Some critics argue that stopping the Bank paying interest would be impractical and/or extremely dangerous. Yet the Bank only started the practice in 2006. Moreover, in many other countries today, the central bank does not pay such interest or does so only on a portion of the commercial banks’ reserves.
The precise amount of the potential saving from not paying interest is the subject of some confusion. Some people argue that the net saving would be only about half this sum because the Bank earns interest – admittedly at a lower rate – on the bonds that it holds, financed by the commercial banks’ reserves, which contribute to the interest payments to banks.
This confuses two things. Ceasing to pay interest on bank reserves does not imply any reduction in the Bank’s bond holdings.
Nevertheless, it is true that the amount of interest saved is expected to fall over time. As rates are reduced, then the cost of paying full interest on banks’ reserves will fall. Moreover, as the Bank’s holding of bonds gradually runs down, or is forced down by the policy of quantitative tightening (QT), then reserves will also fall back.
Some critics have argued that if the commercial banks did not receive interest on their reserves, market interest rates would drop to zero as the banks tried to rid themselves of their surplus money by buying assets, lending money and reducing their deposit rates. In these circumstances, the Bank would effectively lose control of monetary policy.
Yet the policy of not paying interest on bank reserves has been endorsed by two former deputy governors of the Bank, Sir Paul Tucker and Sir Charles Bean, one nearly governor, Lord Adair Turner, one special adviser to the Bank, Charles Goodhart, and the former chancellor and prime minister, Gordon Brown.
They all recognise that there is a simple way to avoid interest rates being forced to zero – namely, to impose minimum reserve requirements on the banks, or to levy special deposits to be held at the Bank.
