Rishi Sunak would save up to £57bn for taxpayers over the next three years if he stopped the Bank of England paying interest on money held by commercial banks at the central bank, according to a new report seen by the Financial Times.
The report by the New Economics Foundation, a left of center think-tank, recommends the BoE reforms the way that its interest rate underpins the financial system — by no longer paying interest on most of the nearly £1tn reserves held by commercial banks overnight.
The funds are deposited at the central bank as a result of the BoE’s quantitative easing programme, which has left lenders with reserves far in excess of what they need to manage their liquidity.
The interest on the reserves cost taxpayers almost nothing when rates were at rock bottom after the global financial crisis, but would cost up to £57bn by 2025 if rates follow market expectations of a rise to 2.5 per cent.
The BoE has previously proposed deviating from benchmark rates for all but a small tier of such funds when rates are negative. Experienced former officials have told the FT that, since such methods have already been accepted by the bank, the NEF proposal is worth considering.
Frank Van Lerven, senior economist at the foundation, said: “While families up and down the country are worrying about how they will afford their next grocery shop or energy bill, the Bank of England will be busy sending billions to bankers.”
Pointing out that the BoE did not pay interest on reserves before 2006, he said the implicit tax on banks was “a feature, not a bug” of the proposals.
This tax would increase when interest rates rose and would potentially amplify the effect of tightening monetary policy. “A reserves policy that pays no interest would be a better way of controlling inflation,” he said.
Under the think-tank’s proposal, each commercial bank would be required to hold a substantial amount of money at zero interest, with the BoE’s interest rate paid on only the last tier of money. This would ensure that the BoE’s interest rate still underpinned the financial system.
The BoE was not persuaded by the report. It said banks would try to recover the loss incurred “through lower deposit rates or higher lending rates than would otherwise be the case, with adverse consequences for the transmission of monetary policy to households and businesses”.
But former senior financial officials said the bank should not dismiss the proposal so lightly. Speaking to the FT, Lord Adair Turner, former head of the Financial Services Authority, said there were many ways that tiered reserves remuneration could work.
“They are options that should not be excluded. They are technically possible and should always have been thought about and part of the debate,” he said. “It is now up to the Monetary Policy Committee and the Treasury to work out in detail whether to implement them in the current conjuncture.”
The Treasury said: “The Bank of England sets monetary policy to achieve its 2 per cent inflation target, not to reduce government borrowing costs.”
It added that the proposal might damage the UK’s fiscal credibility. “None of the euro area, US, Canada or Japan have deployed tiered interest rates when rates are positive,” it said.
The BoE also contends that revising policy on interest paid on the reserves would be a fiscal matter rather than a monetary one.
Andrew Bailey, BoE governor, told a Lords Committee last year that tiered reserves would be “a tax on the banking system”, implying that the central bank could not implement such a scheme without backing from the Treasury.
But Paul Tucker, the former deputy governor of the BoE who implemented the current policy, said such considerations should not inhibit new thinking.
He added the Treasury could tell the BoE that it had a problem with the public finances and requesting the central bank explore whether it could find a way of managing payments on reserves “that both enabled it to achieve its monetary objectives independently and pay less interest to commercial banks”.