It is a strange moment when an idea that you have promoted suddenly moves towards the political centre stage, even if Nigel Farage is the person who is doing the pushing.
This happened yesterday when the Reform Party presented its idea to eliminate payments of interest to the UK's commercial banks and other financial services organisations that enjoy the privilege of having a central bank reserve account balance with the Bank of England. As I have noted here many times, the payment of bank base rate on these accounts at one time cost in excess of £40 billion a year, and still costs in excess of £35 billion per annum now.
From 2009 until 2021 the payment of interest at bank base rate on these reserves was a matter of inconsequence because the base rate in question was 0.1%, and the cost was, as a result, immaterial.
Prior to 2009, the cost was immaterial because the balances on central bank reserve accounts were tiny, totalling only about £20 billion in all.
Before 2006, interest was not paid on these balances.
Andy it is important to note that these balances are not, in any significant sense, sums deposited by the banks in question with the Bank of England on a voluntary basis . The balances in question were instead created as a result of deliberate deficit funding of the economy by the government using newly created money that was spent to manage the consequences of the fallout from the global financial crisis between 2009 and 2016, and to cover the cost of the Covid crisis from 2020 to the end of 2021.
Ignore anything to do with quantitive easing, which was simply a disguise for the fact that the government had created money via the Bank to inject the economy during these periods: these central bank reserve account balances represent the total amount of money that the government did inject during these period to cover the cost of fulfilling its policies.
In total more than £900 billion was injected into the economy in this way, and these balances were recorded by the creation of what were, supposedly, deposits by the commercial bank with the Bank of England.
However, since the banks that benefited did not actually deposit any funds, but instead had these deposit balances created on their behalf by the Bank of England acting on behalf of the government, they represented a windfall to the banks in question.
That windfall turned out to be equivalent of the proverbial golden egg when the Bank of England then began to, quote unnecessarily, increased interest rates to supposedly tackle inflation from late 2021 onwards. From that time onwards, the good times began to roll for all of the banks as a result of these interest payments, enormously increasing their profits with no action on their part. I noted some of this impact here.
Let me also stress that these balances cannot be used by the banks, except to facilitate payments to each other or to the government. That is their sole purpose. This is what is called base money, and it does not circulate in the rest of the economy. It is, instead, the liquidity that has been provided by the government to ensure that the banking system can function properly by guaranteeing every bank should have sufficient funds to pay each other, come what may. This is, in effect, a practical reaction to the Northern Rock affair. This increase in bank liquidity might have been a side-effect of a necessary government policy to keep the economy going, but it has undoubtedly been beneficial in bailing out under-capitalised banks.
The downside has been it has been enormously costly to the government, and has promoted austerity economics because it has been necessary, over the last three years, to make payment of interest at inflated rates on these balances.
The Bank of England and others now argue that such payments are absolutely essential as a mechanism for the delivery of Bank of England monetary policy because, they claim, the Bank could not influence the rate of interest in the economy unless it had to pay bank base rate interest on these balances. There are numerous reasons for rejecting this argument.
The first of these is that since significant payment on these balances has only been happening for less than three years this claim is completely unsubstantiated. We do not know that this is true in the context of the British economy.
The second is that other central banks, including the European Central Bank and the Bank of Japan, do not make payment on all such balances. They pay interest on a tiered basis, making full payment on part of the balances, but by no means on all of them.
Third , there is the argument that this is a windfall profit if this interest rate needs to be paid, and that in practice it should be subject to a substantial excess profits tax to recover most of that sum paid so that the banks are not unduly enriched.
Fourth, the stench of avarice underpinning the arguments that the banks should be paid cannot be avoided.
As a consequence I have made it clear that I think that the current policy is inappropriate and should be reformed, and nothing has yet changed my mind about this.
That said, I recognise that there may be (and I stress the may) some merit to the argument that interest should be paid on a part of these balances to communicate Bank of England interest rate policy and have therefore accepted some cost might still be involved.
Alternatively, I would be quite happy with a windfall tax to cancel most or all of this gain.
Best of all, I would like a substantial cut in bank base rate, certainly to nothing more than 2% now, which would also significantly ease this problem .
But what I am not convinced by is Nigel Farage's claim that the entire sum of £35 billion being paid at present can be recovered to fund other spending. That is largely because if this is pure profit to the banks, as it would seem to be, then they do already pay tax on it and so at least £9 billion is already returned to the government, undermining his logic.
Is it, however, true that his logic is fundamentally correct and that these payments are not necessary in total? On this, I have to agree with him. It is unfortunate that he is the person to raise this issue because of his other politics, but the reality is that commercial banks have been enriched in a way that is unjustified, and is unjustifiable, and the time for reform of this policy to radically reduce this cost has arrived. A policy of tiered rates and, most likely, an excess profits tax to recover much of the remaining sum paid would make a lot of sense. Commercial banks should not be enriched by central government money creation, which statement is the beginning and end of this argument.
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It is astounding that the banks are gifted £35-billion each year.
The question is, where does the bank “find” this money, is it costed?
It is created by the Bank, and charegd to central government
This might be, well, is, a good time to remind ourselves that the BoE is part of the Treasury and so is clearly a part of the govt it sometimes seeks to appear distant from. It’s important to remember then that here we have an obvious demonstration that the govt, when it wants to, is entirely capable of funding its own expenditure, raising the telling question, why aren’t we doing a very great deal more of this?
Do you think Farage got the idea from you or do many other people know about this and the story is well versed and somebody else advised him?
I have not the slightest idea
I have not pspekn. to him about it but he is free to read this blog and many of his trolls no doubt do
Tice came up with it – before he was ousted. Farage is incapable of original thought & thus this is him spouting something with Tice (rightly) identified.
I wish I had set up a bank – just think – free money from the government – to hold their money.
We might have reason to thank Farage yet if he can get ordinary mortals asking why, if there are tens of £bns lying around available doing nothing, we haven’t been hearing about this from the other parties, in particular, Labour’s Rachel ‘I used to work at the BoE’ Reeves. Funny how she managed to miss this, some might think, and rightly too.
Double entry would mean that if this £35bn is pure profit to the banks, then it would show up in the accounts of the banks as higher pre tax profit compared to 2022 when the sums were far lower. But does it?
Yes
As I have shown
Is there a link to your analysis somewhere to see this? I was wondering how the banks accounted for this interest, for example whether it was added to the CBRA or was counted in the bank P&L. Thanks.
There is a link in the piece
If the government no longer pays interest in these deposits then the banks will remove those funds and invest in government bonds instead, where the government will be paying interest.
They can’t
CBRAs are a closed loop
True… but gilt yields would fall as banks play “pass the parcel” to replace their (non interest bearing) Reserves with gilts that have a positive yield.
Not paying interest on all reserves can be done but it is not that simple.
How can they use CBRAs to buy gilts if the govemment does not do QT?
There is an active secondary market and issuance by the DMO; they just keep buying until they are indifferent between gilt yields and CBRA interest rates – between 0.0% and 0.25% would be my guess where short dated gilts would trade (if there is no interest paid on reserves).
I get that CBRAs are a “closed loop”; I get that gilt supply is (absent QT) is determined by refinancing and the budget deficit… all I am saying is that the gilt market will reprice to MUCH lower yields. Consequently, all credit and savings rates would reprice MUCH lower.
Now we agree that the current rate is way to high but, suppose you DID want rates where they currently are then you could not do it unless you pay interest on Reserves in some way or other.
And what if we settled on 2%?
This so could work nicely
And we’re could also review nthe role of the DMO, which seems to me to be a rule unto itself…..
This policy was on a list of proposals on the Reform party’s website, which I looked at in the run-up to the recent local government elections.
I was very surprised to see it there, bearing in mind the sectoral interests they represent, but it was one of those moments when my interest in finding out “what the other side thinks” turns up something interesting!
Karl, yes indeed,
The rest of their program is quite depressing. They virtually deny climate change and urge more use of oil and gas. They want to slash large sums from public spending. Tice talked about ‘waste’!
Then I think back to the time shortly after the referendum when Farage met with a gloating Donald Trump and Steve Bannon. Bannon is now heading to prison-possibly Trump too! Also there was a one time editor of Breibart , a Far Right publication, and others associated with Cambridge Analytica which was used to-probably -swing the Brexit referendum result and American money was involved.
Equally depressing is that Brexit is a failure and no one (except the SNP and Greens) seems to be holding the Conservatives and Farage to account.
Far from Reform being a revolt of ordinary people against elites, I think it is a front organisation for very rich vested interests.
Tice is entirely funding his political lobbying and ideology through reform.
He is buying a voice.
There is no public political movement or momentum here, it is entirely fabricated by personal wealth.
As that has been entirely gained through the rentier economy, then his position is almost predictable.
It subverts democracy when £1= one vote.
Banks pay 28% corporation tax (the 3% bank surcharge on top of the 25% main rate – the surcharge was dropped from 8% when the main rate rose from 19%, so the total tax rate for banks profits went up by 1%). So that should be an extra billion coming back. They also pay the bank levy but that is based on their balance sheet.
The BoE or the government guarantees to compensate bank account holders 85% of their balance if the bank fails. Do the banks pay the BoE an insurance premium for that concession?
My guess is NO.
Yes, but it is modest
We know that the 2007/08 accounting crisis (some would say fraud) meant that banks could not borrow from each other, could not properly formulate an inter-bank offer rate and could not collectively clear the system. The private sector failed miserably, the Reserve Account system failed and the people (us) created lots of money to rescue capitalism.
I have no problem with that. I do have problems with the manner in which the people responsible for this meltdown are still in place and doing exactly what they did before.
Now virtually every party is saying that we have no money, a blatant denial of historical reality.
The fact that these issues are decided by what appears to be an ordained financial priesthood with its own special lexicon is surely an affront to democracy.
Money is created by people acting in unison, a social construct of immense importance the mechanics of which should be discussed openly and in detail.
Presently the uses to which the money we create socially is put is currently destroying our public realm.
I DO believe that paying interest on CBRAs needs to be tackled but there are a few misconceptions about this payment and a few problems with a simple elimination.
At an aggregate level, CBRA balances are not under the commercial banks’ control. They can only be reduced by running a budget surplus (tax exceeding spending) or the sale of gilts over and above simple “funding the deficit” (ie. Quantitative Tightening, the reversal or Quantitative Easing that is largely responsible for the creation of these large CBRA balances. So, they won’t “disappear” if the BoE stops paying interest on these balances.
However, we need to look at how individual and individual bank behave. Banks can only keep up their CBRA balance if customers deposit/hold money with them or they borrow it from other banks that have excess reserves that they are willing to lend out.
If the government pays me £100 (eg. pension) then my account at ABC bank will credited and, in turn, they will have £100 credited to their CBRA. Other things being equal, they will receive interest on their CBRA at Base Rate (£5.25 per annum), they will pay me interest at whatever rate they advertise on my account (typically zero for a current account). Lovely business for the bank….. but I don’t have to take this rip off lying down.
For example, I could put my £100 into an XYZ bank Savings account at (say) 4%. ABC CBRA balance would fall by £100, XYZ CBRA balance would rise by £100. ABC would lose it juicy £5.25 a year in interest margin; XYZ would earn £1.25 a year.
NS&I instant access account currently pays 4%. If I transfer my money there, ABCs CBRA balance would reduce by £100… as would aggregate balances (as NS&I is part of government).
So, the interest paid on CBRAs is “free money” only to the extent that they can get away with paying low or no interest to their customers. In theory, competition should deliver the vast bulk of that interest paid to end customers – well, that is what the market fetishists at the BoE think happens. But we all know it doesn’t. Indeed, it used to be said that you were more likely to change your spouse than your bank.
So, one solution is a “rate floor” on all bank accounts. Just as the Energy Price Cap was originally put in place to prevent users that did not “shop around” being ripped off, a “rate floor” at (say) Base less 1% would prevent banks from benefitting from interest on CBRA balances (beyond 1% which seems a reasonable price for running the system). Of course, this would not benefit the public purse but one could use the tax system to rectify that issue.
If you just pay zero on reserves then, beyond the minimum that each bank has to hold to be part of the payments system, it will just become a game of pass the parcel where banks will to hold anything other than CBRA balances. They would first lend in the gilt repo market, then buy gilts outright and, although the aggregate CBRA balances would not change, gilt repo rates would fall close to zero (probably about 0.25%) and gilt yields in general would fall accordingly. Now, in the current climate this might be a good thing but remember, this framework has to work in all weather; policymakers must have the ability to raise rates if they wish.
Of course, the BoE could keep selling gilts to keep rates up…. and eventually they would sell their entire portfolio and CBRA balances would be reduced to the minimum. This would return us to “the old days” where Reserves were scarce but payment of interest on Reserves would just be replaced by payment of interest on gilts.
The only way this works is if you raise the requirement to hold reserves for each and every bank. If they are forced to hold them then you don’t need to pay interest. This is certainly a solution but the detail of how Reserve requirements are allocated between banks and how that can change over time is difficult….very difficult if these levels are raised dramatically. So, a modest rise would save the government some money… which would be a start. How far we could go? I don’t know – nobody does… but keep going until we see problems emerge.
Thanks
I don’t agree that banks can’t use their Reserves (Central Bank Exchange Settlement Balances) to buy gilts. If a bank buys gilts from, say, a primary dealer, they would transfer reserves from their CBESA to that of the Primary Dealer in exchange for the gilts. How else would they do it?
So, you’re discussing a purchase from a government agency?
And you are discussing this in isolation or in context?
The discussion here is a technical one on process. We can slice the salami this way; or that way. We refer to interest rates, and the BoE responsibilities over interest rates.
The starting point, however is surely the CBRAs themselves. They are there for a reason (although not necessarily a good one). They were not always the size they are; there is a reason for that. The process of handling them is not the fundamental issue. Are CBRAs of this scale required? If not, how best do we remove them, without returning to the failures of the past. We are gingerly moving around this Ming vase; as if the Ming vase was the point. It isn’t. The system is not well designed. At £35Bn it is punitively expensive, and doesn’t do a lot of things it should (like rewarding depositors for saving with banks that frankly don’t deserve them). This looks increasingly like an old, redundant, badly upgraded system that frankly needs to be replaced. But everyone is so afraid that its fragility (and perhaps the built in unintended consequences of the system) means any change may just create a new crisis; that nobody wants to contemplate serious restructuring. That sense of insecurity is itself part of the problem.
“If you just pay zero on reserves then, beyond the minimum that each bank has to hold to be part of the payments system”.
And how is that minimum calculated, and over what period is it set?
NB. The ECB pays 0% on “minimum reserves”.
As you say, no interest was paid on CBRAs prior to 2006. Why was the decision to do so made at that particular time? It cannot be part of a response to the financial crisis which did not start until half way through 2007. However it certainty seems convenient that when the government decided to pump up the CBRAs through massive amount of QE, it had already been decided that interest should be paid on these accounts.
If I was in a suspicious frame of mind I might think that the commercial banks knew that a crash was coming and that it would be handled by QE or something similar, prompting them to lobby the BofE to make the change in interest payments before it would have any great economic significance and would thus pass unnoticed.
I don’t know the answer to that
What an interesting question. A starting point for thinking about this may be ‘Paul Tucker: The repertoire of official sector interventions in the financial system – last resort lending, market-making, and capital [Remarks by Mr Paul Tucker, Deputy Governor, Financial Stability, of the Bank of England, at the Bank of Japan 2009 International Conference “Financial System and Monetary Policy: Implementation”, Bank of Japan, Tokyo, 27-28 May 2009.’
The wider context; the international comparison – the Bank of England is not a supreme authority, and not necessarily the best model; For different ways of looking at this across the central bank spectrum, soon after the Crash. See,
Claudio Borio and Piti Disyatat, ‘Unconventional monetary
policies: an appraisal’; in, BIS Monetary and Economic Department Working Papers No 292 (November 2009).
Thanks!
It would seem fairly simple to stop paying interest, however if the fear that this might spook the markets a la Truss (don’t really buy that) or change consumer behaviour, then a windfall tax or excess interest levy might be a more nuanced solution.
I cannot see how banks have taken any additional risk or provided any additional public benefit that might justify that level additional income given the root cause of the increase in reserves is a) quantitative easing and b) interest rates.
So levy it back off them….would be a vote winner for me.