The Great War and the Bank of England as Market Maker of Last Resort

Mike Anson, David Bholat, Mark Billings, Miao Kang and Ryland Thomas

During the global financial crisis, some central banks acted as market makers of last resort, buying and selling securities in financial markets when trading in them had stalled. Some commentators claimed this role was “a completely new” one for central banks. In this blog, we show, on the contrary, that the Bank of England acting as a ‘market maker of last resort’ has precedent. Using newly transcribed micro-level data which we are publishing today, we detail how officials intervened in the 1914 financial crisis in a way that has at least a passing resemblance to the actions the Bank took during the Great Financial Crisis (GFC) of 2007-09.

The global financial crisis of 1914 and the City of London

The 1914 financial crisis is often forgotten because it was overshadowed by an even more profound crisis in interstate relations. The sudden outbreak of World War 1 in July 1914 was a genuine shock to financial markets. As Dick Roberts pointed out in his book Saving the City, the start of the war triggered financial crises in almost every country in the world.

The City of London was the centre of global financial markets in 1914. At its heart were two global securities markets: the London money market, dealing in international bills of exchange, and the London Stock Exchange, where long-term domestic and international securities were traded.  Participants in both markets depended on short-term funding from commercial banks.  

The London money market

Bills of exchange in the London money market were typically used to finance the purchase of internationally-traded goods on short-term credit. Creditors in these exchanges typically held the bills to maturity and received payment, or sold them in the secondary market

The largest buyers of bills of exchange in the secondary market were discount houses– so named because they purchased bills at a discount on their face value. The discount rate was thus the price that creditors paid for getting cash quickly. Discount houses financed bill purchases using money borrowed at short notice from banks. Like many mutual funds and shadow banks in the GFC, discount houses were vulnerable if the assets they held suddenly became illiquid and banks called in their money.

The saleability of bills of exchange was greatly enhanced if their payment was guaranteed by established third parties. This was the business of the City’s accepting houses. These financial institutions were so named because, for a fee, they ‘accepted’ the obligation to pay the required sum indicated by a bill on behalf of an overseas client (the ‘drawer’). Thus, they played an important role as international market makers by providing a payment guarantee that redressed imperfect information between long-distance counterparties. In the ordinary course of business, the acceptor would pay the bill and be recompensed either in advance or on maturity by the drawer. However, the accepting houses faced potential ruin in wartime if drawers could not remit funds in settlement for the monies the accepting houses were obliged to pay on their behalf.

The London Stock Exchange

The London Stock Exchange was the most liquid and internationally-diverse stock market in the world. The key market participants were ‘jobbers’ – who were market makers in stocks – and ‘brokers’ – who bought and sold stocks on behalf of clients, many of them international investors.

Both firms needed to borrow from commercial banks either to fund their inventory of securities or to make advances to clients for the purchase of stock. Most of that borrowing was short-term ‘call money’ collateralised by the value of the bonds and shares that the firms held. Should stock markets fall or banks not renew call loans, then many firms would be in danger and liquidity in the market would cease.

The Crisis and the Bank’s response

The proximate catalyst of the crisis in the City was a run on both the discount houses and stock market firms starting on Monday 27 July 1914. In an increasingly uncertain environment, some banks began to withdraw their funds from both markets, much as they withdrew funding from shadow banks in September 2008. The resulting crisis peaked over the next few weeks. The crisis’ condensed character thus makes the daily data we are publishing particularly valuable.

By Thursday 30 July, the bill of exchange market had come to a complete standstill.

Enter the Bank of England.

Figure 1 displays the amount paid by the Bank for bills of exchange in July 1914. As the figure shows, the Bank responded to the crisis by substantially increasing its purchases.

Figure 1: Amount paid by the Bank for bills of exchange in July 1914

Source: The Bank of England as Lender of Last Resort Historical dataset  

In reacting this way, the Bank responded to the first financial crisis of the twentieth century in much the way it had responded to crises in the nineteenth century. By 1914, Bagehot’s Rule — that during a financial crisis the Bank should lend cash freely, at a high rate of interest on good collateral — was well-established. Accordingly, as the Bank bought more bills, it did so by applying an increasingly steep discount. In one week, the Bank’s discount rate increased 700 basis points

Figure 2: Daily interest rate weighted by loan value between 25 July and
1 August 1914     

Figure 2

Source: The Bank of England as Lender of Last Resort Historical dataset  

One of the reasons Bagehot advocated raising Bank Rate during a crisis was to attract gold from abroad so the Bank could replenish its reserves, which fell by nearly two-thirds in the final days of July. The pressure on the Bank’s reserves arose in part because commercial banks sought to preserve their own liquidity by calling in loans and by hoarding their own gold by paying out only Bank of England notes to their depositors. That meant those wanting gold coins took their notes to the Bank. 

Under the clouds of war, shipping gold to the City was far too risky a venture for most to undertake. The Bank’s traditional ‘lender of last resort’ manoeuvres thus proved inadequate to the war situation. With the London Stock Exchange suspending trading indefinitely on 31 July and the National Penny Bank failing on 1 August, new and innovative solutions were conjured.

First, the Government announced a ‘Bank Holiday’ that ran from Sunday 2 August through Thursday 6 August. The Stock Exchange was also closed. This gave the authorities time to develop a rescue strategy and prevent runs on banks, discount houses and stock exchange firms. During this interregnum, the Government announced a general moratorium which temporarily relieved debtors of the obligation to repay their debts. Moreover, debtors’ resources were augmented by the Treasury’s production of ‘Bradburys’ – new £1 and 10 shilling notes put into circulation to supplement the  Bank’s higher denomination notes. This enabled the banks to pay out low-denomination Bradburys to their customers rather than gold coin.

Figure 3: £1 note, also known as a ‘Bradbury,’ named after the secretary of the Treasury  

Source: Bank of England Museum            

The Bank also played its part. Interest rates were cut to 5 percent once the Bank Holiday ended (Figure 4). The Bank also widened the eligibility of bills it would purchase (Figure 5). Around 90% of bills brought to the Bank throughout August were bought (Figure 6).  As a result of these market-making activities, Dick Roberts in his book, Saving the City, estimated that the Bank held up to 40% of all bills of exchange in the City by the end of August.

Figure 4: The evolution of Bank Rate, the Bank’s official interest rate, over August 1914

Source: A millennium of macroeconomic data

Figure 5: Bank of England notice on procedure for discounting bills, 22 August 1914

Figure 5

Source: Bank of England Archive C47/289

Figure 6: Percent of bills accepted for purchase by the Bank’s Discount Office in August 1914

Source: The Bank of England as Lender of Last Resort Historical dataset  

These actions by the Bank resolved the immediate liquidity crisis. But there remained an underlying solvency problem. Many of the bills of exchange outstanding were unlikely to be repaid by the City’s accepting houses, given they could not obtain remittance from overseas drawers, especially those residing in belligerent states.  

The Treasury and the Bank once again innovated. Starting in September, the Bank provided ‘advances’ (collateralised loans) to accepting houses to repay obligations they owed. Since most of these obligations were now held by the Bank, this effectively allowed the accepting houses to swap short-term bill of exchange liabilities for a long-term loan (at Bank Rate plus 2 percent); the roughly £74 million worth of advances the Bank made (Figure 7) did not need to be repaid until one year after the conclusion of the war. While the advances appear on the Bank’s balance sheet (Figure 8), they are not accounted for in detail in the daily discount ledger. 


By engaging in these activities, the Bank was trying to revive financial markets. This objective was partly met. By January 1915, the stock exchange re-opened and no other financial institutions failed after August.

Longer term, however, the market in bills of exchange never fully recovered. By the end of the war, Treasury bills had replaced bills of exchange as the City’s benchmark instrument.

And so they remain.

Figure 7: Extract from Discount Office note dated 28 May 1938 summarising 1914 advances on pre-moratorium bills

Source: Bank of England Archive C47/290

Figure 8: The evolution of the Bank’s weekly balance sheet in terms of the stock of discounts and advances. The chart shows that the circa £70 million worth of discounts the Bank makes in August and September are repaid and replaced in October and November by advances of a similar amount but longer term.

Source: Weekly data on the Bank of England’s balance sheet, 1844 to 2006

Mike Anson works in the Bank’s Archive Division, David Bholat works in the Bank’s Advanced Analytics Division, Mark Billings works for Exeter University, Miao Kang works in the Bank’s Advanced Analytics Division and Ryland Thomas works in the Bank’s Monetary Policy Outlook Division.

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