakins, pg 452

Reference List and Bibliography

Peter Howells & Keith Bain(2000): Financial Markets and Institutions. 3rd Edition, Pearson
Education

Frederic S. Mishkin & Stanley G Eakins (2009): Financial Markets and Institutions. 6th Edition,
Pearson Prentice Hall

Pilbeam, Keith (2010): Finance and Financial Markets. 3rd Edition, Palgrave Macmillan

http://www.bankofengland.co.uk

http://www.federalreserve.gov