- Lenders are making billions through a little known scheme
- They receive interest on reserves they have to hold at Bank of England
- These reserves came about as a result of Bank’s Quantitative Easing programme
Political opponents are coming together to demand curbs on a stealth subsidy paid to the High Street banks that costs taxpayers £40 billion a year.
Critics say banks are being handed billions of pounds of money for nothing.
It comes as Labour and the Conservatives trade blows on how they will fill the gaping hole in the public finances.
Lenders are making billions through a little known scheme under which they receive interest payments on reserves – piles of cash – they have to hold at the Bank of England.
These reserves – which amount to more than £700 billion – came about mainly as a result of the Bank’s Quantitative Easing (QE) programme.
Concern: Critics say banks are being handed billions of pounds of money for nothing
Under QE, new money was conjured out of thin air in order to shore up the financial system following the 2008 credit crisis.
The idea was to flood the system with cash to keep interest rates low.
That, the theory went, would encourage people and firms to spend and invest, which in turn would boost the economy.
Under the scheme, commercial banks have to keep cash reserves with the Bank of England.
They earned virtually no returns on this money when interest rates were low.
However, they are now receiving interest of 5.25 per cent because the base rate has soared and QE is being unwound.
As a result, almost £40 billion a year of interest payments are being channelled to the banks, inflating their profits.
It comes at the ultimate expense of the taxpayer, as the government is liable for the Bank of England’s costs.
The scale of the banks’ windfall is huge.
MPs on the Treasury Select Committee found that Lloyds, NatWest, Barclays and Santander made more than £9 billion in 2023 on their reserves.
That was more than twice as much as in the previous year and is around a quarter of their profits. Gerard Lyons, a former economics adviser to Boris Johnson and Liz Truss, said: ‘There is a strong case for changing the current policy of paying interest on bank reserves.
‘The taxpayer foots a big bill – it’s a fiscal transfer from them to the banks.’
Lyons, now chief economist at wealth manager NetWealth, says a portion of the interest paid on banks’ reserves should be axed to save money for the public purse. That proposal is supported by a range of senior figures from across the political spectrum.
They include former Labour Prime Minister Gordon Brown – who wants to use the cash saved to fund schools and hospitals – and two ex-deputy governors of the Bank of England, Charlie Bean and Paul Tucker.
The Left-leaning New Economics Foundation reckons up to £55 billion could be saved over the next five years if some interest payments were suspended.
NEF economist Dominic Caddick said: ‘The European Central Bank already does it, so it’s less controversial.
‘The UK also did before, in the 1970s, so it would not be the end of the world,’ he added.
The foundation advocates an approach called ‘tiering’, which has been adopted by the European Central Bank, whereby banks would receive no interest on a slice of their reserves.
But any such move would risk a clash with Bank of England governor Andrew Bailey, who has made his opposition clear.
Some experts fear that if their ‘stealth windfall’ were crimped, the banks might increase mortgages or slash savings rates in retaliation. Economists at Barclays claim that banks’ earnings could be hit by up to 30 per cent.
High Street banks have profited hugely from the recent steep rise in interest rates. They have put up mortgage and other borrowing costs faster than the amount they pay savers and pocketed the difference.
Any money which is saved by ending their stealth subsidy would help to offset the huge shortfall in public coffers which will dog whichever party wins the election.