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Your money and the financial system Page 1
INSURERS
HIGH ST
BANKS
PENSION
FUNDS
PENSION
FUNDS
CREDIT
UNIONS
HEDGE
FUNDS
YOUR MONEY
AND THE FINANCIAL SYSTEM
BUILDING
SOCIETIES
INVESTMENT
BANKS
INSURERS
ASSET
MANAGERS

Your money and the financial system Page 2
YOUR MONEY
AND THE FINANCIAL SYSTEM
The Bank of England has a unique role in our economy, promoting the good of the
people of the United Kingdom by maintaining monetary and financial stability.
The crisis that began in 2007 seriously disrupted the operation of the financial
system and tipped the world into a major economic downturn. It exposed serious
shortcomings in the tools available to deal with failing banks and the need for
safeguards to preserve the safety and soundness of the financial system.
Far-reaching reforms of the regulatory system followed, including an expanded role
for the Bank of England.
A new Financial Policy Committee was created at the Bank of England to spot threats
to the financial system as a whole. And responsibility for the safety and soundness
of banks, building societies and insurers passed to the new Prudential Regulation
Authority, a subsidiary of the Bank of England.
This pamphlet explores the problems posed by the financial crisis, the major
regulatory reforms that followed, and the new responsibilities of the
Bank of England. It covers:
• The global financial crisis
• What is the financial system
• Capital and liquidity: the building blocks of a safer financial system
• Why is a bank’s capital important
• Why is a bank’s liquidity important
• How did the crisis change financial regulation in the UK
• The Bank of England’s Financial Policy Committee (FPC)
• The Prudential Regulation Authority (PRA)
• What happens if commercial banks run short of money
A stable financial system means households and businesses can have confidence
their money is safe, insure against risk and rely on access to finance when they need it –
in good times and in bad.

Page 3
The Bank of England
is able to lend money
to keep the banking
system operating
smoothly.
The Bank of England
oversees the
operation of financial
infrastructure,
including the main
payment systems in
the UK.
LIQUIDITY
INSURANCE
The Bank of England
has special resolution
powers allowing
troubled banks to fail
in an orderly way.
PAYMENT
SYSTEMS
SPECIAL
RESOLUTION
The
Bank of England
and the
financial system
PRUDENTIAL
REGULATION
AUTHORITY
FINANCIAL
POLICY
COMMITTEE
The Prudential
Regulation Authority
is responsible for the
safety and soundness
of banks, building
societies, credit
unions, insurers and
major investment
firms.
MONETARY
POLICY
COMMITTEE
The Bank of England’s
Monetary Policy
Committee sets
interest rates to keep
inflation low – a key
ingredient of a stable
financial system.
The Bank of
England’s Financial
Policy Committee
is responsible for
spotting and fixing
threats to the stability
of the financial
system as a whole.

Your money and the financial system Page 4
The global financial crisis
The financial crisis that began in 2007 prompted
a major economic downturn around the world.
Before the crisis, the global
economy had experienced a long
period of sustained economic
growth with low inflation.
Benign economic conditions with
low interest rates led investors
to search for higher returns on
riskier investments, like mortgage
lending to the rapidly-growing US
housing market.
The banks fuelled a credit boom
that led to a big expansion in the
size of the financial system.
By 2007, lending by British
banks had grown to five times
the size of the UK economy.
Standards of risk assessment
and monitoring began to slip,
amid an air of complacency
among some investors.
Bad debts in lending to the US
mortgage market had been
rising gradually for some time.
In mid-2007, the emergence of
problems at a small number of
banks prompted a reassessment
of creditworthiness and risk-taking
across the financial system.
Concerns spread rapidly to global
financial markets, affecting the
UK and other banking systems.

Page 5
In the UK, the high-street bank
Northern Rock was badly hit by
concerns over the quality of its
business.
In September 2007, its depositors
began queuing outside branches to
withdraw their money.
This was the first ‘run’ on a British
bank since the 19th century.
Northern Rock had to seek
emergency loans from the Bank of
England. It was nationalised by the
Government in February 2008.
The crisis worsened during 2008
as the financial system cut back on
the risky lending built up during
the long credit boom.
The position of many banks and
insurers worsened, culminating
in the high-profile collapse of
the US investment bank Lehman
Brothers, Bradford & Bingley in
the UK and Hypo Real Estate in
Germany.
Bad debts
increased
The Bank of England responded
with new measures to pump
liquidity into the banking system.
The Government provided large
sums of public money to HBOS
and the Royal Bank of Scotland.
Problems
spread
rapidly
Severe strains on the financial
system tipped the global economy
into recession as business
confidence and demand collapsed
towards the end of 2008.

Your money and the financial system Page 6
What is the financial system
The financial system is central to the working of
the economy and modern life.
The financial system has many
parts that allow money to flow
around the economy. The bestknown
are high-street banks,
building societies and insurers.
Others include pension funds,
asset managers, investment banks,
credit unions and hedge funds.
All of these and more make up
what we call the financial system.
A healthy and stable financial
system provides three key
services to the economy:
• it makes payments from one
person or business to another;
• it supplies finance to businesses
and households; and
• it allows us to insure against risk.
INSURERS
HIGH ST
BANKS
PENSION
FUNDS
PENSION
FUNDS
CREDIT
UNIONS
Payments worth
£230bn
every day
HEDGE
FUNDS

Page 7
Each day the financial system
settles millions of transactions,
including spending in the
shops and online, payment
of bills, wages, benefits and
withdrawals from high-street
cash machines.
The total amount of money passing
through UK payment systems is
enormous, with a value of over
£230 billion every single day.
In a world without payment
systems every transaction – even
the purchase of a house – would
have to be paid by handing over
cash!
Insurance companies allow
people to insure against the
risks they face in their
businesses or daily lives.
Many worthwhile opportunities
would be overlooked without the
protection of insurance, which
allows businesses to expand
with more confidence and the
economy to grow.
The financial system brings
savers and investors together
to put money to work.
One person’s savings in a bank
can become the investment in a
business that will create new jobs,
or a mortgage for house purchase.
And savings can be invested in
shares by pension funds to allow
firms to grow.
If a large bank or insurer gets
into serious difficulties,
problems can spread rapidly
across the financial system.
Before long, even healthy banks
can be starved of cash and the
whole financial system can get
into trouble.
BUILDING
SOCIETIES
Central banks and regulators
work to keep the financial system
stable.
A stable financial system means
households and businesses can
have confidence their money
is safe, insure against risk and
rely on access to finance when
they need it – in good times and
in bad.

Your money and the financial system Page 8
Capital and liquidity:
the building blocks of a
safer financial system
Capital and liquidity are key ingredients for
a safe and secure financial system.
A bank balance sheet provides
a snapshot of its financial
position.
It is the simplest way to show how
a bank’s capital and liquidity are
important.
CAPITAL
A bank’s capital includes money
invested in the bank by its
shareholders, plus any profits
it has saved up from previous
years.
The balance sheet has two equal
sides.
One side shows a bank’s assets.
The other shows its capital and
liabilities.
LIABILITIES
A bank’s liabilities are money
that doesn’t belong to the bank
and which it will have to repay.
This is money it holds on behalf
of customers in current and
savings accounts, together with
the proceeds of bond sales to
investors.
Bonds sold by a bank are IOUs
that allow it to raise money from
pension funds or other banks.

Page 9
ASSETS
A bank uses its capital and
liabilities to make loans to
households, businesses and
other banks.
These loans are recorded on the
balance sheet as a bank’s assets.
Any money not lent out by a bank
is held as liquid assets like cash.
LIQUID ASSETS
A bank’s liquid assets include the
cash in its tills, its deposits at the
Bank of England and holdings of
safe assets like government bonds
that it can sell quickly for cash.
A bank holds liquid assets to
meet withdrawals by depositors
and investors.
A BANK
BALANCE SHEET
LIABILITIES
ASSETS
CAPITAL
– SHAREHOLDERS’ MONEY
– RESERVES FROM PAST PROFITS
DEPOSITS
– MONEY IN CURRENT ACCOUNTS
– MONEY IN SAVINGS ACCOUNTS
LOANS
– TO HOUSEHOLDS
– TO BUSINESSES
– TO OTHER BANKS
A bank or insurer
that doesn’t hold
enough capital or
liquid assets can
get into financial
difficulty.
That means it
may not be able
to provide crucial
payment services,
loans or insurance.
BONDS
– MONEY FROM BOND SALES
TO INVESTORS
LIQUID ASSETS
– CASH
– DEPOSITS AT BANK OF ENGLAND
– GOVERNMENT BONDS

Your money and the financial system Page 10
Why is a bank’s capital important
An unexpected slowdown in the economy can mean
some borrowers get behind on their repayments and
some loans may not get repaid at all.
Solvent
bank
A bank can make financial
losses if some of its risky loans
are not repaid.
This shows up on its balance sheet
as a fall in the value of its assets.
A BANK
BALANCE SHEET
LIABILITIES
ASSETS
CAPITAL
– SHAREHOLDERS’ MONEY
– RESERVES FROM PAST PROFITS
DEPOSITS
– MONEY IN CURRENT ACCOUNTS
– MONEY IN SAVINGS ACCOUNTS
LOSSES ON RISKY LOANS
– TO HOUSEHOLDS
– TO BUSINESSES
– TO OTHER BANKS
SAFER LOANS
– TO HOUSEHOLDS
– TO BUSINESSES
– TO OTHER BANKS
A bank’s capital acts as a
shock absorber to pay for
the unexpected losses it
makes on its risky loans.
Its balance sheet shows a
fall in capital equal to the
value of its losses.
A solvent bank
has more than
enough capital
to pay for the
unexpected
losses it makes
on risky loans.
In the picture, the
white box labelled
CAPITAL is larger
than LOSSES ON
RISKY LOANS.
BONDS
– MONEY FROM BOND SALES
TO INVESTORS
LIQUID ASSETS
– CASH
– DEPOSITS AT BANK OF ENGLAND
– GOVERNMENT BONDS
This protects a
bank’s depositors
and the money
it borrows from
investors.

Page 11
A bank is
insolvent if
its capital is
smaller than
the unexpected
losses it makes
on risky loans.
In the balance
sheet picture,
the white box
labelled CAPITAL
is smaller than
the box labelled
LOSSES ON
RISKY LOANS.
In this case, a
bank’s capital
is too small to
protect all of the
money it owes to
depositors and
investors.
A BANK
BALANCE SHEET
LIABILITIES
ASSETS
CAPITAL
– SHAREHOLDERS’ MONEY
– RESERVES FROM PAST PROFITS
It’s the financial regulator’s job
to ensure a bank protects its
depositors by holding enough
capital to meet unexpected losses.
Healthy banks with more
capital can lend more to support
the economy.
LOSSES ON RISKY LOANS
– TO HOUSEHOLDS
– TO BUSINESSES
– TO OTHER BANKS
Insolvent
bank
DEPOSITS
– MONEY IN CURRENT ACCOUNTS
– MONEY IN SAVINGS ACCOUNTS
SAFER LOANS
– TO HOUSEHOLDS
– TO BUSINESSES
– TO OTHER BANKS
BONDS
– MONEY FROM BOND SALES
TO INVESTORS
LIQUID ASSETS
– CASH
– DEPOSITS AT BANK OF ENGLAND
– GOVERNMENT BONDS

Your money and the financial system Page 12
Why is a bank’s liquidity
important
If a large number of depositors and investors try
to withdraw their money unexpectedly, a bank
can run short of cash.
In normal times withdrawals
from a bank are fairly
predictable.
Solvent
bank
LIABILITIES
A solvent bank holds enough cash
and liquid assets to pay out fully to
its depositors on demand.
In the balance sheet picture, the
white box labelled LIQUID ASSETS
is larger than to the box labelled
WITHDRAWALS.
A BANK
BALANCE SHEET
ASSETS
WITHDRAWALS
– BY DEPOSITORS
– BY INVESTORS
DEPOSITS
– MONEY IN CURRENT ACCOUNTS
– MONEY IN SAVINGS ACCOUNTS
LIQUID ASSETS
– CASH
– DEPOSITS AT BANK OF ENGLAND
– GOVERNMENT BONDS
LOANS
– TO HOUSEHOLDS
– TO BUSINESSES
– TO OTHER BANKS
BONDS
– MONEY FROM BOND SALES
TO INVESTORS
CAPITAL
– SHAREHOLDERS’ MONEY
– RESERVES FROM PAST PROFITS

Page 13
A bank is insolvent if withdrawals
by a bank’s depositors and investors
exceed its cash and liquid assets.
In the balance sheet picture, the
white box labelled WITHDRAWALS is
larger than the box labelled
LIQUID ASSETS.
The financial regulator requires
banks to hold minimum
amounts of cash and liquid
assets to ensure withdrawals
can be paid in full.
This could happen if depositors
lose confidence in a bank, fearing
their money is not safe.
But big surges in withdrawals
from a bank are rare.
A BANK
BALANCE SHEET
LIABILITIES
ASSETS
If banks unexpectedly run short
of cash and liquid assets, the
Bank of England is able to lend
money on a temporary basis
to preserve the stability of the
financial system.
Insolvent
bank
WITHDRAWALS
– BY DEPOSITORS
– BY INVESTORS
LIQUID ASSETS
– CASH
– DEPOSITS AT BANK OF ENGLAND
– GOVERNMENT BONDS
DEPOSITS
– MONEY IN CURRENT ACCOUNTS
– MONEY IN SAVINGS ACCOUNTS
LOANS
– TO HOUSEHOLDS
– TO BUSINESSES
– TO OTHER BANKS
BONDS
– MONEY FROM BOND SALES
TO INVESTORS
CAPITAL
– SHAREHOLDERS’ MONEY
– RESERVES OF PAST PROFITS

Your money and the financial system Page 14
How did the crisis change
financial regulation in the UK
It’s widely acknowledged there were failings of
regulation during the financial crisis.
During the crisis, the UK
authorities – and others globally
– lacked the tools to deal
effectively with a failing bank.
And no-one was responsible for
regulation of the UK financial
system as a whole.
The weaknesses of regulation
in the UK were addressed in
new legislation to keep the
financial system safe and sound.
These changes built on public
consultation.
Other countries made similar
changes.
A package of major reforms in
2013 created an independent
Financial Policy Committee
(FPC) at the Bank of England and
two new financial regulators: the
Prudential Regulation Authority
(PRA) and the Financial Conduct
Authority (FCA).
In 2009, the Bank of England was
given a statutory objective to
safeguard the financial system.
A Special Resolution Unit was
created at the Bank of England
to manage the failure of
troubled banks to protect other
parts of the financial system.
BUILDING
SOCIETIES
CREDIT
UNIONS
INSURERS

Page 15
The Financial Policy Committee
was established to keep risks
in check across the financial
system as a whole.
If the FPC sees evidence of the
financial system growing too
quickly, it can apply the brakes
to keep credit in check and stop
debt rising unsustainably. Just as
important, the FPC can release the
brakes to support the economy if
credit growth has stalled.
The PRA is a subsidiary of
the Bank of England. It is
responsible for the safety and
soundness of around 1,700
banks, building societies, credit
unions, insurers and major
investment firms.
The PRA focuses on the firms
that pose the most risk to the
operation of the financial system.
The Bank of England’s
responsibilities for regulation
of the infrastructure supporting
the financial system were
extended in 2013.
Financial infrastructure includes
the payment systems that let
money flow around the economy
to support payments for goods
and services and trading in the
markets for shares and bonds.
HIGH ST
BANKS
PENSION
FUNDS
The Financial Conduct Authority
is a separate institution and not
part of the Bank of England. It
acts to prevent market abuse
and ensures that consumers get
a fair deal from financial firms.

BUILDING
SOCIETIES
Your money and the financial system Page 16
The Bank of England’s Financial
Policy Committee (FPC)
The objective of the FPC is to spot and fix threats to
the financial system as a whole.
There are two key policy levers in
the FPC tool kit. These are its
powers of Direction and
Recommendation.
Recommendations
to anyone
FINANCIAL POLICY
FPC Directions are binding
instructions on the Prudential
Regulation Authority and
Financial Conduct Authority.
COMMITTEE
The FPC can issue a Direction to the
Prudential Regulation Authority to
make banks, building societies and
large investment firms:
• raise or lower the total amount of
capital on their balance sheets;
• adjust the amount of capital for
unexpected losses on specific
types of loans – say to the
property market.
Directions
to PRA & FCA
HEDGE
FUNDS
PENSION
FUNDS
CREDIT
UNIONS
INSURERS

BUILDING
SOCIETIES
Page 17
The FPC can make a
Recommendation to anyone.
For example, it can recommend
to HM Treasury that it should be
given new powers, or that the
scope of regulation is enlarged
to include a wider set of financial
institutions.
It has a special power to
make a comply-or-explain
Recommendation to the
Prudential Regulation Authority
and the Financial Conduct
Authority.
If the regulators decide not to
implement a comply-or-explain
Recommendation, they are
required to explain publicly their
reasons for not doing so.
INSURERS
Comply-or-explain
Recommendations
to PRA & FCA
The FPC is chaired by the
Governor of the Bank of England.
It includes the Bank’s three
Deputy Governors for financial
stability, prudential regulation and
monetary policy and its Executive
Director for financial stability.
It has four external members
selected for their experience and
expertise in financial services.
The Chief Executive of the
Financial Conduct Authority is
also a member.
The FPC meets at least four
times a year. Shortly after each
meeting the FPC announces new
policy measures in a Statement
and a fuller Record of its thinking is
published a few days later.
Twice a year it issues a
Financial Stability Report with a
comprehensive assessment of
the risks and outlook for the UK
financial system.
INVESTMENT
BANKS
HIGH ST
BANKS
PENSION
FUNDS
Policy decisions can be put to a
vote, but usually the FPC sets
policy based on a consensus view.
The FPC is accountable to
Parliament for the use of its
powers, mainly through regular
appearances of its members
before the House of Commons’
Treasury Select Committee.

Your money and the financial system Page 18
Prudential Regulation
Authority (PRA)
The PRA was set up as part of a package of major
reforms to help safeguard the financial system.
The PRA is a subsidiary of
the Bank of England. It is
responsible for the safety and
soundness of around 1,700
banks, building societies, credit
unions, insurers and major
investment firms.
The PRA protects the interests
of insurance policyholders and
promotes competition among the
firms it regulates.
INSURERS
1,700
FINANCIAL FIRMS
BUILDING
SOCIETIES
BANKS
INVESTMENT
BANKS
The PRA monitors and sets
standards for safe levels of
capital and liquidity in these
firms.
CREDIT
UNIONS

Page 19
The PRA uses judgement to
focus its work on those firms
and activities posing the
greatest risks to the financial
system and to policyholders.
It assesses the soundness of
firms against the risks they are
facing and risks that could arise in
future. The PRA works with firms
to minimise these risks. But that
doesn’t mean a firm won’t be
allowed to fail.
If the worst happens, the
PRA works with the Bank of
England’s Special Resolution
Unit to ensure that a bank can
fail without disrupting the
supply of key financial services.
This means the wider financial
system can continue to support
the economy and the needs of
the public.
The PRA Board is accountable
to Parliament, mainly through
regular appearances of its Chief
Executive before the House
of Commons’ Treasury Select
Committee.
The PRA publishes its own Annual
Report.
The PRA’s most important
decisions are taken by its Board.
The PRA Board is chaired by the
Governor of the Bank of England.
Its members include the Bank’s
Deputy Governors for financial
stability and prudential regulation.
The PRA Board has a majority of
independent external members,
including the Chief Executive of
the Financial Conduct Authority
(FCA) and four others selected
for their experience and
expertise in financial services.
The PRA works closely with
other parts of the Bank of
England, especially the Financial
Policy Committee, which is able
to give Directions and make
Recommendations to the PRA.
It cooperates closely with its
sister regulator, the FCA.
The FCA is a separate institution
that acts to prevent market abuse
and ensures that consumers get a
fair deal from financial firms.

Your money and the financial system Page 20
What happens if commercial
banks run short of money
The Bank of England is able to lend money to keep
the banking system operating smoothly.
It’s difficult for a bank to hold
enough cash to guard against
every possible withdrawal.
Holding too large a pool of spare
cash would limit a bank’s ability to
lend and could hurt the economy.
Even well-managed and wellregulated
banks can run short of
money temporarily.
An operational hitch could make
it difficult for a bank to meet
withdrawals of money as they arise.
Or a general loss of confidence
among depositors and investors –
similar to what happened during
the financial crisis in 2007 – might
spark a surge in withdrawals that
a bank is unable to fulfil.
It’s in the public interest that
the Bank of England is able to
lend money to keep the banking
system operating smoothly.
These loans provide ‘liquidity
insurance’ for commercial banks.
In the balance sheet picture, a
bank has run short of cash and
liquid assets, but a temporary loan
from the Bank of England allows it
to pay all of the withdrawals by its
depositors and investors.
Otherwise temporary cash
shortages could lead to serious
disruption of the payment
systems.
Liquidity
insurance
The Bank of England can lend
money in normal times and
at times of stress, either to
individual banks or to the
banking system as a whole.
If it makes a loan to a troubled
bank, it is sometimes referred to as
the ‘lender of last resort’.

Page 21
Only banks and building societies
can borrow direct from the Bank of
England because of the crucial role
they play in the nation’s payment
systems.
The Bank of England charges its
borrowers a premium over market
rates of interest. This ensures they seek
money first in the open market before
turning to the Bank of England.
Loans are made for short periods only
and secured on high-quality collateral
like government bonds to protect the
Bank of England against losses.
The Bank of England does not
provide long-term finance
for banks, nor will it lend to
insolvent banks.
Finance of that sort might come
from the government under
the direction and control of the
Chancellor of the Exchequer.
A BANK
BALANCE SHEET
LIABILITIES
ASSETS
WITHDRAWALS
– BY DEPOSITORS
– BY INVESTORS
LIQUID ASSETS
– CASH
– DEPOSITS AT BANK OF ENGLAND
– GOVERNMENT BONDS
BANK OF ENGLAND LOAN
DEPOSITS
– MONEY IN CURRENT ACCOUNTS
– MONEY IN SAVINGS ACCOUNTS
LOANS
– TO HOUSEHOLDS
– TO BUSINESSES
– TO OTHER BANKS
BONDS
– MONEY FROM BOND SALES
TO INVESTORS
CAPITAL
– SHAREHOLDERS’ MONEY
– RESERVES OF PAST PROFITS

Your money and the financial system Page 22
Each day the financial system handles millions
of transactions. These include your spending in
the shops, the payment of your household bills,
wages, benefits and withdrawals from highstreet
cash machines.
PAYMENTS
A stable financial
system provides the
payments services,
finance and insurance
that are crucial to
everyday life.
SAVINGS
& LOANS
INSURANCE
The financial system
brings together savers and
investors to put money to
work. Your savings in a bank
are turned into mortgages
for house purchase, or
loans that finance new
investment in businesses
and create jobs.
Insurance companies
protect you against the risks
in your business or in daily
life. With the protection
of insurance, businesses
can expand with more
confidence helping the
economy grow.

Page 23
YOUR MONEY
AND THE FINANCIAL SYSTEM
The Bank of England Museum tells the story of the
Bank from its foundation in 1694 to its role today
as the nation’s central bank that sets interest rates
and keeps the financial system stable.
Opening hours
Monday – Friday: ​10.00am – 5.00pm (last entry 4.45pm)
Closed at weekends and Public Bank Holidays
Admission is Free
Address
Bank of England Museum
Bartholomew Lane
London
EC2R 8AH
Tel: 020 7601 5545
Email: museum@bankofengland.co.uk
Web: www.bankofengland.co.uk

FUNDS
Your money and the financial system Page 24
INVESTMENT
BANKS
INSURERS
ASSET
MANAGERS
This pamphlet was written by Joe Ganley, the
Bank of England’s communications resources manager,
who would like to hear your comments at:
fspamphlet@bankofengland.co.uk
If you have any questions or enquiries about the
Bank of England, you can email us at:
enquiries@bankofengland.co.uk
Or write to:
Public Information & Enquiries Group
Bank of England
Threadneedle Street
London
EC2R 8AH
You can telephone the Bank’s public enquiries team on
020 7601 4878
To find the Bank on social media go to:
www.twitter.com/bankofengland
www.youtube.com/bankofenglanduk
www.flickr.com/photos/bankofengland