MNI INTERVIEW: Good Case For Reserve Tiering- Ex-BOE Official

There is a strong case for the Bank of England to move from its current full reserve remuneration to a tiered regime, which would deliver a hefty fiscal gain with no loss of monetary policy efficacy, former senior BOE official David Aikman told MNI.

The drum beat for a shift to a tiered-reserve regime is intensifying with former Deputy Governor Paul Tucker recently published a paper advocating it and as pressure on the public finances pushes the Treasury to find ways to lower debt interest costs.

The Bank has not made any public commentary on the case for reserve tiering but Aikman, who now heads Kings Business School, said “I would be very surprised if there hadn’t been a dialogue between the Bank and the Treasury on this.”

NO TRADE OFF

The BOE currently operates a system of full reserve remuneration, with the entire GBP838 billion of assets acquired under quantitative easing funded at Bank Rate, which has been rising rapidly, driving up public debt servicing costs.

While full reserve remuneration has succeeded in getting short market rates aligned with Bank Rate, Aikman does not believe that switching to a tiered regime would weaken the link between the policy rate and market rates. (MNI INTERVIEW2:Altering BOE Reserve Payments May Backfire-Bean)

“It is the remuneration of marginal reserves that should affect market rates. I don’t think there should be a trade-off,” he said.

Aikman ruled out the possibility of the BOE simply terminating reserve remuneration altogether.

“They want to independently choose when they unwind the stock of QE .. so they will have to find some way of either continuing to pay Bank Rate on the entire stock or doing this tiering approach,” he said.

Tiering, used by the Swiss National Bank and others, pays interest only on marginal reserves. The savings on UK debt interest costs could be vast.

“Depending on where people are expecting Bank Rate to go, you are talking about tens of billions of pounds of profits for the banks. In no way is this marginal,” Aikman said.

WINDFALL TAX

Aikman, who until 2020 was Technical Head of Division in the Financial Stability Strategy and Risk Directorate at the Bank, was highly sceptical that a switch to tiered reserves would pose a financial stability risk, with banks’ net interest margins rising as Bank Rate has risen rapidly to 2.25% from 0.1%.

“Banks have had those profits now. In the event Bank Rate keeps increasing this will be a windfall tax,” he said.

The Tucker paper estimated savings from moving to a tiered-reserve regimen at around GBP30 billion and GBP45 billion over each of the next two financial years, or 1.6% and 1.2% of GDP, on the assumption that the Bank lowers reserves through active gilt sales.

“I do think from an optimal fiscal policy perspective you are going to have to impose taxes somewhere. Imposing them on the banking system is highly justifiable ... I think they should do it,” Aikman said.

A tiered reserve regime could see some increase in the cost of credit as bank margins widen, but “as a result Bank Rate would go up a little bit less than it otherwise would,” Aikman said, negating the economic effect.