Banks have waited years for higher interest rates to revive their fortunes. But in the UK, where markets predict interest rates will hit 4 per cent by May, taxpayers could end up contributing via the Bank of England.
This would play badly with voters during a cost of living crisis. The government and the BoE might therefore stop paying interest to banks on the so-called “reserves” created during quantitative easing.
QE converted long-term government liabilities into overnight borrowing. The BoE bought £847bn of gilts, financed with the new “interest-paying reserves”.
The interest paid by the central bank has been at a lower rate than the coupon payments it receives on the gilts. That has allowed it to hand the Treasury a cumulative profit of £123bn to the end of April. But once interest rates rise above 2 per cent, that cash flow will turn negative. The left-of-centre think-tank New Economics Foundation has put the UK bill at up to £57bn over the next three years.
The UK is in a tight spot because its vast amount of index-linked debt, nearly a quarter of the whole, is forecast to more than triple debt interest spending to £83bn in the two years to next April.
A further sustained one percentage point increase in interest rates and inflation would cost an additional £18.6bn the following year. Going back to paying no interest on reserves would help ease the pain.
The dire state of public finances will make it tempting for the government to rewrite the rules so the reserves — or at least a big part of them — carry no interest.
Advocates point out that paying no interest on reserves was the norm before the financial crisis. Even so, the rule change would be equivalent to imposing higher tax on banks.
The obscure nature of the implicit levy will appeal to politicians who like to find ways to pluck feathers from geese with minimal hissing. It is a subtler way of transferring money from banks to the government than Spain’s €1.5bn annual windfall tax. Hungary has imposed a similar levy
Politicians would not care that saddling commercial banks with a non-interest-bearing asset would make them even less attractive to investors. But they should weigh up the totality of disadvantages. Making commercial banks less competitive would increase flows to shadow banks. That would create new risks to financial stability.
Source: Economy - ft.com
