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Why taxpayers are paying £40bn in interest on Bank of England reserves

Spring flowers bloom in front of the Bank of England building, in London, Britain, March 21, 2024. REUTERS/Toby Melville
Former chancellor Gordon Brown wants the Bank of England to stop paying so much money to banks. (REUTERS / Reuters)

UK taxpayers are paying banks almost £40bn a year as the Bank of England pays interest on reserve deposits they are required to hold at the central bank for regulatory purposes. Money former chancellor Gordon Brown wants to see deployed towards hospitals and schools.

Commercial banks have some £750bn in reserves deposited with Bank of England, and just like a regular deposit where the bank will pay you interest for having your money with them, the central bank is required to pay interest on that amount.

That means that the Bank of England is paying 5.25% to commercial banks just to hold their money, which comes in at about £40bn a year.

Why are taxpayers footing the bill?

Ultimately, UK taxpayers have to foot this bill as the government is liable for the BoE costs via the Treasury.

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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 net loss to the BoE is, however, less than the £40bn as the central bank generates interest on the £730bn of government bonds it owns.

Read more: UK GDP falls by 0.3% as official data confirms recession in 2023

The Treasury will pay out over £150bn to the Bank of England to fund its payments to the banking sector by 2028, this on top of the £30bn already paid out in 2023.

Could this money go towards schools?

Former chancellor Gordon Brown is now proposing a shift that would see over a billion raised from banks to fund public services.

The UK’s longest serving chancellor told ITV’s Preston Show that if the Bank of England were to change its rules closer to what the European Central Bank (ECB) and Swiss National Bank do, a minimum of £1.3bn of taxpayers money would be freed.

The bank levy would involve a change in the rules to enable the government to redirect funds from the interest payments made to banks from the reserve deposits they are required to hold at the Bank of England for regulatory purposes. This alone would raise more than £1.3bn, Brown suggests.

Brown believes £1.3bn to be the minimum that could be raised, with the former chancellor telling the ITV journalist that it could yield multiples of that that could be used on hospitals, schools and infrastructure.

What are the consequences of this bank levy?

Former BoE chief economist Andy Haldane has said “it is a way of doing it” but there might be consequences in the long run for mortgage holders

“It is basically a tax on the banking system and you could do it. The profits are really fat right now,” he told Preston.

“The risk is the cost is not actually [being] borne by the banks but by them passing on that tax to millions of savers and low deposit rates, and millions of mortgage holders and higher mortgage rates,” he warned.

Why are UK banks required to deposit money with Bank of England?

Reserves are deposits held by commercial banks such as high street lender like HSBC or Lloyds at the central bank.

Banks use reserves to settle payments with one another. They do not rely on other markets to be 'monetised', meaning they do not need to be sold to get hold of cash first.

Central banks impose reserve requirements – the minimum amount a commercial bank must hold in liquid assets – to give confidence to the public that banks have, in normal circumstances, sufficient cash on hand in the event that large deposits are withdrawn. This makes reserves crucial in case of a bank run and allows banks to cushion losses and keep lending to households and businesses during economic downturns.

Read more: Bank of England leaves interest rates unchanged at 5.25%

The BoE has said that it is implementing the final leg of the global Basel bank rules that increases capital requirements [liquidity to lending ratio] at UK banks by about 3%. However, this should only happen by January 2030.

What are the ECB and the Fed doing?

Last September, the ECB decided to stop remunerating banks' minimum reserves to contain the amount it pays in interest and the losses it is likely to make. It also debated raising banks' obligatory reserves – to 2% from 1% of deposits to mop up more cash from the banking system.

Last year, the ECB paid about €136bn in interest to banks just for holding their money.

In a joint paper, Paul De Grauwe from the London School of Economics and Yuemei Ji, Professor of Economics at University College London, argued that central banks should not be paying banks to hold their reserves.

“It is difficult to find an economic justification for why bankers should be paid for holding liquidity while everybody else accepts not to be remunerated.

“The lack of economic foundation for paying interest on banks’ liquid reserves becomes even more striking when considering that central banks make profits because they have a monopoly from the state to create money. The practice of paying interest to commercial banks amounts to transferring this monopoly profit to private institutions.

“This monopoly profit should in fact be returned to the government (the taxpayer) that has granted the monopoly rights. Paying out interest on banks’ reserve balances amounts to a massive transfer from taxpayers to commercial banks organised by the central bank. This does not appear to be a fair system.”

And the Swiss National Bank...

The Swiss National Bank is evaluating whether to raise banks’ minimum reserve requirements.

The central bank stopped paying for the money lenders must hold at the institution as a minimum reserve as of December in a move that that will save the country 300 million francs (£269m/$340m).

The US Federal Reserve pays banks on their deposits and last year shelled out about $162bn to banks.

Is a Labour government likely to change the status quo?

Unlikely, given the consequences and wider ramification – but stranger things have happened in politics, and the government of the day does wield a lot of power.

Watch: Gordon Brown: Treasury must leave ‘comfort zone’ to ‘break out’ of low growth

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