Kwasi Kwarteng has quashed calls to impose a new “tax” on Britain’s banks that might have raised billions of pounds, following strong opposition from the sector and warnings that the costs would be passed on to consumers.
The UK chancellor was urged by influential economists to raid what one banker called the “ultimate cash behind the sofa” by reducing or stopping interest payments on the large reserves held by commercial banks at the Bank of England overnight.
The policy could have raised tens of billions of pounds as interest rates rise and helped plug a fiscal hole estimated at up to £60bn, following last month’s “mini” Budget.
But the prospect sparked alarm among senior bank executives, who feared they might be targeted by a chancellor looking to raise money and urged the Treasury in recent days not to target bank profits.
The Financial Times has learned that the idea was briefly studied in the Treasury although the department said it was not under “active consideration” and would not be adopted.
With interest rates having risen sharply, lenders are receiving much higher returns on more than £800bn they have parked at the BoE since 2009 as a result of quantitative easing programmes.
Instead of paying interest on these “reserves” at the bank’s official rate — currently 2.25 per cent — the government could have decided to force banks to hold the money at the BoE at a lower — or even a zero — interest rate. Banks have argued the move would have amounted to a “stealth tax”.
Frank van Lerven, a senior economist at the left-of-centre New Economics Foundation think-tank, said £200bn would be paid in interest to commercial banks by the end of 2026-27. “Instead of looking for funding cuts across the public services, the government could stop paying interest altogether,” he said.
The idea was also backed by Julian Jessop and Gerard Lyons, two economists who had the ear of prime minister Liz Truss during the Tory leadership campaign, and enjoyed clear political appeal.
One large bank warned the Treasury this week that such a move would impact profits “significantly”, lowering the revenues the exchequer receives through taxes and the 8 per cent bank surcharge.
One executive said any cut to interest payments would have become a “tax on the consumer” because banks would have passed on the costs. Another said it would have put UK banks at a significant competitive disadvantage to other European and US institutions.
Andrew Bailey, Bank of England governor, said last year that he opposed the idea, telling a House of Lords committee: “It is a tax on the banking system. It is not monetary policy; it is fiscal policy.”
Bailey added: “It would complicate the transmission of monetary policy substantially, because that begins with us setting the short-term official rate — the official bank rate. That transmits through the interest rate we pay on the reserves that banks hold at the Bank of England.”
As interest rates have gone up, the Treasury has paid interest on the money printed under the £850bn quantitative easing programmes that the BoE has used to stimulate the economy and resolve financial squalls since 2009.
The money created ends up being held by commercial banks and receives an interest rate equivalent to the central bank’s official rate, so that banks are willing to leave the money sitting at the BoE.
When interest rates were close to zero, this policy made the Treasury money; but as they have risen this is no longer the case. Each percentage point hike by the BoE costs the exchequer almost £10bn a year.
With rates going up quickly — and expected by financial markets to be above 5 per cent by this time in 2023 — the change would push up debt interest servicing costs to well over £100bn.
The Treasury said the proposal would have acted as “an additional tax on banks” and created the impression the UK was choosing not to pay interest owed because the costs were too high.
It added: “This proposal risks damaging the UK’s fiscal credibility, and none of the euro area, US, Canada or Japan have deployed tiered interest rates when rates are positive.”