Draft Cash Ratio Deposits (Value Bands and Ratios) Order 2018

John Glen Excerpts

Tuesday 15th May 2018 General Committees

[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.

--- Later in debate ---

[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.