THE UK government could save £55 billion over the next five years if it limits the amount of money the Bank of England pays interest on to commercial banks, according to analysis from the New Economics Foundation.
The Treasury will pay out over £150 billion to the Bank of England to fund its payments to the banking sector by 2028, on top of the £30 billion already paid out in 2023. This is a result of the Bank of England paying interest on all central bank reserves, including the £875 billion created through quantitative easing (QE).
Instead, the analysis finds that the Bank of England could pay interest on a smaller portion of reserves by requiring commercial banks to hold 10 per cent of their liquid assets in reserves that pay no interest. This would save the government £55 billion over the next five years.
This 10 per cent ‘reserve requirement’ is lower than requirements used by central banks in China and Brazil in recent years and the UK in the 1970s. The European Central Bank has recently announced a policy to stop paying interest on these reserves, and the application of this in the UK has been discussed by former deputy governor of the Bank of England, Sir Paul Tucker.
The Bank of England holds money for commercial banks in reserves and currently pays interest on all of this. The level of interest is set by the Bank’s own interest rates. The Treasury is responsible for funding any gap between the interest the Bank of England receives on bonds bought via quantitative easing and the interest it pays out, along with any losses the Bank makes from active sales.
The analysis shows that the government could save billions by implementing a tiered reserves policy which would reduce the proportion of central bank reserves on which the Bank of England pays interest to the banking sector.
The analysis finds that, over the next five years:
- A one per cent reserve requirement, equal to the policy implemented at the European Central Bank would save the government £1.3 billion a year.
- A 2.5 per cent reserve requirement would save the government £3.3 billion a year, enough to fund a mass insulation programme for 7 million homes over five years. Such reserve requirements are common place in Switzerland.
- A five per cent reserve requirement would save the government £6.6 billion a year, enough to fund repairs for crumbling schools and hospitals over the next five years. Such reserve requirements are lower than those used by China this summer.
- A 10 per cent reserve requirement would save the government £11.5 billion a year, enough to implement all the above policies. Such reserve requirements would be lower than in the UK in the 1970s.
Dominic Caddick, economist at the New Economics Foundation, said: “At a time when millions are struggling with rising mortgage and debt costs, the Treasury are set to pay out billions in public money to fund transfers to commercial banks. The policy of the Bank of England paying interest on reserves was introduced in response to the financial crisis, but now we’re 15 years on and in a different economic context, the government needs to change its approach. Public money should be spent supporting people through the cost of living crisis, not giving banks a huge bonus.”
* Source: New Economics Foundation