I have been asked to explain how the central bank reserve accounts held by the commercial banks with the Bank of England are created. This note seeks to do that.
First, note that central bank reserve accounts (CBRAs) are held by the UK's commercial banks with the UK's central bank – the Bank of England.
As a central bank the Bank of England is owned by the UK government. It is responsible for the day-to-day management of the money supply in the UK; for the regulation of commercial banks in the UK and for managing the settlement of inter-bank debts in sterling, for the issue of which currency it is responsible.
The central bank reserve accounts serve two purposes. Firstly, they provide the mechanism by which payments from commercial banks and their customers are made to and from the government. Secondly, they are the mechanism used by commercial banks to make settlement of the liabilities that they owe each other when fulfilling the obligations that their customers request be settled with customers of another bank.
These accounts are as a result restricted for the use of commercial banks and some other regulated entities in the financial services industry. It is believed that there are only a few hundred of them as a result.
Second, note that before 2007 there were almost no such balances, at least in total. The commercial banks and the Bank of England sought to achieve this result each day but used other very short-term overdraft and loan arrangements if that was not possible at that time. The current situation where all CBRAs are, in effect, bank despot accounts held by the UK's commercial banks as a mechanism to guarantee their ability to make settlement to each other is almost entirely a creation of the post 2008 global financial crisis as a result.
Third, note that this change was in no small part motivated by those banks refusal to trust each other to make settlement after 2007, in which year it became clear that major commercial banks could fail when none had effectively done so since the 1860s. Once banks had demonstrated their own inability to manage their balance sheets at the time of the global financial crisis it became apparent that these banks would need to hold funds with the Bank of England to prove their ability to fulfil their own promises to pay.
Fourth, the central bank reserve accounts were, in my opinion, deliberately boosted in value by the Bank of England to facilitate this inter-bank payment process. This was the way in which banks were bailed out post-2008 to prevent them failing again.
In that case the way in which these reserve accounts have been increased in value needs to be noted. Doing so requires four things to be understood:
- Overall, the sum held on these accounts is not within the control of the commercial banks. The sum that each bank might hold will vary from day to day. However, that is the consequence of payments between banks varying. However, the quantum of funds held in the CBRAs as a whole is determined by the Bank of England on behalf of the government because it is the sole creator of what is called ‘base money'.
- ‘Base money' is sometimes called ‘central bank money'. It comprises the currency issued by central banks in the form of notes and coins plus the balances on the CBRAs.
- Base money is created as a result of the CBRAs being used to transfer funds from the Bank of England into commercial banks on behalf of the government, to whom it acts as primary banker through the Consolidated Fund, and to also receive payments from those banks that are due to the government.
- In summary, payments from the Bank of England Consolidated Fund account to the commercial banks increases the sums held in the central bank reserve accounts and so create what is called base money. These payments are made in the ordinary course of government business to make settlement to whomsoever the government chooses to make payment to, from an old age pensioner to the sums used to redeem gilts when they reached their repayment date. Payments to the government via the CBRAs include taxes due, the proceeds of new gilt issues and the receipt of the many trading sums owed to government agencies.
In that case the only way in which the balances on the central bank reserve accounts can increase is by the government spending more into the economy than it receives back from it. There is no other way in which this can happen. In turn that is only possible because the government can decide to fund its expenditure with new money created on its behalf by the Bank of England. That new money that the Bank of England creates for the government is base money.
The corollary is also true. The only way in which the balances on the CBRAs can be reduced is by the government collecting more money from the commercial banking system than it spends into the economy e.g., as a consequence of taxes paid being in excess of government expenditure, or by raising new borrowing in excess of current requirements e.g. because of quantitative tightening.
In this context, the role of quantitative easing can appear to be confusing, although it is actually quite straightforward. The pattern is as follows:
- At any time it wishes the government can decide to issue now financial instruments. These can be very short term, in which case they are described as Treasury Bills and are redeemed in days. Alternatively, they can issue bonds or gilts, which can have duration from a year or so to fifty years or more. It has been government practice to only issue such bonds when there is a deficit on its Consolidated Fund account with the Bank of England, the aim being to restore a neutral balance on that account. This, however, is not a necessity and before 2008 it was commonplace for this account to also be cleared through the so-called Ways and Means Account that the government maintained with the Bank of England, which was an overdraft in all but name.
- The issue of new financial instruments, of whatever their nature, results in new financial flows from the commercial banks to the government either because the banks themselves buy these instruments or, more commonly, because their customers do. These flows move through the CBRAs in either case since this financial conduit to and from the government is only available to the banking sector and a very select limited number of other financial services sector entities. Whether the payment the commercial bank makes is as principal or agent for their customer makes no difference: the flow is from them to the government via the central bank reserve accounts. The result of the issue of new bonds is to reduce the balance in the CBRAs, meaning that the balances on those accounts created by government spending being in excess of routine income are cancelled in whole or part. Bond issuance of this sort, it is stressed, is not a part of the quantitative easing process.
- If the Bank of England then decides to undertake quantitative easing all that it does is lend funds to its legal subsidiary, the Bank of England Asset Purchase Facility Fund Limited (the ‘APF'). This company is fully indemnified with regard to its activities by HM Treasury and as such an agent of Treasury and is not under the effective control of the Bank. That company then uses the loan funds provided to it by the Bank of England to buy bonds issued by HM Treasury on the open financial markets. There is no reason why these bonds need to be owned by the commercial banks, and it is likely that most of them will not be. This is inconsequential to the resulting movement through the central bank reserve accounts, which is represented by a flow of funds from the account of the APF to the commercial banks, which as a result increases the central bank reserve accounts balances.
- As a result bond issues cancel the CBRAs created by government spending being in excess of government income, and QE then in turn cancels that process, as if the bond issue never took place., effectively restoring the CBRA balances created by expenditure exceeding income. Given that the bond that was issued is, after being repurchased using QE under the effective ownership and control of HM Treasury it is easy to argue that the bond in question has effectvely been cancelled. This is the accounting position reflected in the Whole of Government Accounts, which are the only true and fair accounting representation of this transaction[1].
- QE is then a simple way of swapping bonds that need never have been issued for base money, and QT reverses that swap.
As a result the reality is that QE and QT are window dressing and it is the excess of government spending over income and routine bond issuance since 2008 that has created the CBRA balances.
[1] https://www.gov.uk/government/collections/whole-of-government-accounts
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Thanks Richard, that is helpful but doesn’t quite tell the whole story. I’ve got the idea that a CBRA contains the money involved in transactions between the government/BoE and the commercial bank. But how does money get out of the CBRA?
To go back to Tim Rideout’s example in a previous thread, the BoE credits my bank’s CBRA with my state pension each month. As a result the bank adds a sum to the spreadsheet it maintains in my name (which I think of as my bank account). But then I withdraw £100 cash from the bank. Hasn’t that money ultimately come from the CBRA?
At one level I can see that my bank could have “created” the £100 outside the CBRA. However if my pension can’t move out of the CBRA then that £100 effectively exists twice, which seems a nonsense. Somehow the credit to my bank account, which needs to be done at the point of withdrawal if not before, should somewhere be balanced by a debit and if that is to the CBRA that looks like movement of money out of it.
(I am still trying to get my head round the explanation of how the government increased CBRAs; it seems there are parallels with the pension example since the monetary value of the “cancelled” bonds seems to end up in two places at once, in the commercial banks’ CBRAs and in the APF. But I probably need to read that story a few more times to make sure I have understood it).
Money gets into a CBRA because the Bank of England pays it there on behalf of the government
Money on CBRAs can be transferred by commercial banks between themselves
And money can leave CBRAs if cash flow to the government is greater than its cash spend e.g. because tax + borrowing is greater than spending
But that’s it. Otherwise, this is a completely sealed system. The money never moves into the commercial banking system. Commercial money never moves into the CBRAs.
I have an example in mind to explain that. Let me write it….
You’re still thinking money is real and not accounting entries. And I promise you, it is only accot8ing entries. There is literally no real thing called money. I am b between lectures this afternoon. Let’s see if I can do this for you….
I should be writing a book
Thanks, I do get the idea that money isn’t “real” and in most cases consists only of numbers on electronic ledgers. However my low-level understanding of accountancy is that for every credit there is a debit. Your concept of CBRAs as a “sealed system” would imply there can’t be a debit there to balance the credit to my account outside the system – but I can’t see where else it might be.
Apologies for distracting your book writing. I hope in a small way thinking of ways to explain complicated concepts in a way understandable to me will help in communicating to a wider audience.
The debits and credits can cross the boundaries
But there is nothing tangible that does
And I just did nit get the double entry done today. Too much reaching today
Indeed, you should. Certainly, on this subject.
Jonathon,
The problem with trying to think in total bank account amounts and reserves is really not helpful, the two never actually touch in any way.
The money showing your bank statement is in effect just an IOU from the bank to you, crucially is not money at all. It is just a record of what you could draw out at short notice…that is all. Like Schrodingers cat, it only exists when you make a withdrawal, whence the bank will have to dip into its stock of reserves to provide you with your cash. Obviously the bank would much prefer you do not do that and hope you will leave it on account as they have to pay the BoE face value then for every note you take out! Which is one reason the banks put a limit on daily cash withdrawals
So if you decide to withdraw your £100 in cash the bank will (begrudgingly) oblige. However of you decide not to, the balance just stays on the IOU account for when you do. So in effect it does exist twice due to the wonders of fractional reserve banking, so you actually hit the nail on the head there : ).
A helpful way to think of this is to consider money as a promise, a promise to pay. Your bank can increase its promises to you, ie increase your account by 100 promises because it has received 100 new promises itself from the BoE. It needs the BoE promises to be there in order to fulfil those it has made to you.
But it does not give you its BoE promises, both sets are separate and both need to exist concurrently for you to be 100 meaningful promises up!
You get it, exactly
Jonathan, I think you are right. If you take out £100 in Bank of England notes then your bank had to obtain those from the BoE. That will have been paid for out of their CBRA. So the CBRA balance could be converted into BoE notes and vice versa. It has no effect on BoE liabilities as the notes and CBRA are both liabilities of the BoE. This will only ever have a marginal effect when we do not use a lot of notes and there are £90 billion of them compared to £952 billion of CBRA. If we stopped using notes completely and handed them all in to our banks then they would deposit them back at the BoE and that £90 billion would get added to the CBRA balances.
The notes are part of base money
They do not behave in the way CBRAs do though
Tim, I think you are right – before I saw this I just made a long rambling post (on this and other things) that says the same as you.
Tha public will never see CBRA money; they are ‘out of the loop’. Notes and coin are the unique form in which the public can acquire and use the secure money of the sovereign issuer.
Place beside that fact the dynamics of real change; the digitial revolution (and the legacy of Covid), means notes and coin are fast being phased out, for the universal use and acceptability of bank credit (with the banks accessing base money not avaiable to the public). This is a real public loss, because while everyone had access to notes and coins, now measures of creditworthiness are used to select and sieve the public, by banking intermediaries who alone have access to base money (other than ‘fading’ notes and coin).
This system transfer is used effectively to boost the status and universality of bank credit, and at the same time also is further reinforced by the £85,000 guarantee provided by the Government, that ensures the public can have confidence they can deposit money with commercial banks, solely because the Government guarantee provides a base-money like appearance to bank credit it soes not otherwise possess.
Your first para especially relevant – highlighting that notes and coin are exceptional
Yes, Richard – which is why I believe the decline of notes and coin is a real public loss; which is scarcely noticed, and nobody seems to care: all of which will delight the banks.
It is also a reminder of something quite fundamental: that “money” (which mainstream, neoliberal economics does not believe is the essence of economics, but operates only as a mere facilitator of “real” economic activity); when money is in fact far more critical to the functioning of the economy, which exists essentially as a money process. Thus the financial sector is not simply one economic operator ranking pari passu with all the others, but actually is a special case that enables the other sectors to perform. It cannot therefore merely be considered to be entitled to the same liberty as all the other sectors; it has special immutable responsibilities (banking especially) to everyone.
Thanks all, especially Tim for realising I was quite deliberately using as an example a cash withdrawal. (Though partly because the transaction ends there, using paying a bill as an example would introduce other banks and other CBRAs.
But I think I am slowly seeing the light. There aren’t quite parallel universes, but essentially anything I do with the credit for pension in my bank’s CBRA will either be transacted via that CBRA to another bank’s CBRA (e.g. bank transfer of one sort or another, or cheque) or be mediated by cash which is explained as another sort of “base money”. So in effect providing cash is the only way the bank takes money out of its CBRA but it isn’t changing it from being base money.
Is that right? It still feels an odd distinction, and no doubt I will take a few days to digest the implications and ask more questions if that is OK.
I will get me double entry version out tomorrow I hope
I need a day off
A very good summary. But, at the risk of nitpicking…..
(1) From a historical perspective, I remember that the drive to increase reserves held by commercial banks came in conjunction with rules to restrict unsecured lending between banks. It was almost entirely driven by the Authorities (rather than the banks not trusting each other). This process actually started pre the Great Financial Crash – but the Crash gave it added urgency and led to the system we have today where failure by any one bank should not bring down the system. Banks really are much safer today than ever before.
(2) Also, I not sure that people understand the anatomy of a “bank run” and why more reserves protects the system. If you transfer money to someone today (with an account at a different bank) it is virtually instant; the receiver is credited with the funds before the corresponding transfer of reserves at the BoE (which used to be netted and settled at the end of the day). So if the sending bank goes bust the receiving bank is on the hook for the money it has already credited to its client’s account. Now, in normal times, waiting and netting makes sense as there will be millions of transactions and many will net off against each other. BUT if there is a bank run then all the flows will be one way and there will be a massive credit exposure until they are settled periodically during the day (or at the end of the day). It is aggravated by banks hoarding money (delaying instructions to transmit money) as they don’t know if the next run will hit them and want to keep liquid. Remember, the fact that banks “lend long, borrow short” (maturity transformation) means that they will always be vulnerable to a “run”. To make it safer, banks must maintain sufficient reserves to cover these payments and, knowing this, it gives confidence to all banks to release money from their accounts without fear. Liquidity regulations have really changed banks behaviour and this was seen a few years ago when Fed Funds rate really spiked for no apparent reason. What happened was that the Fed saw all these excess reserves on Bank’s Reserve accounts and thought it would mop up that liquidity will a sale of bills… but the commercial banks did not want to reduce their reserves and the primary dealers that had bought the bills had real trouble financing them and caused a big spike in rates to the huge surprise of the Fed. The point is that there is a much bigger appetite to hold reserves that anyone realised… and I am not sure that this has changed.
(3) People seem a little hung up on bank notes. On the assets side of the Commercial Bank’s balance sheet will be reserves at the Central bank plus notes/coins in their safe (plus a lot of other stuff). Its liabilities will be deposits.. If you take our £100 cash then the Commercial bank’s assets and liabilities will both shrink by £100 (reserves unchanged, holding of notes reduced by £100). Now, if the bank wishes to replenish its stock of notes an armoured truck will show up with £100 and the bank’s reserve account will be debited by £100.
From the BoE’s side reserves are a “liability” (I use inverted commas here as the nature of it is not like a normal liability) as are notes in issue. So, when it delivers notes to the bank its “bank note liability” rises by £100 and its “reserve account liability” falls by £100. Yes, a bit complicated but one can think of notes as reserves that can be held outside the banking system (that earn no interest).
Sorry for a long and rambling reply but there is a lot of detail here that does matter when we are trying to get the BoE to alter its operational activities (which, ultimately, is the aim I think).
Thanks
I note your historical perspective, but as a matter of fact markets did freeze henc3 official reaction
The same risk was thought likely in 2020
But this is hair splitting so thanks
Yes, markets did freeze in 2008. The fear was that they would again in 2020 but they didn’t, largely due to the changes made to the banking system after 2008.
I suppose the reason I think the history matters is that your version suggests that the banks all stared into the abyss in 2008 and afterwards said “You know what, that was scary. Why don’t we all carry more reserves and collateralise all interbank transactions so this does not happen again?”. I am afraid this endows the banks with too much intelligence and cooperative spirit!
My version is…
Pre-2008 (2006 ish, I think but don’t quote me)
BoE: I think we need to modernise our monetary policy framework
Banks: Yeh, whatever…. as long as it doesn’t cost us anything. Let’s talk…….
2008
Banks: HEEEEELLLLLPPPPPP
BoE: OK we will save you
Post 2008
BoE: Now, enough talk you WILL do what we want… and it’s going to be way tougher than you ever imagined.
Banks: Yes sir!
Today
Banks: You know all those tough capital and liquidity rules you put in place? Are they really needed? We could make more money without them!!
BoE: Hmmmmmm
I like that
Richard, is there a reference you could share, perhaps from the BoE? I’d like to settle a long-running debate with a monetarist on this subject!
No, or I wouldn’t do this
Thanks anyway – very informative as always.
Richard,
Thanks very much for such informative work. I only had a passing interest in this but you have ignited my desire to expand my knowledge. Please keep up the good work.
What text books would you recommend your final year economics students to read re government accounting and macro economics?
Hope the T account entries below make sense.
Jonathan,
In an earlier blog thread you enquired about how your pension appears in your bank account and visualising the entries in a T account format.
I shall assume your bank is called XYZ Bank.
The entries flow through 3 distinct ‘areas’ but are opposite and equal.
1. BoE Books
Debit: Consolidated Fund £185.15
Credit: XYZ Bank CBRA £185.15
Creating the pension spend into existence of £185.15
2. XYZ Bank Books
Debit: BoE CBRA £185.15
Credit: Jonathan Account £185.15
Recognising the converse side of the pension spend in XYZ Bank
3. Jonathan’s Books
Debit: XYZ Bank £185.15
Credit: Pension Income £185.15
Receipt of pension
Thanks
I think it a little more complicated than that but I am too tired to finish it today
Thanks all.
One thing that immediately struck me from Clive Parry’s explanation is that a bank’s CBRA is equivalent to its cash holdings … and since cash doesn’t earn interest why should those reserves? Which brings us full circle to the blog by Richard that led me trying to make sense of reserves.
There does seem to be a difference of opinion which can no doubt be resolved. Was it the banks or the BoE that built up the CBRA amounts? Plus when and why? Clive’s account seems to imply that even the central banks themselves (the Fed in his spike story) think that reserve account liquidity is ordinary money built up by the banks themselves that they might spend on something.
(I am still somewhat mystified by the way QE built up CBRAs. It seems to me sale of bonds by the government requires debiting the CBRAs when they are purchased, and the APF buying them back involves crediting the CBRAs. If QE purchases exceeded bond issues, then CBRA reserves would increase, but Richard has several times made a point of showing that bond sales and purchases almost exactly cancel).
CBRAs are only created by the BoE
Banks cannot create them
I ad it I thought I had now dealt with this…..
No, Richard is right…. and I don’t think I contradict him in any meaningful way.
All money spent by government becomes CBRAs one way or another.
All money drained by government (taxes, sale of gilts) will reduce CBRAs.
Open market operations by the BoE will raise of reduce CRBAs depending on whether they do repo or reverse-repo transactions (or outright purchases or sales of securities).
Money created by banks through advancing credit to a client does not impact the level of CBRAs
One must be careful using the word “cash” as it means different things in different contexts. I DO talk about bank notes and observe that they are LIKE CBRAs but they are not the same. They are linked due to the fact that any net issuance of notes will reduce CBRAs and commercial banks can count notes they hold as liquid assets in the same category as CBRAs for regulatory purposes. Bank notes do not carry interest so, by and large, most people choose not to hold too many of them but they are issued and destroyed according to demand from the banks/general public; the BoE merely responds to requests from the banks. Generally speaking, changes in the desire to hold notes are small and have little to do with the level of interest rates and, for monetary policy purposes can be ignored. (Money launderers and preppers are generally interest rate sensitive!)
The reason the BoE wants to pay interest on reserves is so that interest rates in the wider economy go up. (Why they want that is another story….. but let’s run with that higher rates are needed for the purposes of this discussion). Under current arrangements paying interest on reserves is the only way to do this (given the huge level of reserves slopping around).
The challenge (and it is a new challenge that did not exist pre QE) is to transmit higher rates to the economy without rewarding banks for doing nothing.
At its heart this debate is about the privileged position that banks hold in our monetary system and what are their obligations to wider society in return for that privilege. Higher rates in a post QE world (with quite tough liquidity requirements) is a new thing and we need to establish a fair and just way to do it. Clearly, the banks want reserves to carry interest; the BoE is happy to oblige their mates and lack the imagination to see the problem or solve it; we need to challenge this…. and are doing so.
As usual, thanks
You do have to be careful with the language of all this because it seems to me that it changes in meaning or nuance within what part of the hierarchy of money you are referring to.
What I will say is that the ‘choice’ to issue interest against the CBRA is very damaging as it helps to convince the wider electorate that the Government is indeed in debt and has to pay it back and can’t help people.
This interest payment muddies the waters yet again. It’s very frustrating.
Every time I think I’ve got this it wriggles away into a confusion of text and terminology. A simple animated graphic would help me enormously. Any chance (at some point)?
That would be expensive
Not necessarily. Could be a film student project, for example; or made pro bono/at very little (crowd-funded?) cost by sympathetic professionals. TBD?
I think you are optimistic
Edward
I found this series of video tutorials on bank/central bank balance sheets of great help. There are quite a few of them but well worth the effort of you are interested.
https://www.khanacademy.org/economics-finance-domain/core-finance/money-and-banking/banking-and-money/v/banking-1
Thanks, Vince. I see that fractional reserve banking is in the list, though, so how accurate is this explanation?
It isn’t. Full stop.
Well as Richard says it not that accurate but its good for the basics and theory, for a beginner.
The multiplier model is not accurate because in reality the banks can more less create loans at will(as long as there are willing borrowers)and it was the risky lending that was not regulated well. The are no official reserve ratios in reality either or at least not in the UK. Not that reserve ratios helped much as they were largely way to small in any case ,the interbank lending market also allowed a dodge around there.
So that made banks open to bank runs in a crisis and so froze the banking system. The central banks did bail them out with emergency loans. It also created all these surplus CBRA’s via QE so the system had enough liquidity(which saved the stock and property markets and thus the banks too)
So the banks are indeed much safer now as Clive has pointed out because they are now sitting on way more of the stuff….but at what cost to us the rest if us if we now have to start paying interest on a means that was created to help rescue the risky financial system in the first place?
The multiplier model is nonsense
The ephemeral nature of money is quite bizarre isn’t it?
We say it it is not real, it’s just a promise (which I accept as you would expect me to after coming here for so long getting my head around this stuff).
Yet you can see the effects of what it makes happen or not.
It reminds me of gravity – we can’t see it around us, but we know it is there.
What IS real about money is the results of when there is not enough of it, and when there is too much – it’s maldistribution if you will.
The CBRA is also a totem to this maldistribution. There seems to be enough money for the private banks and their activities but certainly not enough for the rest of us and the real economy. The Government is happy to act as guarantor to speculative banking but not as a guarantor of the NHS or social security.
And adding insult to injury, Sunak wants to portray the CBRA as a debt constraint on the help people need right now.
It’s sickening actually – either the private banks have us by short and curlies – a form of black mail, or they have bought the politicians who have voluntarily chosen to fund their excesses. Or both.
It’s really not on, and to me we are now in a post political situation. Politics is part of the problem which leads me to some very unfortunate conclusions about how to achieve change. It seems to me that being nice and reasonable about this has long passed.
I hope I am working on stuff on this
Loved your typo, Richard – “bank despot accounts”!
Don’t correct it!
🙂
Apologies to Richard for having to continue moderating this thread when he should be enjoying his weekend. But Clive Parry brings up something else that confuses me.
Clive says that the BoE paying interest on CBRAs is the only way they can make interest rates go up in the wider economy. But why should that have any influence, given that CBRAs are effectively insulated from the rest of the economy (with the exception of a small amount of cash withdrawal)?
The CBRAs set inter bank loan rates and that’s how rate changes are then transmitted into the economy
Does that require the rate to be paid on £900 billion of CBRAs? I seriously doubt it
It worked before 2019, and in 2011 so much less would do for that purpose
Not the ONLY way – it is A way……. and the purpose of this discussion is to tease out ways to allow higher rates to be transmitted to the economy without rewarding banks nor doing nothing.
Currently, if a client deposits £1 million with a bank overnight there is nothing profitable that the bank can do with it. Liquidity rules prevent it funding (say) a mortgage with this money (as was the Northern Rock business model) so it is “pass the parcel” with the deposit to other banks but eventually it will only ever pay what is paid on CBRAs. So the client will only get that rate (zero), too. (Indeed, I know senior banker at a UK Clearer that would call clients asking to take their money elsewhere!). The client will then search out opportunities to lend at a higher rate… which, if CBRAs carry no interest, might only be 0.25% (say)…. at a time when the BoE wants market rates at (say) 2%.
So, as I see it the possibilities lie in a combination of
(1) raise reserve requirements further (and pay zero on this higher amount) and pay a market rate on excess reserves.
(2) force banks to “pass on” higher rates to their depositors.
(3) tax banks in a way to claw back this extra interest paid on reserves.
Until 2008 and QE none of this was relevant as BoE open market operations to control rates was typically to add reserves into a steadily growing economy. Post QE and at zero rates it was not relevant either…. but it is now and that is why we are all feeling our way towards a solution.
But I am off to bed and then away sailing – I expect to see all the answers on my return!! (unless I am storm bound and have nothing better to do!).
A question.
Can commercial banks cause the creation of CB reserves?
Suppose commercial bank A creates money by increasing deposits but does it at a faster rate than other banks. As that money is spent, a % will end up in the accounts of other commercial banks and will require the movement of reserves from bank A to these other banks. Suppose bank A does not have enough reserves to cover its position will it be able to gain the necessary reserves by borrowing from the BoE using its loans as collateral? Will it therefore have caused an increase in CB reserves?
This used to happen
These reserves are now of a size to prevent that happening
The risk that it might will provoke regulator intervention
Thanks for this, Richard. Still trying to get my head around it, but this helps a lot.
Do I have this right, then, that the Central Bank Reserve Accounts are essentially cash collateral that the commercial banks are required to keep with the Bank of England for liquidity support? To give other financial institutions confidence that transactions involving one of these banks will be settled in full? If so, is there any no need to pay interest on these amounts than there would be on banknotes and coins (or gold) held in a vault. Indeed, keeping sort of holdings would involve a cost.
It sounds as though the amounts on Central Bank Reserve Accounts were very low before 2008: paying interest on the substantial amounts that have built up since then is effectively subsidy to the commercial banks. It is not clear to me that the Bank of England needs to compensate the commercial banks for the reserves they must hold to meet regulatory requirements. Perhaps the Bank of England should make an equal and opposite charge for providing their government-guaranteed service of holding deposits and clearing interbank transactions?
What rate do they pay? Is it the base rate? Or SONIA – the Sterling Overnight Index Average, that is the standard rate for commercial lending – also administered and published by the Bank of England – https://www.bankofengland.co.uk/markets/sonia-benchmark
Base rate is paid
The BoE creates the reserves – the banks can’t
All the banks can do is shift them between them
It is staggering that the BoE thinks it must pay interest on funds it created
I will finish the double entry tomorrow
I did nit finish some teaching until too late on Friday and it has left me unexcited by more work this weekend
bank despot accounts ! Even better
🙂
Richard, it is interesting to speculate on why BoE is paying the commercial banks interest on the funds it has created for them and I wonder if this relates to the planned changes to the Basel III requirements being imposed by the Bank for International Settlements?
It intrigued me that numerous central banks all increased their base rates on the same day, suggesting a coordinated operation.
The Basel III details make very heavy reading but the link is here for those interested.
https://en.wikipedia.org/wiki/Basel_III
But given the BoE is exceptional in doing this (see the work by NEF) this cannot be true
Having thought a bit more, I am trying to make sense of where CBRAs come from, but can someone confirm if I am on the right lines?
I can see that government spending requires payment via banks, which results in an increase in their CBRAs and a corresponding payment (e.g. of a pension) made outside of the CBRA. Conversely a payment to the government means the CBRAs are reduced and the corresponding debit (e.g. of some tax owed) is made of an account outside the CBRAs; anyone buying government bonds means a similar movement through accounts.
So that seems to mean any net amount in CBRAs results simply from a shortfall between government spending and government receipts. Which seems to suggest to me that amount can be more or less anything, the government can vary it almost infinitely outside the control of the banks just by adjusting the number of bonds issued. But that makes a nonsense of any importance being placed on the amount held in CBRAs, or for that matter it earning interest … except that such interest in itself is just more unbalanced government spending outside bank control. Have I got something wrong again, it all sounds too arbitrary to be meaningful?
Next I want to make sense of QE. Some bonds originally sold by the government (so involving reducing the amount in CBRAs) are bought back (increasing the CBRAs again) except by a different arm of government, the APF. If they exactly balance the CBRAs would stay the same, but more QE would be one way of government choosing to increase the overall size of CBRAs. I can see that could make sense if the government wanted to increase CBRAs pretty quickly, as they did after the banking crisis, without waiting for an imbalance between spending and taxation to do the job. However it seems to me that the amount of extra liquidity in the non-CBRA universe cannot be more than the resulting increase in CBRAs.
Then I ask what might happen if QE was unwound. If bonds held by the APF were sold, the effect on CBRAs would be the same as when those bonds were first issued, a reduction in the CBRAs. It might have a negative impact if banks felt that their liquidity in relation to day-to-day inter-bank transactions made them more cautious about settling accounts (as in 2008) so QT would have to be applied with a little care. Outside the CBRAs, there would be more bonds available to buy on the stock exchange, which if it works as a perfect market would mean a drop in bond values – and presumably a drop in value of whatever else is sold to buy them at an attractive price, presumably shares in companies. If that logical connection is right the government, who are usually beholden to the City of London, are unlikely to ask the BoE to do QT to any significant extent right now given share prices are already looking spooked (though of course they could do it to an insignificant extent just as a political gesture).
Am I getting anywhere near understanding, or am I just confusing myself more and more?
I think you’re pretty much there….