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Of all the deserving causes that politicians are keen to endorse as we limp towards the UK general election — the NHS, social care, education, defence — a £40bn annual payout for the country’s big banks must be one of the least likely vote winners.
The sum is what the Bank of England, underwritten by the Treasury, currently hands out to the likes of NatWest, Lloyds and HSBC as interest generated at the base rate of 5.25 per cent, on the banks’ £760bn of reserves held at the central bank.
It’s an abstruse topic, the detailed economics of which have been closely analysed by my colleagues Chris Giles and Toby Nangle. But because of the large sums involved, the interest paid on central bank reserves has also become intensely political in the run-up to the July 4 poll.
In a typically populist move, Reform UK — Nigel Farage’s rebranded Brexit party — has made abolition of the scheme a policy priority. The Green party has meanwhile pledged a windfall tax on banks’ “excessive profits”, while the Liberal Democrats vowed to reverse cuts that the Conservative administration have applied to bank-focused taxes — a balance sheet levy and a supertax.
This is the context in which reserve interest should be seen. Stripping away a commercially appropriate return on money deposited with the central bank would be tantamount to a 100 per cent tax bill on that earned interest. In a different context — individuals’ savings account interest, for example — even the most radical socialist would blanch at such a seizure.
There is another moral argument against eliminating interest on reserves: to do so would be to move the goalposts half way through the game. Until a couple of years ago, banks in many parts of the world had been through a long cycle of subdued profit margins brought about by ultra-loose monetary policies. That was particularly true in Europe where interest rates were nudged, or fell below, zero for many years as policymakers tried to spark growth. When interest rates are low, the margin between deposit interest and loan interest tends to be compressed. Lower margins meant lower profits and subdued stock market valuations. Allowing banks to benefit from today’s symmetrically higher rates is only right.
The related central banking arguments against abolition are powerful, too. As BoE governor Andrew Bailey has reiterated in recent speechesthe current system is a key mechanism for transmitting monetary policy to the economy. That in turn feeds through to benefits for customers — reserve interest pegged to base rates underpins higher deposit rates and lower lending rates. Financial stability is also enhanced: remunerated reserves incentivise banks to keep high levels of liquid funds at the BoE.
In truth, even reformist policymakers are not advocating the kind of extreme interest seizure that Farage has suggested. Economists that Farage claims as backers of his plan have in fact argued for a far subtler change — creating a relatively small tier of reserves that would go unremunerated while the remainder would still attract interest.
Such a system already applies in the eurozone, where the European Central Bank last year imposed a 0 per cent tier of compulsory reserves equivalent to 1 per cent of banks’ deposits, with interest paid on surplus reserves. It is too early to chart the impact, but bankers suspect that the transmission speed of rate changes may be impaired. In exchange, eurozone central banks are saving about €6bn in interest payments.
An incoming Labour government in the UK, now universally predicted by the polls, should not countenance even this kind of relatively small change. And not only because the monetary gain would be small. Imposing yet another de facto tax on banks would undermine all the pro-business, pro-growth, pro-investment policy preparations that Sir Keir Starmer’s party has made over the past year or two. Quixotic windfall taxes imposed by European governments have compounded shrunken profit margins and spooked foreign investors, keeping the region’s bank valuations way below those of US rivals.
It is encouraging that chancellor-in-waiting Rachel Reeves has professed no intention of pressing Bailey (her former boss at the central bank back in the early 2000s) to make such a backdoor change to bank taxation. Nor should she be swayed into raising the front-door supertax or levy. The growth agenda that forms a central plank of Labour’s electoral pitch cannot be effectively fuelled with a whipping-boy banking sector.
patrick.jenkins@ft.com
