Cash Ratio Deposits (Value Bands and Ratios) Order 2013

Lord Newby Excerpts

Monday 20th May 2013 Grand Committee

Moved By

[Lord Newby]

That the Grand Committee do report to the House that it has considered the Cash Ratio Deposits (Value Bands and Ratios) Order 2013.

Relevant document: 23rd Report from the Joint Committee on Statutory Instruments, Session 2012-13.

[Lord Newby]

My Lords, the draft order makes changes to the cash ratio deposit scheme, which is how the Bank of England funds its monetary policy and financial stability functions. Under the Bank of England Act 1998, banks and building societies of a certain size are required to place a proportion of their eligible deposits in a non-interest-bearing account in the Bank of England. The Bank of England then invests these deposits in interest-bearing assets, specifically gilts, and the return it makes funds its monetary policy and financial stability functions.

The Government continue to believe that the cash ratio deposit scheme is the right way to fund the important policy work of the Bank. The operation of the cash ratio deposit scheme means that the Bank’s income is subject to changes in two variables: first, changes in the gilt rate; and secondly, the size of deposits eligible for the scheme, which is largely driven by the performance of the banking sector. Over the past five-year period, both of these have been lower than expected, which has caused a shortfall in funding for the Bank. The Government seek to address this shortfall by recalibrating the parameters of the cash ratio deposit scheme to current economic conditions.

Specifically, the order increases the proportion of deposits that eligible financial institutions are required to deposit at the Bank of England from 0.11% to 0.18%. It also increases the total amount of deposits that an institution has to hold to be eligible for the scheme from £500 million to £600 million. These changes, when taken alongside efficiency savings to be made by the Bank, aim to ensure that the Bank of England’s income is able to cover the costs of its policy functions over the next five years.

The Government have come to this conclusion after conducting their five-yearly review of the cash ratio deposit scheme. The parameters for the scheme were last set out in 2008, and, of course, economic circumstances have changed significantly since that time. I shall set out some of the more detailed findings of this review.

The total costs of the Bank of England’s monetary policy and financial stability functions between 2008 and 2013 are expected to be around £600 million. The income that the Bank of England is expected to receive over the same period is only £520 million. This will generate a shortfall of £80 million, which the Bank will have to recoup from its reserves, resulting in a reduction in the dividend that the Bank passes over to the Exchequer. This has largely arisen because the return the Bank has received on its investments over the past five years has been lower than expected. At the time of the previous review, the Bank had estimated that its investments would generate a return of 5% based on market expectations of gilt yields in 2008. However, the Bank’s average return is now expected to be about 4.25% between 2008 and 2013.

In addition, the level of deposits that the Bank has received under the CRD scheme has grown slower than expected. In 2008, these were expected to grow at 4.5%. They have instead grown by just under 2%, reflecting the performance of the banking sector during the financial crisis. Should no action be taken, the review found that the outlook for the coming period is much worse. The projected costs of the Bank’s monetary policy and financial stability functions over the next five years are expected to rise to £670 million. This increase is driven by the costs of additional responsibilities that the Bank is taking on, including the supervision of clearing houses and security settlement systems, macroprudential regulation and the setting up of the Financial Policy Committee to identify, monitor and take action to reduce risks to the financial system.

In contrast, the income that the Bank will receive will fall further because market expectations of gilt yields remain low over the next five years. This means that if no action is taken, the Bank’s income will be £440 million and its costs will be about £670 million in the next five-year period, generating a £230 million shortfall. In meeting that shortfall, the Bank is playing its part. It has committed to bearing down on its costs. In particular, it will seek efficiency savings through establishing a shared corporate services model with the Prudential Regulation Authority. The Bank’s budget for the next five-year period takes these savings into account.

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[Lord Tunnicliffe]

My Lords, I thank the Minister for presenting this order. I would almost say that the scheme is essentially a tax on banks and effectively a charge—a way by which the Bank of England receives appropriate revenues to support its policy activities. My understanding from the paperwork—I briefly read the report—is that in essence the revenue from this scheme has proved to be significantly less than predicted. Essentially, the Bank got its forecasts wrong, and therefore it needs to adjust the parameters of the scheme to raise its income over the next five-year period.

The report says that the Government announced the setting up of a review on 18 September 2012. I just wonder how thorough this review has been, because it concludes that this scheme is the best way of going about this but there is little argumentation. It seems to be quite an elaborate scheme. Banks and building societies funding this policy activity is an entirely reasonable idea but the scheme does seem elaborate and I believe that it would bear a more careful review. Therefore, my first question is: in how much depth have the Bank and the Treasury looked at this scheme of requiring banks to place non-interest-bearing deposits with the Bank of England to fund the Bank of England? How much study has there been into whether this is the best way of doing it?

The increase in the levy—a de facto levy—is pretty substantial. As the Explanatory Memorandum points out, the expected revenue will rise from £436 million if the parameters have not changed to £657 million over the period under consideration. That is a 50% increase.

I note from the consultation that there has been no great squeal from the banks which will be paying it, and therefore one must assume either that these sums of money are lost in the roundings of such institutions or that the banks feel that the increase is fair. Nevertheless, it calls into question the efficiency of the Bank of England and whether, in what I loosely call the 2013 review, the efficiency has been properly considered.

In listing the outcomes of the review, the report goes on only to explain the parameters which have changed requiring a review and one efficiency saving, which is in the back-office joint operation with the PRA. Does the Minister feel that the efficiency of the Bank has been properly reviewed? Does he feel that there should be further mechanisms to review the level of funding of the Bank of England in the circumstances?

I have a very open mind on this. I think that the Bank of England should be as efficient as possible. Equally, however, given the tremendous change in circumstances and the responsibilities of the Bank of England, not only do we need an assurance that the Bank of England is as efficient as possible; we need an assurance that the resources are adequate to meet the exceptionally increased responsibilities now being placed on it. Has the Court of the Bank of England carefully considered the funding over the next five years, and can we be assured that the court feels that it is adequate for these new responsibilities?

I turn to my final question. This number might be too small but, again, it is in the roundings. The Explanatory Memorandum says that the larger institutions will have to top up their deposits with the Bank to the tune of £1.558 billion. To a mere mortal that is quite a substantial sum. I do not understand from the EM the extent to which this sum impacts on the balance sheet and capital reserves of the banks and the extent to which that will have an impact on their lending capability. The whole of industry, and in that sense the nation, is looking to the banks to lend more, to create more liquidity and to increase industrial activity. It is crucial that we do not see any significant impairment in the banks by the changed parameters in this scheme.

I would be grateful if the Minister could answer those questions. As I said, we do not want the Bank to be underfunded. We want it to be efficient and therefore, in the generality, we support the order.

[Lord Newby]

My Lords, I am grateful to the noble Lord. I will attempt to deal with his questions. He asked about the basis of the scheme. There was a significant review in 2008 which considered whether a fee-based approach would be a better way of funding the Bank. That review concluded that the benefits arising from the Bank’s activities accrued to the whole banking sector and that it was not possible to apportion the service being received in that way to individual firms. That remains the case.

We asked the banks whether they agreed with that. Some 154 organisations were proactively invited to respond to the Treasury's consultation which ran earlier in the year, in February and March, and the Treasury received three responses. Broadly speaking, the responses were sympathetic to what was being sought. I think that we can take it that this is one of those cases where the banking community is not up in arms about what is proposed.

The noble Lord asked about efficiency and whether this will be properly reviewed, whether resources are adequate and whether the Bank is operating efficiently. The background is that the Bank’s real-term budget is not any higher now than it was in 2000-01, so there has not been a drift. It is fair to say that the Bank has not been subject to significant savings over the past year or two. However, the Government’s view is that the past year or two has been a period of almost unrivalled change in the financial services and regulatory architecture and in the role that we wish the Bank to undertake. Therefore, this was not the time to have a root-and-branch look at efficiency, particularly given that many of the efficiencies that we are talking about will be realised only when the PRA is up and running and it is possible to see how well the joint operation of the back-office activities is going and how much can be saved in that way. Between now and the next review, the Treasury and the Bank itself will look at efficiency afresh in the light of the new arrangements which are happening all around them and the new responsibilities that the Bank itself has taken on in terms of the FPC and direct regulatory roles. Yes, we are concerned about efficiency, but we need to get the balance right and we will be looking very carefully at that over the next year or two.

Finally, the noble Lord asked about the effect of the cash ratio deposits on the Bank’s ability to lend. The cash ratio deposits continue to count as assets for the financial institutions making them so they do not have an impact on the capital requirements. Obviously, however, they represent an opportunity cost as the cash is tied up with the Bank without a return. Nevertheless, as he suggested, this opportunity cost is relatively small. The best estimates of the extra return they will forgo is about £220 million and this will be split between 150 institutions, albeit not equally. Although this is a not-insignificant sum, it is insignificant compared with the £13.8 billion that the banks have drawn from the Funding for Lending scheme. Taken together, the banks are bearing a modest cost. I think that that is why they were content when we undertook the consultation.

I hope that I have answered the noble Lord’s questions. On that basis, I commend the order to the Committee.

Motion agreed.