Discount market

By:

James Knight

James is a lead editor for Invezz, where he covers topics from across the financial world, from the stock… read more.

Updated: Aug 20, 2021

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The market dealing in treasury bills, bills of exchange and short-dated bonds and consisting of the banking system, the accepting houses and the discount houses. Although the existence of discount houses as such is unique to the City of London, a money market of some kind is a feature of all financial centres. The discount houses originally dealt mainly in bills of exchange accepted by the merchant banks, but over half of their assets now consist of government (including local government) securities, and they also hold negotiable certificates of deposit. The discount houses purchase these securities from the government and the private sector with money borrowed from the banking system, including overseas banks in London, and to a lesser extent from indus­trial and commercial companies, supplemented by their own capital.

Their profit is made by borrowing at very short-term (normally twenty­four-hour call-loans) and lending by discounting securities at slightly higher rates of interest. In this way the discount houses take up the surplus liquidity of the banking system and lend it to the government and those issuing bills of exchange. The discount houses retain some bills to maturity; others are sold to the banking system as they near maturity. The discount houses perform a useful function in providing a flexible and smooth market in short-term securities, and also play an important part in the mechanism by which the authorities exert control over the monetary system. The ability of the discount houses to borrow short and lend long depends on their knowledge that they can borrow from the Bank of England at any time. This borrowing, which arises when the commercial banks and overseas banks cal! in their loans, comes about through the bank discounting eligible paper for the discount houses, in which circumstances the market is said to be ‘in the bank’. There is an understanding that the discount houses will always take up the treasury bill weekly tender, although since the new policy of credit control they no longer do so by a ‘syndicated bid’ at a uniform price. The rate at which their bids are made naturally reflects and influences the leve! of all short-term interest rates, which, therefore, the treasury authorities push up or down by varying the amount of the tender.

Reference: The Penguin Dictionary of Economics, 3rd edt.