Our response to HM Treasury’s consultation on proposed changes to the cash ratio deposit scheme

Background

The Building Societies Association represents mutual lenders and deposit takers in the UK including all 46 UK building societies. Mutual lenders and deposit takers have total assets of over £375 billion and, together with their subsidiaries, hold residential mortgages of £245 billion, 20% of the total outstanding in the UK. They hold more than £250 billion of retail deposits, accounting for 22% of all such deposits in the UK. Mutual deposit takers account for 31% of cash ISA balances. They employ approximately 50,000 full and part-time staff and operate through approximately 2,000 branches.

Executive summary

We believe that this review is an opportunity lost.  Rather than tinkering at the edges, HM Treasury should have taken steps to ensure all those that benefit from the Bank’s work contribute financially, not just those perceived to have the deepest pockets ie deposit takers. 

The shortfall in funding for the unremunerated policy functions since 2009/ 2010 indicates a radically different funding approach is necessary.  The Bank needs a funding model that is sufficiently responsive to work in times of prolonged stress and historically low interest rates.

That said, we are pleased to see that a small number of institutions will either fall out of the current scheme or place reduced CRDs.  But deposits will rise for the majority of institutions.

Comment

We are most grateful for the opportunity to comment on the proposed changes to the scheme. 

The costs of the Bank of England’s unremunerated functions - monetary policy and financial stability operations – are currently funded by non-interest bearing deposits that building societies and banks (“eligible institutions”) are required to place at the Bank.  Eligible institutions are those with eligible liabilities over a certain threshold; they are required to place a percentage of deposits over that threshold.  The deposits obtained from eligible institutions are invested in interest-yielding assets.  Since the CRD scheme was placed on a statutory footing in 1998, the scheme has been reviewed at five-year intervals.

We had expected a more comprehensive review this time given the huge changes in regulation caused by the financial crisis.  We are therefore disappointed that only the fringes of the scheme have been adjusted.

The review provided a perfect opportunity to identify the beneficiaries of the Bank's operations.  They are quite clearly a wider group than the eligible institutions which currently pay the costs.  Even the HM Treasury[1] refers to CRD income funding the “ongoing supervision of the financial market infrastructure”. 

Monetary and financial stability is in the interest of the economy as a whole.  It does not seem unreasonable therefore for the costs to be met by the Bank of England’s general income including that arising from seigniorage and foreign reserves rather than by charging the building society and bank sector alone.  This is the model followed by the majority of central banks across the world.  At the very least, we would like to know why this part of the Bank of England has to be funded differently. 

The consultation[2] refers to alternative funding arrangements.  It does, however, dismiss an examination of seigniorage by saying there have been no significant developments in the funding methods of other central banks over the past five years to warrant a new in-depth international comparison.  We disagree.  The fact there have been no developments could signal that other central banks’ models work adequately and do not need changing. 

As we argued previously[3], if the seigniorage model is ruled out then a widening of the contributors to the current scheme should be considered.  We urge HM Treasury to think again – and before the next five year review is due - about spreading the costs of its policy work more fairly and widely across the financial services sector, particularly the larger players.  Insurers are an example of financial institutions that need, inter alia, financial stability to stay in business; large investment firms too would not be able to operate without stability.  Yet they do not contribute. 

One simple way to achieve this would be abolish the CRD scheme and fold the costs of the Bank’s unremunerated policy work into future PRA fees. Contributions from non-deposit takers could be based on alternative criteria such as assets under management, number of transactions or fee income.  HM Treasury rejects[4] a fee-based approach citing its 2008 review which concluded that it was not possible “to apportion the service being received to individual firms”.  We argue that the current system also does not apportion the service to individual firms.  It is merely skewed towards those deposit takers with higher eligible liabilities (and perceived deeper pockets). 

Another reason to look again at how to fund the Bank’s unremunerated activities is the shortfall in funding since 2009/10.  The most recent annual report[5] shows a figure of £20 million.  The shortfalls have been caused by a drop in the level of CRDs and market interest rates as well as an increase in Bank spending.  They underline the fact that the current model is not sufficiently responsive to work in times of prolonged stress and historically low interest rates. 

As an aside, we note⁴ HM Treasury states the FSA has generally levied larger amounts on firms that pose a greater risk to its objectives.  Our experience is simpler, the regulator has generally levied larger amounts on larger firms, regardless of their risk appetite or profile.  The current regulatory fee model does not, for example, take into account the unique, low-risk nature of mutuals.  For too long, mutuals have been grouped with riskier, shareholder-driven banks.  Now is the time to develop a new metric.

Response time

Only 25 calendar days (19 working days) are given to provide a response.  This very short period is justified by the fact that government has already consulted on this issue.  We disagree.  The earlier 2012 consultation (in the form of a letter) gave stakeholders just 18 calendar days (11 working days) to respond. 

The current consultation also justifies this short response time by saying the impacts of the changes are small.  Again, we disagree.  HMT’s own impact assessment says larger building societies and banks will need to increase their deposits by a total of £1,558 million, in addition to the £2,480 million they held in 2012/13.  This represents a 62.8% increase for those firms, hardly a small impact.

Questions

1. The proposal to increase the CRD from 0.11 per cent to 0.18 per cent

2. The proposal to raise the deposit threshold from £500 million to £600 million

The Bank’s annual accounts show there has been a shortfall in funding for the unremunerated policy functions since 2009/ 2010.  This has been caused by the lower average return on CRDs, lower growth in eligible liabilities – and an increase in Bank spending.  This indicates a different funding approach is necessary, one that is consistent but sufficiently responsive to work in times of prolonged stress and historically low interest rates. 

HM Treasury proposes to address this shortfall by increasing the ratio from 0.11% to 0.18%, a rise of 63%, and by raising the minimum deposits threshold from £500 million to £600 million, a rise of 20%.  The 2013-2018 summary budget[6] includes assumptions on investment yields and growth in eligible liabilities – as did the 2008 review, which proved to be somewhat wide of the mark.  In other words, the Bank is continuing to use the same methodology, one that was clearly not sufficiently flexible to cope with events such as the financial crisis.

One aspect the Bank could control further is costs.  These are acknowledged to grow 2% over the next five years.  This forms an uncomfortable contrast with the building society sector which has managed to reduce its management expense ratio by more than a third over the past fifteen years.  The 2% increase also sits uneasily next to the proposed cap of 1% on benefit increases.  Whereas the Bank has ended its two-year pay freeze, many mutuals are still taking more drastic and lasting action to reduce overheads.

Without a detailed budget it is hard to form a view on where the money is spent and where savings could be made.  There are general comments on efficiency savings from, for example, having a single PRA operation as both Bank and regulator.  But there are no figures, timelines or indication of accompanying reductions in either CRDs the costs of other stability related measures (FSCS and FSA fees).

Ten years ago, HMT’s CRD review[7] said the Bank should consider ways in which the transparency of the scheme could be enhanced for instance by publishing a more detailed breakdown of expenditure by function.  We have not seen the spirit of this recommendation carried through although we note that CRD income started to be identified separately in 2004.  As a bare minimum, we believe these figures should be broken down so eligible institutions can see how the CRD income is comprised, invested and spent, with all sets of figures provided at more regular intervals.  Eligible institutions may also welcome the opportunity to consider the potential for greater efficiencies and whether there is net value derived from the activities.   For potentially new contributors this is particularly pertinent.

Concern about the apparent lack of accountability at the Bank is not new.  We note the Treasury Select Committee[8] concluded inter alia that the Bank needed to be more open about its work, and had to be held more clearly to account than it had been in the past.  One area that has not been factored in is the Bank’s widening role from purely monetary policy and financial stability to supporting the UK economy as a whole.

The impact of the proposed changes affects larger building societies and banks most; those with more than £750 million eligible liabilities face an overall rise of 62.3% on top of other regulatory fee rises. 

We welcome the fact that 14 deposit takers will be removed from the scheme and that 12 will see the size of their deposit fall.  This does not take away the fact that the remaining 113 of the 139 eligible institutions (as at December 2012) face significant rises in cash ratio deposits.  This is not the impression given by HM Treasury.  The consultation points to just 20 institutions making 86% of the deposits.  20 is a significant number, however, and includes mutuals, which are smaller, lower risk and more conservative than plc-owned banks.  The amount of the Bank’s help and facilities each of the 20 has required will vary widely.

Helpfully the consultation provides the December 2012 figures for mean (£17.9 million) and median (£2.4 million) deposits.  It would have been useful to have projections for future years as well.

3. Whether there are any technical aspects of the operation of the scheme that could be improved.

No comment.

HMT consultation on changes to CRD scheme