Draft Cash Ratio Deposits (Value Bands and Ratios) Order 2018
(6 years, 6 months ago)
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The Economic Secretary to the Treasury (John Glen)
I beg to move,
That the Committee has considered the draft Cash Ratio Deposits (Value Bands and Ratios) Order 2018.
May I say what a pleasure it is to serve under your chairmanship, Mr Robertson? The draft order, which was laid before the House on 16 April, makes changes to the cash ratio deposits scheme, by which the Bank of England funds certain functions. Under the Bank of England Act 1998, banks and building societies of a certain size are required to place a proportion of eligible deposits in an account with the Bank of England. In turn, the Bank invests those deposits in interest-bearing assets—namely gilts—and the return on those investments is channelled into the funding of its monetary policy and financial stability functions. There is a resultant systemic benefit to the whole banking sector, and to the wider public, from the sustained and stable operation of those functions. For those reasons, the Government are confident that the cash ratio deposits scheme is the best way to fund the Bank’s important policy work.
I will make some remarks on the performance of the scheme in the past five years, from 2013 to 2018. The Bank’s income generated by the scheme is driven by two factors: the yield on gilts and the size of deposits eligible for the scheme, which is largely driven by the overall performance of the banking sector. Over the last five-year period gilt yields, and to a lesser extent the growth in deposits, have been lower than expected, which has caused a shortfall in the Bank’s funding. A similar shortfall arose in the five-year period leading up to the last review of the scheme, which was carried out by the Government in 2013.
The Government seek to address the problem by recalibrating the parameters of the scheme over the forthcoming review period. In particular, they seek to move away from the current use of a fixed ratio as the measure by which institutions calculate the proportion of their deposits to be placed at the Bank; instead, the ratio would be indexed to actual gilt yields. Under an indexation approach, the ratio will be calculated once every six months, to align closely with prevailing gilt yields. Such an approach should lead to a smoother income profile for the Bank, as it will dynamically adjust to the investment environment. It will reduce both the risk of a shortfall in income, if yields do not perform as expected, and the likelihood of future funding deficits for the Bank. The indexation model also has potential benefits to payers. For example, if gilt yields were to increase, institutions would not then be required to place as much on deposit at the Bank.
The Government have consulted on the changes to the parameters of the scheme that are before us today. Alongside the Bank’s efficiency savings, the changes proposed by the order will ensure that the income generated from the scheme covers the costs of the Bank’s policy functions over the next five years. The Bank’s costs have increased since Parliament last agreed to the scheme, and it has committed to maintaining its costs at 2018-19 levels over the next five years. Any subsequent enhancements will be funded from efficiency savings generated elsewhere. Those cost-saving measures include a comprehensive programme of cost containment and reprioritisation. The Bank will also continue to increase transparency about its income sources and the application of income generated under the scheme.
The changes to the scheme are expected to increase the Bank’s income over the next five years and generate income closely aligned to its forecast costs. It is worth noting that the amount that most institutions are required to deposit at the Bank under the scheme is relatively small. In December 2017, 81% of deposits were made by just 20 institutions, with 14 of those each contributing more than £50 million. The majority of contributions are from larger banks and building societies.
The Bank of England Act 1998 sets out that the cash ratio deposit rate can be changed only once every six months. The deadline for amending the rate ahead of the next six months is 1 June 2018. If the scheme is not amended by that date, the shortfall in the Bank’s funding will continue.
The changes proposed by the draft order are sensible and proportionate in the light of the issues identified in the 2018 review. The draft order will ensure that the Bank’s important monetary and fiscal and stability functions are fully funded. For that reason, I commend the draft order to the Committee.
Anneliese Dodds (Oxford East) (Lab/Co-op)
It is a pleasure to serve under your chairmanship, Mr Robertson. I am grateful to the Minister for those helpful explanatory remarks.
It is clearly essential that the Bank’s monetary policy and financial stability functions are adequately funded, and I therefore understand why some reform is necessary, given the shortfall arising under current arrangements. None the less, it is important that we properly interrogate this matter, given that we are talking about very large sums needing to be raised—£845 million over the five years to 2023—and extremely large sums of the Bank’s capital being held in order to raise that sum. I therefore have some questions for the Minister.
First, has a proper cost-benefit analysis been conducted on this approach to raising funds, as against other possible options? According to the summary of consultation responses for the scheme review, one respondent
“considered that a fee-based mechanism would be the fairest, most efficient and most transparent means of funding the Bank’s critical monetary policy and financial stability policy work. The respondent noted that, whilst the consultation paper explained that a fee-based model would require more in-depth analysis, no indication had been given to if, or when, such in-depth analysis will take place. The respondent understood that the current legislative agenda makes changing the basis of funding the CRD scheme difficult, but nonetheless considered that discussions on this proposal should begin.”
It will be interesting to discover from the Minister when and where those discussions about a fee-based model will take place.
I tried to do my own back-of-an-envelope calculation yesterday to work out whether the current approach is a relatively expensive or cheap way of raising the funds that the Bank needs for the overall economy, given that returns from gilts are generally low compared with other forms of investment. We could say that this is a rather banal calculation, in some ways. Banks are returning to substantial levels of profitability, in many cases, and something that costs a bank a lot may only cost its shareholders; that would not, therefore, necessarily constitute a major public policy concern.
I thought it was helpful to think this through from the neutral point of view of overall economic efficiency. In theory, the freed-up balances from banks could be invested in riskier but more profitable forms of investment. The five-year yield on UK gilts currently appears to be 1.15%. Traditionally, banks’ return on equity has been substantially higher than that, outside crisis periods. However, the return on equity has been reduced substantially by the financial crisis and subsequent regulatory requirements, and Brexit is also predicted to challenge returns on equity. I think it is interesting, and important, to compare the two levels of returns.
The respondent who suggested a fee-based approach may not have been concerned with efficiency—although the protection of banks’ profits may have been involved, given that, as I understand it, the respondents to the consultation were the banks that already contribute to the scheme. None the less, the respondent also referred to greater transparency arising from a fee-based system. I think there is some argument for that, given that it is, as I understand it, the method used to cover the cost of financial regulation via the Prudential Regulation Authority.
It was maintained in some of the documentation that I read that it would not be possible to adopt a fee-based system because the Bank’s monetary policy and financial stability functions affect all market actors. However, one could surely say the same thing about the PRA’s functions, to an extent. Furthermore, the threshold applied to this scheme means that, as the Minister rightly mentioned, the lion’s share of the contribution is made by the 20 largest institutions, with 146 making some kind of contribution and many other institutions that have eligible liabilities of less than £600 million making no contribution. Not each and every institution that benefits from financial stability currently makes a contribution, so I do not really understand that argument.
To conclude this point, it may indeed be sensible to stick with the current approach, albeit with the changes that the Minister has just adumbrated. However, given that at least one respondent suggested a fundamentally different methodology, it would be helpful to hear the Minister’s thoughts.
Secondly, how sensible was it to retain the current five-year cycle for determining the method and level of funding for the Bank on these operations? I say that because many of its financial stability functions, in particular, could be impacted significantly by Brexit, as of course could its monetary policy functions. As colleagues may well know, the PRA has introduced an EU withdrawal fee to its regime for financial institutions. However, there seems not to be even a single mention of Brexit in the explanatory memo for this change or the document “Review of the cash ratio deposit scheme: consultation on proposed changes”, which was released in February this year. Indeed, the latter suggests that the Bank’s policy costs will remain static over the four years following 2018-19. Does the Minister genuinely feel that the proposed method of contribution is likely to prove sufficient if we see the kind of no deal, highly disruptive scenario for which some Government Members have been pushing?
Finally, I note that the consultation suggests that we are talking about relatively small beer. The consultation document notes:
“In the wider context of the total tax burden on banks and building societies the review notes that in 2016-17, £3.0 billion was raised from the government bank levy, and over £1.6 billion from the bank corporation tax surcharge. Corporation tax receipts from the banking sector over the same period totalled £4.8 billion. By comparison the CRD scheme is looking to recover £169 million per annum.”
That tax burden is reducing in incidence because of decisions made by the current Government. I accept that the absolute value of tax collected has not diminished, given the return of many banks to profitability, as I have already mentioned.
Of course, many learned commentators suggest that that is one of the main reasons why corporation tax receipts appear to have increased despite a lowering of the rate. Those commentators suggest that the receipts would have not reduced, but risen if the rate had not been cut. In addition, I gently draw colleagues’ attention to the fact that the reduction in the bank levy is not compensated for by the corporation tax surcharge, and it leads, over time, to a £1.4 billion gap, as evidenced by the Government’s Red Book at the last Budget. We should therefore take decisions in this area informed by the fact that, overall, this Government have substantially reduced the taxation that falls on our banking sector. That is not, I suspect, an approach with which many of our constituents would agree.
John Glen
I thank the hon. Lady for her observations and challenges. As I set out at the beginning of my speech, the context was to secure sufficient funding for the Bank of England’s execution of its monetary policy and financial stability functions. I recognise that there was a range of contributions to the consultation, with 19 responses received to the informal consultation and three to the public consultation, but overall there were no substantial arguments against the proposal.
The hon. Lady raises the question whether there should be a fee-based mechanism. In any consultation there will be a range of views, but I think the consensus was on tweaking the existing model to give more assurance on the amounts that will need to be deposited, and to reflect a more responsive approach to prevailing gilt returns.
Andrew Bridgen (North West Leicestershire) (Con)
The Minister pointed out in his opening address that the Bank of England had suffered a deficit on the current system, as a result of lower than expected gilt yields. Will the new system allow the Bank to eliminate that deficit, or will it be carried forward?
John Glen
For the deficit over the last five-year period on its expenditure on these two functions, the Bank will have been obliged to find the funds from other sources within its organisation. We want to ensure that these particular functions—the monetary policy and financial stability functions—are properly funded and that there is flexibility over the amounts based on the prevailing gilts; they will be transparently and publicly available, because they are quoted all the time.
On the risk of the expansion of costs in the light of Brexit, the Government are working toward a solution that involves a long-term economic partnership. The enduring functions of the Bank of England to satisfy monetary policy and financial stability will continue. If, at some future point, the Bank of England realises further costs, it will be for the Bank to have conversations with the Treasury about the matter, but that is not anticipated. The Bank has been able to make projections over the next five years and commit to a budget that it is happy with under this model.
I have just received some advice on carried-forward costs. There are no fixed costs over five years, and there will be no carry-forward of the deficit. That will be dealt with, and we will start on the basis of the budget over the coming five years.
The hon. Lady made some wider observations about corporation tax. I think that they are out of the scope of this discussion, which is simply about the provision for this function of the Bank of England.
Anneliese Dodds
I mentioned corporation tax only because the consultation for the order set the requirement to place deposits with the Bank in the context of overall tax burdens on banks. It was mentioned in the consultation first; I did not come up with it initially.
John Glen
That was mentioned in passing, but the order is designed to give better assurance about the realising of the return required for the Bank of England to carry out these functions. I do not have anything more to add, so I hope that the Committee will agree to this draft order for the benefit of the Bank, our banking sector and the users of those services across the country.
Question put and agreed to.