Why does the Bank of England waste £1.5bn a year?

Yesterday British Labour members elected the progressive Jeremy Corbyn as their new leader with a 59% share of the vote, against the 3 other candidates. He will now be the opposition leader.

So the Conservatives are on the attack, we have seen it already. He will be painted as “a threat to our national security, our economic security and your family’s security”.

So Corbyn should take make sure that whatever is said is thrown back at the Conservatives. The objective is has to be seen to be more competent on security, economics and families. It should be easy.

His first test will come on Wednesday at noon. Each week the British Prime Minister has to justify his policies in a 30 minutes questions and answer session in parliament. Anything can be asked and will, it can be watched live on TV and the exchange provides good entertainment. The opposition, and other parliamentarians can ask searching or sycophantic questions from the prime minister.

The strategy for Corbyn to pursue, hopefully, will be that the government portrays itself as a inclusive government for hard-working families, but that this is in effect one big lie. In reality, the Tory government is a government for the hedge funds which finance it, the banks which it subsidises,  and the City which has an undue influence over the country. It is a government for the 1%.

So what should Jeremy Corbyn ask? It has to throw the Prime Minister off balance and ideally you want to see him defending the indefensible. You can now send your suggestions to the Labour Party, and I have. How about this?

Is the Prime Minister aware that the government currently subsidises the banks to the tune of more than £1.5bn a year?

Is he happy that an allegedly independent Bank of England subsidises banks for no reason whatsoever, and could he suggest a better way to spend £1.5bn a year?

I give him a clue, rather than giving it to the banks, which will spend it on extortionate bonuses, the government could use the money to build 5 new hospitals! EACH YEAR. Why does he waste it on banks?

Cameron will mumble and stumble something about the real threat to inflation will come from Labour, whereas the integrity of the Bank of England will be threatened by the left-wing Corbyn…

The retort should be, that Cameron does not understand anything about Monetary Policy, the bank rate could be set just by edict, and the £1.5bn thus saved be spent on infrastructure improvements for the people, rather than being wasted by the Bank of England on, what will end up, as bankers’ bonuses. Why does Cameron not stop that waste? Is he sure the Bank of England knows what it is doing? Does he know that if Bank of England increases rates, the government will have to  increase subsidies, as in the US?

So the tactics should be clear for the Corbyn front bench. In the end they will have to look more competent on anything to do with money, than the Conservatives.

So what should stick is that the government subsidises banks. It is a government for banks, and not hard-working people. There might be some intricate reason for the management of interest rates to do so (I have not found one) but nevertheless, that management of interest rates is not free. The £1.5bn is a huge cost to us and a huge subsidy to banking.

Now, in any case, it will move the discussion on and casts doubts the competence of the Bank of England. The fact is that it costs the government £1.5bn in subsidies to the banking sector. Can the Tories justify that?

So whether this question will be picked, among many others, remains to be seen.

You might want to stop reading here, as the remainder of this post is really just footnotes substantiating the point made above. If you are interested how this all works, please read on. I have just included everything here as further references. First, excerpts from comments of the longandvariable blog by Tony Yates, the professor of economics who organised a letter criticising the economic policies pursued by Corbyn. Muy discussion in the blog is with Tim Young.

First of all I set out how the Bank of England operated at the time of economic boom, until say 2008, when lending always increased.

Well, Let us go back to first principles. Reserves are money either deposited by banks at the Central Bank, or borrowed from the banks at the central bank.

The distinction is important. If banks deposit money, they receive 0 interest form the Central Bank.

If banks borrow money from the central Bank, they pay currently 0.5% to the Central Bank.

Before we go any further, can we just agree on that. The Central Bank is just like any other bank, it takes in deposits and makes loans. (which, to confuse the Dickens out of everybody, are both called reserves for the central bank) The central Bank pays less interest on deposits than it charges on loans. As all banks do. As otherwise the Central Bank would not be a bank, but some kind of spending department of the government.

The only clients of a central bank are commercial banks. I go to Barclays for my banking, I have a deposit account there it is called deposits. I have a loan there it is called a loan.

Barclays Bank goes to the Central Bank for its banking. Barclays has a deposit account there, it is called reserves. And Barclays has a loan account there , it is also called reserves. (No kidding, that is what they call it, although it really is a deposit account and the other one is a loan account)

So if Barclays has surplus notes (cash) and deposits it with the central bank, the Central Bank takes the excess cash and and credits the deposit account of Barclays with the Central bank which pays no interest. The Central Bank paid no interest on the cash. After Barclays exchanged the cash for a deposit account, the deposit account pays no interest either

As Barclays cannot force anybody at all to take the cash somebody deposited, it cannot create inflation. Same with the money which Barclays has in its deposit account with the central bank. It cannot create inflation either.

So there is no risk to inflation, just because somebody deposited some cash – that is the most ridiculous thing I have ever heard.

Then I set out how this was different when quantitative easing happened in the years since 2009.

I think we agree that what I described above (relationship customer-commercial bank vs. relationship commercial bank-Bank of England) is more or less correct BEFORE 2009. The Bank of England lent money out at a higher rate (the official bank rate) than it paid on its deposits.

That was until 2009. After 2009 everything was different. The UK started Quantitative Easing, which resulted in £375bn of extra money in the banks, which the banks did not know what to do with, as you say.

Now, for some reason, the BoE started indeed paying 0.5% interest on this money. The Bank of England therefore changed from a bank into a spending department of the government. It does not have any interest income from the commercial banks (nobody is borrowing from the BoE as all banks have enough cash and only small demand for loans), but pays a deposit interest rate on the deposits (reserves) of commercial banks at the Bank of England.

The BoE does not spend the money on you or me, but specifically gives 0.5% interest per year to commercial private sector banks. That is the interest it pays on the money deposited with it by commercial banks. It is therefore an industry subsidy to the banks, Which resulted over the 5+ years we have had it at perhaps a £9bn subsidy to the banking industry.

Now, I have never heard anybody mention this anywhere, but the facts are clear. The BoE did not need to pay interest, but it chose to do so and therefore SUBSIDISES the banking sector to the tune of around £1.5bn a year.

The reasons we have to have this interest rate subsidy to banks (we are told by the high priests of this cult called monetary policy) is because to prevent rates from falling further, as you rightly say, repeating the official line. (You say it might prevent inflation, but the whole official point of QE was of course to create a bit of inflation). But that could be much easier achieved a lot cheaper. The BoE could say: Banks have to lend money at a minimum rate of 0.5%, and not below, and that would also put a floor under the rate. A monetary policy by edict, rather than to fiddle around with “monetary operations” in the “interest rate market”. Lyn Eynon makes similar points above, citing other alternatives to straight subsidies.

Nobody, of course, calls “interest payments on commercial banks deposits (reserves) at the BoE” a subsidy to the banking sector, as nobody calls the initial QE a subsidy either. But QE provided profits, (and liquidity) to the financial sector. If we assume a 10% profit of the £375bn to the financial sector, we now have a total cost of this “monetary policy” since 2009 of £37.5bn for QE and £9bn for interest rate subsidies since then, resulting in almost £50bn from the public purse to the financial sector. with a further 1.5bn added each year. Deposits at the bank of England by commercial banks (reserves) are still over £315bn five years after starting QE.

So, in summary, you are defending a regime which subsidises the private sector banking industry to receive a total of£50bn.

In addition another ongoing £1.5bn subsidy a year, when for this £1.5bn we could build at least five new 500 bed hospitals Each year.

Are you mad?

And finally, I make the point that really there is no justification whatsoever in the subsidising of commercial banks the Bank of England.

@Tim Young
“As I mentioned in a reply to Lyn, the BoE has paid interest on reserves since 2006:”

Well, if that is the only thing I got wrong, that is truely shocking. My apologies.

Because that means, that I am right with the conclusion that £1.5bn of taxpayer’s money is being wasted in subsidies to commercial private sector banks, whose management then pays that money to itself in huge salaries and bonuses.

“There is no pleasing prejudiced ignorant lefties. ”

I guess about 99.9% of the population are ignorant. And all of them would be shocked by that fact of £1.5bn waste organised by the bank of England.

They are fobbed off with “Sorry, that is monetary policy, love, if we do not pay 0.5% on reserves, then we will have inflation”. Which, frankly, is incompetent nonsense. Or worse, fraud. The government is paying interest to the commercial private sector banks for money which the government arranged to give to them, through the £375bn QE programme in the first place. In return it gets nothing.

Do we know anybody else, or any other company, which gets money given to it by the government, and then gets interest on top? For doing absolutely nothing? But the private sector commercial banks will.

Now, why do we have a completely inefficient system to set interest rates, when a declaration of “The bank rate is 0.5%” would do the job just as well.

In fact, it would not only be £1.5bn a year cheaper, it would be also more efficient if no interest was paid to banks. The idea was for QE to be used to fund real economic activity, through increased lending. Well, paying 0.5 interest will STOP the banks lending money. Why should they lend, as they have a nice, risk-free little earner? they would be stupid to lend it to start-up companies and other risky investments.

Now, in any other walk of life you would be sacked for gross incompetence, but it seems that in the Bank of England you are richly rewarded.

http://www.cityam.com/blog/1403005369/more-330-bank-england-staffers-are-paid-100k-or-more-heres-how-their-salaries-break

Is it time to close this not fit for purpose institution such as the Bank of England. They really need a big cull, it seems to me.

We are always looking for productivity improvements, the financial sector is a prime target. We could start at the top, with the Bank of England.

@Tim Young
“The reason why the date matters is that it shows that paying interest on reserves was not some subsidy to banks to bail them out from the financial crisis, as is sometimes alleged.”

Well, if it is true that the BoE already paid interest on deposits we could go back to 2006 and find out whether that was justified, or whether the BoE were equally incompetent then, as it is now

“Why do you think any entity pays a return on its liabilities? Do you think that it is to subsidise the holders of those liabilities?”

You do understand the difference between Tim Young lending me £100, and Tim Young Bank plc lending me £100?

To illustrate:

If you lend me £100 and I pay you back £110 in a year’s time, the £10 will be compensation for you not having the money to spend, while I can, and also to compensate you for the credit risk that I might not pay the money back. But you can only lend me £100 if you actually have the money. Not so with banks.

Now, if Tim Young Bank plc lends me money, it can do so even though all the deposits it has are already lent out. It will just go to the Bank of England and will get the money and that is what is meant by “Loans create deposits” , It is as simple is that. Money created out of thin air.

So previously the TY Bank balance sheet looks like

Assets: £1,000
Liabilities £1,000

after the loan to MU

Assets £1,100
Liabilities £1,100

That is how things worked until, say, 2008. the balance sheets of the banks increasing through higher lending.

In 2009 that stopped. Nobody wanted to borrow, nobody wanted to lend, big depression. The Bank of England created QE, buying gilts from anybody who wanted to sell them.

The £1,000 Assets in detail of TY Bank plc looked before QE like:

Loans outstanding: £600
Notes and Coins £100
Gilts: £300

Now in 2009 TY Bank plc decides out of its own free will to participate in the QE programme. It wants to sell its gilts, for whatever reason, even though they pay 5% interest and seem to be a good safe investment, when to its depositors it only pays 2%. Money for old rope, would be the colloquial expression.

Now, TY Bank plc bank decides to sell the gilts. TY Bank plc gets the market value of the gilts, and uses that money to deposits at the Bank of England.

So the Balance Sheet of TY Bank plc looks like after QE:

Loans outstanding: £600
Notes and Coins £100
Money deposited at the BoE: £300

So, the Bank receives no interest on the notes and coins it holds. Nobody does, even though it is a liability of the BoE.

It receives 0.5% interest on the money deposited at the BoE. Now, this is entirely at the discretion of the BoE. The gilts were sold by TY Bank plc to the BoE and swapped for a deposit account entirely voluntarily, even though the gilts payed a higher interest rate (5%, which is fixed) and the deposit account paid a much lower one (0.5% at the discretion of the BoE).

Now if I went to the TY Bank plc and borrowed £100 from it, say, through my credit card accout with the bank, then TY Bank plc would charge me a whopping 25% interest (or more!), and I would have to pay £125 back in a years time.

The Balance Sheet would look as follows:

Loans outstanding: £600
Notes and Coins £100
Money deposited at the BoE: £200
Credit cards outstanding: £100

So total assets of TY Bank plc would not have increased, they are still £1,000.

But, more importantly, whether the BoE paid 0.5% interest on the “Money deposited at the BoE” or not, me borrowing from TY Bank plc via my credit card would not have been influenced by the 0.5% official bank rate at all. Neither would have any other decision in the UK economy. It is worth saying that again: Whether or not the BoE pays interest on “Money deposited at the BoE” does not make one bit of difference to the progression or health of the UK economy. It is a pure industry subsidy!

The BoE could decide tomorrow to stop subsidising banks, and abolish the 0.5% rate it pays on Money deposited there from banks. It could treat “Money deposited at the BoE” just as it treats other liabilities “Notes and Coins” on which it does not pay any interest either. Nothing would change, other than the profitibility of the UK banks, which would be lowered by £1.5bn a year.

Now, Tim, you not think the public should be told about this scandal, and how would you suggest it is best publicised, that instead of building 5 new hospitals a year, the government decides to give the money to private sector banks!

For nothing in return whatsoever.

Here is the Bank of England official view.

Here is what the Federal Reserve is doing, they are planning to pay more for money held by banks at the Central Bank of the USA, the Federal Reserve. That is how they want to implement the rate rise everybody is talking about.

And here is another blog, giving another view, that there should perhaps be a tax on deposits at the Central Bank by commercial banks (reserves) to encourage spending. So that is exactly the opposite as the government paying interest on reserves. This is from 2009.

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