54/98
20 April 1998
Cash ratio deposits: Government response to consultation
The cash ratio deposit (CRD) scheme, which contributes to the funding of the Bank of England's activities, will be simple and transparent, Chief Secretary Alistair Darling said today.
The Chief Secretary was speaking on the day the Government's response to the consultation on the scheme was published. It has decided that the initial CRD ratios should be:
- zero on Eligible Liabilities up to 400 million Pounds; and
- 0.15 per cent on Eligible Liabilities over 400 million Pounds.
Mr Darling said:
"This scheme reflects the responses to the consultation, taking into account the impact of the likely new charging regime of the Financial Services Authority and also the desire for administrative simplicity and clarity.
"This puts the Bank of England's funding on a secure, transparent and accountable basis."
When the CRD ratio was 0.35 per cent, Ministers gave a commitment that 'the overall burden of supervision on deposit-taking institutions in aggregate will be no greater than it is today, and preferably lower'. The new ratio represents a significant reduction in the aggregate burden, even after taking into account the charges of the Financial Services Authority (FSA).
The CRD scheme is proposed in Clause 6 and Schedule 2 to the Bank of England Bill. Commons consideration of Lords Amendments to the Bill is taking place today.
It is intended the CRD scheme will come into force on 1 June 1998.
The Government's response was published in response to a Parliamentary Question from Stephen Timms , MP for East Ham.
Notes to editors
1. A consultation document on the maintenance of cash ratio deposits which contribute to the funding of the Bank of England's activities was published by the Treasury on 25 November 1997.
2. Banks currently place non-interest bearing CRDs with the Bank on a voluntary basis. The current CRD ratio is 0.25 per cent (reduced from 0.35 per cent on 1 April 1998). As part of the reforms introduced by the Bank of England Bill, it is proposed to place the scheme on a statutory basis. This is designed to improve transparency and accountability.
3. The consultation document explained the rationale for the scheme and its institutional coverage - banks, building societies and certain European institutions. It also set out proposals on the definition of eligible liabilities - which forms the basis on which the CRDs are calculated - and the distribution of CRDs.
4. Media copies of the Government's response to the consultation can be obtained from Fiona Hamilton in the Treasury Press Office on 0207 270 5185 or fax 0207 270 5244.
5. Non-media copies can be obtained from the Treasury Public Enquiry Unit on 0207 270 4558.
Cash ratio deposits
Response to consultation
Issued by H M Treasury
20 April 1998
Response to consultation on cash ratio deposits
Introduction
1. On 25 November 1997, the Treasury issued a consultation document on cash ratio deposits. The paper sought views on how the cash ratio deposit (CRD) scheme proposed in Clause 6 of and Schedule 2 to the Bank of England Bill should be implemented in detail.
2. Under the Bill, the Treasury is provided with order making powers:
- to define the eligible liabilities which form the basis of the CRD scheme and specify how they are to be calculated (Schedule 2, para 2(2))
- to specify value bands and ratios applicable to those eligible liabilities (Schedule 2, para 5).
3. The Bill states that before making such orders, the Treasury "shall consult the Bank, such persons as appear to them to be representative of persons likely to be materially affected by the order, and such other persons as they think fit". It also states that in exercising the power to make these orders "the Treasury shall have regard to the financial needs of the Bank."
4. The consultation paper discussed broad options for the CRD scheme and the concluding section contained specific questions for consultees.
5. This paper sets out the Government's response to the consultation process and outlines the timetable for the implementation of the scheme.
6. Additional copies of this document can be obtained by calling the Public Enquiry Unit on 0171 270 4860/4558.
2. Underlying rationale and principles
2.1 Purpose of the scheme
7. The Bank of England performs a wide range of functions. As well as having responsibilities for monetary policy and financial stability, it is banker to the banking system. It also performs agency services for the Government, including printing and distribution of banknotes, gilts registration services and the management of the Government's reserves.
8. It has a number of sources of income:
- the Treasury pays for the agency services;
- banks, other financial institutions and Government Departments pay for direct banking services including the provision of settlement systems;
- the Bank obtains income from its capital and reserves;
- the Bank also earns income on the assets which match CRDs.
9. This income funds the Bank's activities and generates a return on its capital.
10. At present the banks maintain CRDs with the Bank on a voluntary basis. As part of the reforms in the Bank of England Bill designed to recognise the Bank's new responsibilities, and to improve transparency and accountability, it is proposed in the Bank of England Bill to place the CRD scheme on a statutory basis. The Bill also extends the coverage of the scheme to include building societies, in recognition of the important role that these institutions play in the financial sector and the benefit they derive from the sterling liquidity which the Bank provides, as well as from the Bank's objectives for price stability and the stability of the financial system as a whole.
2.2 Coverage of institutions
11. Under the present voluntary scheme, banks authorised to operate in the UK place non interest bearing CRDs with the Bank. This applies to all institutions authorised under the Banking Act 1987, and European authorised institutions who have established branches in the UK under the Banking Coordination (Second Council Directive) Regulations 1992.
12. Deposit -taking institutions' balance sheets are characterised by assets (loans) with long term maturity, and liabilities (deposits) many of which can be called in at short, or no, notice. As a result, they rely particularly on access to the Bank's provision of liquidity to the system as a whole. Only a few banks - the settlement banks - have accounts at the Bank of England to settle their obligations. But the other institutions base their liquidity management on holdings of liquid assets and credit facilities with the settlement banks, which ultimately depend on their access to central bank liquidity. This, in effect, provides deposit-taking institutions with cover against the risk that their liquid liabilities run down faster than they can liquidate assets. These institutions are also direct beneficiaries of the Bank's other roles in monetary and financial stability.
13. Building societies have similar balance sheets to banks, and compete with them across a wide range of business. In the same way, they benefit from access to sterling liquidity. As a central part of the UK's financial system, they also benefit from monetary and financial stability. So the Bill proposes extending the scheme to cover building societies. Other financial institutions - such as securities firms and insurance companies - typically run balance sheets in which the maturities of assets and liabilities are more equally matched. So they are less dependent on access to Bank liquidity.
14. A number of responses to consultation argued that the Bank's public good functions should be paid for by general taxation, and that therefore CRDs were an inappropriate means of funding the Bank. Alternatively, responses suggested that the institutional coverage should be widened to include other types of financial institution. The Government remains of the view that the deposit-taking institutions in particular benefit from the Bank's provision of liquidity. As a result, it proposes to retain the central features put forward in the consultation document; that cash ratio deposits placed by banks and building societies should continue to provide one source of income for the Bank. This CRD scheme has worked well for over twenty years.
3. Definition of eligible liabilities
3.1 Current position
15. The current definition of eligible liabilities (ELs) covers the bulk of short-term sterling deposits with the eligible institutions. So it is broadly proportionate to each institution's potential exposure to liquidity risk from maturity transformation, which underlies the CRD scheme.
16. Specifically, ELs are currently defined as an institution's gross sterling deposits, including repo liabilities and net sterling liabilities to non-resident offices and positive net currency liabilities, but excluding sterling deposits with an original maturity of over two years. These are offset by loans to other UK banks, (except for holdings of shares and debt securities with an original maturity greater than five years), and any balances held with the Bank (excluding CRDs and special deposits). Liabilities arising to the Bank from its money market operations are excluded (ie repos with the Bank).
17. Loans to other banks are excluded from the calculation of ELs to avoid double-counting, otherwise liabilities which are matched by loans to other banks would count as ELs for both institutions.
18. Repos with the Bank incurred as part of its money market operations are excluded. This is to avoid distortions in the money market that might arise from a different treatment of repos and outright sales and purchases of bills.
19. The current definition also includes net foreign currency liabilities (if positive), so that only foreign currency liabilities which back sterling assets are counted as part of an institution's ELs. Similarly institutions may deduct from their ELs deposit liabilities to non-resident offices, that are not net sterling liabilities.
3.2 Proposed changes
20. Given that an institution's CRD liability should broadly reflect its potential exposure to sterling liquidity risk, the consultation paper proposed no major changes to the current definition. But changes are needed as a consequence of the application of the CRD scheme to building societies, and the paper proposed one minor change to the list of claims which may be offset against eligible liabilities.
Implications of extending the coverage of the scheme
21. As already stated, the CRD arrangements allow banks to net off loans to other banks in the scheme. When the scheme extends to building societies, all eligible institutions will be allowed to offset loans to other eligible institutions in calculating their ELs.
Reverse repos to the Bank
22. Infrequently the Bank needs to absorb liquidity from the marketing its operations. The paper proposed that any liabilities incurred by the Bank in its money market operations should not be allowed as an offset in the calculation of ELs. This would mirror the position of liabilities incurred to the Bank in these operations. In practice, this would mean dropping reverse repos to the Bank as an offset from the current reporting forms.
3.3 Responses
23. Responses were invited to the following questions:
Does the proposed definition of ELs adequately reflect exposure to liquidity risk from maturity transformation?
A number of institutions supported the proposed definition. However, institutions which argued that CRDs were an inappropriate means of funding the Bank challenged the use of Eligible Liabilities. Separately there was some support for a scheme which included a measure of foreign currency liabilities in the calculation of Eligible Liabilities. The Government remains of the view that the deposit-taking institutions in particular benefit from the Bank's provision of sterling liquidity. The Government recognises that the Financial Services Authority has consulted on charges that incorporate measures of gross foreign currency liabilities. However, the inclusion of gross foreign currency liabilities in the calculation of Eligible Liabilities is not consistent with the rationale for the CRD scheme which relates to sterling liquidity, although net foreign currency liabilities will continue to be included. It therefore does not propose any changes to the definition of ELs or institutional coverage of the CRD scheme, as put forward in the consultation document.
Is it appropriate to exclude any liabilities the Bank incurs in its money market operations?
A large majority of responses agreed that it was appropriate to exclude any liabilities the Bank incurs in its money market operations. The Government plans to adopt the change proposed in the consultation paper.
The items covered by the planned definition of Eligible Liabilities are given in Annex A.
4. Aggregate level and distribution of CRDS
Aggregate level
24. Under the current voluntary scheme, banks with ELs of less than 10 million Pounds are not required to place CRDs with the Bank. Banks over that threshold keep on deposit at the Bank 0.35% - reduced to 0.25% on 1 April - of all their ELs; these deposits earn no interest. Following the decision to put the scheme on a statutory basis, the Government has been reviewing the overall level of CRDs and the distribution between different institutions.
25. The overall burden of the CRD scheme on deposit-taking institutions will be reduced in the light of the transfer of banking supervision to the FSA, having regard to the Bank's overall financial needs. Responses were invited on the overall level of CRDs.
26. The responses argued for a substantial cut in the CRD burden, and some proposed in addition a 'sunset clause', or review of the scheme within five years. Responses also argued that CRDs should not fund a dividend to the Treasury, and that the Bank should be made more accountable with better disclosure of costs.
27. The consultation document said 'The Government has made clear its intention that the overall burden of CRDs and supervisory fees on the deposit-taking sector should be no greater than it is today, and preferably lower'.
28. The Government also attaches great importance to making the statutory CRD scheme transparent and accountable. It believes that it is important to establish as a basis for the scheme a clear set of principles and transparent arrangements for their application. The Government believes that CRDs should be set to cover the Bank's unrecovered running costs associated with monetary policy and financial stability, with the Bank's free reserves remaining broadly constant in real terms over time.
29. The table below sets out the Bank's best estimate of its costs, after the transfer of banking supervision, and associated sources of income:
| Million Pounds (1998/9 prices) | |
| Total costs | 190 |
| Treasury payment for agency services | 67 |
| Charges to customers | 44 |
| 111) | |
| This leaves: | 79 |
| monetary policy | 46 |
| financial stability | 16 |
| banking and market services associated with | 17 |
| monetary policy and financial stability |
The costs are based on the average position over the next four years, excluding a cost of 20m Pounds representing the overheads relating to the transferred supervision function. The actual costs as they appear in the Annual Report will be higher than these underlying figures, because the 20m Pounds overhead will not be reduced immediately.
30. The Government has concluded that, consistent with the principles set out above, the bands and ratios should be designed to deliver income to the Bank of 79m Pounds. Assuming an average interest rate of 7%, this is equivalent to initial cash ratio deposits of 1,130m Pounds.
31. The Government will keep the bands and ratios under review in the light of changing circumstances. It will anyway review the scheme within five years.
Bands and ratios
32. The consultation document gave four examples to illustrate different possible approaches to banding:
33. The consultation paper asked the following questions:
Should there be a flat rate, or banding system? If banding, is one of the examples shown preferred? Should there be a greater weighting relative to size?
34. The responses tended to deal with these questions together:
The majority favoured a banding approach with a zero band, rather than a threshold approach, in order to avoid a steep marginal rate at the threshold. There was less consensus on the actual values of the bands and ratios. A number of institutions favoured a low threshold with a flat rate. Some suggested a zero band up to 200m Pounds ELs, with a simple rate above, others argued for a zero band up to 350m Pounds, with a simple rate above. There was also some support for multiple bands, with a greater weighting relative to size. Some responses suggested that the weighting should depend on the scope of business as well as size.
35. The Government has decided that the starting point for the statutory scheme should incorporate a zero band up to 400m Pounds ELs, with a single 0.15% band on ELs above 400m Pounds. This scheme reflects the responses to consultation, taking into account the impact of the likely new charging regime of the Financial Services Authority, and also the desire for administrative simplicity and clarity.
5. Orders and timetable
36. The Treasury is proposing to lay orders for the statutory scheme as soon as possible after Royal Assent, with the intention of bringing the scheme into force on commencement of the Act (planned for 1 June).
37. The Financial Services Authority also plans to introduce its
charging scheme on 1 June.
Annex A: Items Covered by the Proposed Definition of Eligible Liabilities
Include:
- Sight Deposits
- Time Deposits
- Certificates of Deposit
- Commercial paper
- Bonds and other instruments up to 5 years maturity
- Liabilities under sale and repurchase agreements (repos) of gilts, other
- than those with the Bank of England
- Liabilities under sale and repurchase agreements (repos) of other paper,
- other than those with the Bank of England
- Items in suspense (excluding internal accounts)
- Smart cards
- Credit items in transmission (only 60%)(see footnote 1)
- End-of-day repos in RTGS with Bank of England
minus:
- Deposit liabilities with greater than 2 years original maturity
- (optional)2
Subtract:
- Balances with Bank of England (excluding CRDs and special deposits)
- Debit items in transmission (only 60%)(see footnote 1)
- Balances with and loans and advances to other eligible institutions
- Certificates of deposit issued by other eligible institutions
- Commercial paper issued by other eligible institutions
- Claims under sale and repurchase agreements (reverse repos) of gilts with
- other eligible institutions
- Claims under sale and repurchase agreements (reverse repos) of other
- paper with other eligible institutions.
- Investments in other eligible institutions up to 5 years maturity
Add if positive:
- Net foreign currency liabilities
- minus (if positive):
- Deposit liabilities to non-resident offices less net sterling liabilities
- to non-resident offices (optional) (see footnote 2)