© Reuters. FILE PHOTO: People stand outside of the Bank of England in London, Britain, October 10, 2022. REUTERS/Hannah McKay/File Photo
By David Milliken
LONDON (Reuters) – Britain’s government should review the Bank of England’s policy of paying interest to banks on the reserves they hold there, potentially saving 30-45 billion pounds ($34-51 billion) a year, former BoE deputy governor Paul Tucker wrote on Friday.
Tucker, in an article for the Britain’s Institute for Fiscal Studies (IFS) think tank, said he was not certain that it would be right to move immediately to a system where banks would only receive interest on a fraction of their deposits at the BoE.
However, he said an early change should not be ruled out, and that either way the BoE should set out a new policy on how it would treat reserves during any future rounds of quantitative easing.
British banks hold around 947 billion pounds of reserves at the BoE, largely as a result of the 838 billion pounds of quantitative easing that the central bank is yet to reverse.
Banks are paid interest on the reserves at whatever is the BoE’s current interest rate – just 0.1% less than a year ago, but 2.25% now and forecast by markets to exceed 5% next year.
BoE Governor Andrew Bailey has said the current system is essential to transmit changes in the BoE’s official interest rate through to the wider economy.
However Tucker, who was deputy governor from 2009 to 2013 and is now a researcher at Harvard University, said similar effects could be achieved by paying interest on just 100 billion pounds of reserves.
Based on recent interest rate forecasts and the BoE’s plans for unwinding QE, such a tiered system of reserves remuneration would save 30-45 billion pounds in each of the next two financial years, Tucker estimated.
Britain’s public finances are under heavy strain – with the IFS estimating on Tuesday Liz Truss’s government needed to find 62 billion pounds a year of savings – and the interest payments represent up to 1.6% of annual gross domestic product.
However, Tucker said moving to a tiered system of reserves remuneration was not the “easy win” it might appear.
The policy might be viewed as a tax on banks – though Tucker said careful study was needed into whether it would actually damage banks’ financial stability or reduce lending, rather than just lower profits and bonuses.
Changing policy also risked creating an impression that existing BoE policy could not be relied on, he said.
The BoE had better information than he did on whether these adverse effects were likely, Tucker added.
($1 = 0.8872 pounds)