My Lords, I beg to move that the Committee has considered the draft Cash Ratio Deposits (Value Bands and Ratios) Order 2018, which was laid before the House on 16 April this year. The draft order makes changes to the cash ratio deposits scheme, which is the way by which the Bank of England funds certain functions. Under the Bank of England Act 1998, banks and building societies of a certain size are required to place a proportion of eligible deposits in an account with the Bank of England. In turn, the Bank invests these deposits in interest-bearing assets, namely, gilts. The return on those investments is channelled into the funding of the Bank’s monetary policy and financial stability functions. There is a resultant systemic benefit to the whole banking sector from the sustained and stable operation of these functions, as well as for the wider public. For these reasons, the Government are confident that the cash ratio deposits scheme is and remains the most appropriate means of funding the Bank’s important policy work.
The operation of the scheme means that the Bank’s income generated by the scheme is driven by two factors: first, the yield on gilts; and secondly, the size of deposits eligible for the scheme, which is largely driven by the overall performance of the banking sector. Over the last five-year period, gilt yields and to a lesser extent the growth in deposits have been lower than expected. On average, annual yields were 2.7% versus the 3% expected in 2013. This has caused income to be £70 million lower than was forecast at the last review. A similar shortfall arose in the five-year period leading up to the last review of the scheme that was carried out by the Government in 2013. The Government are seeking to address this problem by recalibrating the parameters of the scheme over the forthcoming review period.
In particular, the Government are seeking to move from a scheme that currently uses a fixed ratio as the measure by which institutions calculate the proportion of their deposits to be placed at the Bank and will instead move to one where the ratio will be indexed to actual gilt yields. Under an indexation approach, the ratio will be calculated once every six months to align closely with prevailing gilt yields. Such an approach should lead to a smoother income profile for the Bank as it will dynamically adjust to the investment environment. It will reduce the risk of a shortfall in income if yields do not perform as expected and reduce the likelihood of future funding deficits for the Bank. The indexation model also has potential benefits to payers themselves. For example, if gilt yields were to increase, institutions would not then be required to place as much on deposit at the Bank.
The Government have consulted on the changes to the parameters of the scheme before us and the majority of respondents have acknowledged and accepted the increased costs associated with the Bank’s functions. Alongside the Bank’s efficiency savings, the changes proposed by the order will ensure that the income generated by the scheme covers the costs of the Bank’s policy functions over the next five years. As the Bank’s costs have increased since Parliament last agreed to this scheme, it has committed to maintaining its costs at 2018-19 levels over the next five years and that any subsequent enhancements will be funded from efficiency savings generated elsewhere. These cost-saving measures include a comprehensive programme of cost-containment and reprioritisation. The Bank will also continue to increase transparency around its income sources and the use of income generated under the scheme.
The proposed changes to the cash ratio deposit scheme are expected to increase the Bank’s income over the next five years and generate income that is closely aligned to the Bank’s forecast costs. It is worth noting that the amount that most institutions are required to deposit at the Bank under the scheme is relatively small. In December 2017, 81% of deposits made were by just 20 institutions, with 14 of those contributing more than £50 million. The majority of the contributions are sourced from larger banks and building societies.
The Bank of England Act 1998 sets out that the cash ratio deposit rate can change once every six months and the deadline for amending the rate ahead of every six-month period is 1 June 2018. If the scheme is not amended by this date, the shortfall in the Bank’s funding will continue. The changes proposed by the order before us are sensible and proportionate measures in the light of the issues identified in the 2018 review. The order will ensure that the Bank’s important monetary and financial stability functions are fully funded, and for that reason I commend it to the Committee.
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