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What’s going on with Reform’s proposed overhaul of Bank of England reserves?

Tice said the policy would raise £35bn over the next five years, a figure which leading tax lawyer Dan Neidle described as "magic".
Tice said the policy would raise £35bn over the next five years, a figure which leading tax lawyer Dan Neidle described as "magic".

Reform UK announced plans to squeeze a bit of extra money out of the banking system on Monday through a major overhaul of monetary policy.

Reform’s suggestion is that the Bank of England could stop paying interest on the remaining £700bn of commercial bank deposits created through quantitative easing.

By paying Bank Rate on those reserves, the Bank of England – and ultimately the Treasury – is having to transfer money over to the commercial banks.

Cutting interest payments on those deposits is not a hugely radical suggestion. Two former Bank of England governors and a former Prime Minister, Gordon Brown, have suggested that the costs of QE could be reduced by moving to a tiered system of reserves.

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This would mean some portion of commercial bank deposits would not receive any interest. The European Central Bank (ECB) stopped paying interest on a very small portion (around one per cent) of bank deposits last year.

However, stopping interest payments entirely, as Tice wants to do, is much more radical and much more dangerous.

Firstly, it would raise very big questions for the effectiveness of monetary policy. By stopping all interest payments to commercial banks, the Bank of England would effectively be left with a policy lever which is not attached to anything in the real economy.

“Paying Bank Rate on reserves anchors the implementation of monetary policy,” Andrew Bailey told the House of Lords in February. “We would have to be very careful how we implemented anything like that”.

Combining this with Tice and Farage’s £40bn tax cut could be quite the inflationary cocktail.

This impact could be mitigated if the Bank were to tier reserves – that is, only pay out interest on reserves which exceed a regulatory minimum – but this would also raise less money and, to repeat, is not Tice’s preferred option.

For what its worth, Bailey has never been keen on the idea, describing it as “tax on the banking system”. It’s also worth noting that consumers would likely have to bear the cost at some point down the line.

Leaving aside the technicalities, there’s big question-marks about how much the policy could raise. The short answer is that we don’t know because it depends on the future path of interest rates. As interest rates fall, the measure will be less lucrative.

Tice said the policy would raise £35bn over the next five years, a figure which leading tax lawyer Dan Neidle described as “magic”.

Different tiering systems would raise vastly different sums. For instance, Deutsche Numis suggested that moving to the ECB’s tiered system would raise £1bn per year.

Discussing his own proposals, Gordon Brown suggested the measures could raise a minimum of £1.3bn annually, potentially more.

Either way, it seems unlikely to fully fund Reform’s Great British tax cut (not that they’ll be bothered). Don’t be surprised though if sooner or later one of the major parties makes a move on bank deposits.