Why are we giving a £24bn-a-year subsidy to profitable commercial banks? | Letter

“The BoE’s payment of interest on reserves is a conventional policy tool that preserves monetary transmission and financial stability; reducing or removing it to save a perceived subsidy could destabilize policy effectiveness and tighten credit conditions more than it saves.”

Short take: The letter fixates on a £24bn annual subsidy from remunerating reserves at Bank Rate, but this is how modern central banks maintain a floor and policy credibility. Paying interest on reserves helps anchor funding costs, prevents rate/pass-through frictions, and stabilizes interbank liquidity—especially when gilt and liquidity conditions tighten. The suggested ‘marginal tranche’ scheme would be complex to implement and could fragment banks’ incentives, distort balance sheets, and muddy transmission of cuts or hikes. The real missing context is the broader design: what is Bank Rate today, what risks would arise if the reserve base shrank, and how would lenders react? The windfall-tax angle is politically charged; the policy mechanism matters more.

“Transitioning from a floor system to a tiered reserves framework would represent a structural hit to bank profitability, effectively acting as a permanent, non-discretionary tax on systemic liquidity.”

The proposal to restrict interest payments on reserves to a marginal tranche is a direct threat to the net interest margin (NIM) of major UK banks like Lloyds (LLOY) and NatWest (NWG). By essentially taxing the 'excess' liquidity that banks hold at the Bank of England, the government would effectively claw back billions in profitability currently buoying bank balance sheets. While the author frames this as a subsidy, it is actually a byproduct of the 'ample reserves' framework adopted post-2008 to ensure financial stability. Reducing this payout would force banks to either tighten lending standards or lower deposit rates, potentially stalling credit growth in an already fragile UK economy.

“Reserve remuneration is a real fiscal transfer, but the letter's proposed fix risks unintended monetary-policy side effects that could prove costlier than the £24bn subsidy it aims to eliminate.”

Holtham identifies a real mechanic: the BoE pays ~3.75% on £640bn of reserves, costing taxpayers ~£24bn annually. His proposed tiered-reserve solution is theoretically sound—paying interest only on marginal reserves would preserve monetary policy transmission while cutting costs by ~£19bn. However, the article conflates two separate issues: (1) whether reserve remuneration is *necessary* for policy, and (2) whether it's *efficient*. Pre-2006 history proves nothing about modern corridor systems. The stronger critique is whether unilateral BoE action risks disintermediation or capital flight—banks might reduce reserve holdings if rates drop, forcing the BoE to buy more gilts or accept tighter monetary conditions than intended.

“Switching to marginal interest on reserves would cut roughly £19bn from annual UK bank profits without impairing monetary control.”

The letter correctly flags an expensive legacy of QE: the BoE paying 3.75% on roughly £640bn reserves hands banks £24bn annually for a function that marginal pricing could achieve. Pre-2006 the Bank paid nothing on reserves, so the current setup is not a technical necessity. Yet the piece ignores that abundant reserves also blunt the impact of rate hikes on deposit competition and could make any tranche system vulnerable to sudden reserve shifts during stress. Barclays, HSBC and Lloyds would see immediate net-interest-income pressure if a 20% tranche were adopted, but the larger risk is whether the BoE would need compensating tools that erode the supposed fiscal gain.