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How Rachel Reeves Could Use Bank Of England Reserves To Boost Her Spending Power

The Treasury is footing the bill for interest repayments on £750bn reserves held by commercial banks at the Bank of England. (Alamy)

5 min read

Could reforming Bank of England reserves be a way for Rachel Reeves to raise money for ailing public services? A number of economists with links to Labour believe so.

Since winning power in July, the new Labour Government has stressed repeatedly just how dire a state the public finances are in thanks to 14 years of Conservative rule. Prime Minister Keir Starmer has warned that "painful" decisions await when Chancellor Rachel Reeves sets out the Budget in October, in order to repair what they claim is a £22bn "black hole" left by the Tories. Tax rises and spending cuts are widely believed to be on the horizon.

It is a tough message for the Government to deliver to the country at a time when public services are under strain and cost-of-living pressures continue to challenge households.

According to some left-leaning think tanks, however, there are other ways that Reeves could raise vital funds that haven't been the subject of much discussion up to now. They relate to billions of pounds held by the Bank of England.

The Treasury, funded by the taxpayer, currently pays around £40bn per year on interest repayments on BoE reserves, a figure economists broadly agree is higher than was expected when the arrangement was set up after the financial crisis in 2008. 

The Institute for Public Policy Research and the New Economics Foundation say exploring bank reserves could be a method of saving money for the Government and allow it to spend more to fund the UK's ailing public services. Former Labour prime minister Gordon Brown has has also suggested a change in the rules could free up money for ministers to spend money on areas like the NHS and schools. 

Perhaps unexpectedly, Nigel Farage's right-wing Reform UK has also expressed support.

It is an idea which the think tanks have discussed with people in the Starmer administration, PoliticsHome understands, and some economists who once worked for the think tanks now have jobs in the Government — potentially taking the thinking with them.

The NEF's former director Miatta Fahnbulleh, the newly-elected Labour MP for Peckham, has been appointed a minister at the department for energy security and net zero, and former IPPR director Cary Roberts is an adviser in 10 Downing Street.

What bank reserves we are talking about?

There are around £750bn of reserves held at the BoE by different commercial financial institutions, with the BoE paying interest payments on that figure. 

When interest rates were low, payments were low. However with interest rates at a 16-year high at the beginning of 2024 at 5.25 per cent, payments on the bank reserves have increased signficantly to around £40bn a year. 

The cost the BoE's interest payments are footed by the Treasury, which ultimately results in the taxpayer paying for those reserves and squeezing public finances. 

How much money could they save? 

The NEF has argued that if the Government stopped interest repayments on the reserves, it could save around £20bn per year.

This could create significant cash injection for public finances at a time when public spending for unprotected departments faces a real terms cut post 2024/25 based on current fiscal rules. 

What do left-leaning think tanks say?

Senior economist at IPPR, Carsten Jung, told PoliticsHome interest payments on bank reserves were acting as a "drain on the government finances" with the UK "an international outlier". The Federal Reserve in the United States and the European Central Bank (ECB) operate differently, he said.

Yung said the bank should move to a tiered system so that the BoE, and by extension the Treasury, would only pay interest on a certain percentage of the reserves.

"Our position is that these reserves are very much worth exploring, and the Government should ask the Bank of England to review how it could implement tiered reserves and discuss these issues around what the impact on bank profitability would be," said Yung.

"What would the impact on its monetary policy effectiveness be? And lay out some options of how we could do reserved tiering, and what the pros and cons of these options are."

Dom Caddick, an economist at the NEF, said his thinktank supported exploring reserves as way of raising money because "this current state of events, tight on public services and welfare, while giving exuberant payments to the banking sector, is unacceptable". 

"The headline figure for us is that we're spending £40bn a year on interest payments that are going directly and only to the banking sector... this didn't used to happen.

"We used to have a system where monetary policy was implemented before 2008 where the cost of implementing monetary policy was essentially zero."

What do other economists think?

Ben Zaranko, senior researcher at the Institute for Fiscal Studies (IFS) told PoliticsHome the topic of bank reserves is increasingly being discussed as a potential money saver for ministers. However, he warned there are risks to the approach because the consequences on the banking system could be unpredictable. 

"The way to think about it is that if you move very slowly and carefully, and you only made a very modest change, you wouldn't expect it to have big knock on consequences, but you also wouldn't save that much," said Zaranko. 

"The more you try and save, the greater the risk you're running of triggering something or risking financial stability issues.

"There's a really good argument for this if you are going to move gradually and carefully but, as a result, the savings aren't going to be as big.

"The other end of that spectrum is to what Reform UK we're proposing, or what the New Economics Foundation proposed, which is basically to switch it off entirely.

"That gets you the bigger savings, but it also means it's a bigger jump into the unknown, and we don't quite know how all of the chips would fall."

He said "lots of very sensible people" are "advocating for sensible, small, cautious changes, rather than a 'big bang'."

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