LONDON ― The Bank of England would likely treat any failure by the U.K. Treasury to transfer funds to cover losses related to quantitative easing as a breach of the indemnity it was issued by government in 2009, policymakers were told on Tuesday.
The guarantee, that was theoretically open-ended, was issued to the Bank of England by then-Chancellor Alistair Darling in an exchange of letters with the bank’s then-Governor Mervyn King to enable an asset purchase facility (APF) to help support the economy in the wake of the 2008 global financial crisis.
When asked during a Treasury Select Committee meeting whether there was a contingency for non-payment in the event transfers became politically untenable due to their size, BoE Governor Andrew Bailey said the bank considered the indemnity “binding.”
“Let’s assume that this scenario you paint happens, I don’t expect it will, but let’s just assume it does for a moment … we would take the view that the government has a liability to us, and we would have to decide how to book that [negative equity] onto our accounts,” Bailey said.
While the bank has in the past transferred a cumulative £123 billion in profits from the facility to the public purse, higher interest rates have seen the facility incur large losses the past year. This is due to most of its assets being long-dated or acquired when yields were at record lows, contributing to a scenario where the income the bank currently receives is much lower than what it compensates banks on their reserves.
“The U.S. has a much shorter maturity on its portfolio,” Dave Ramsden, the bank’s deputy governor for markets and banking, told the committee. “We in the U.K. have issued more long-dated debt, we bought many more long-dated gilts.” The Fed, which is not indemnified by the U.S. Treasury, instead carries QT losses on its balance sheet until they can be paid off.
On Tuesday, official public borrowing statistics confirmed the government had spent £9.7 billion more than in October 2022 largely as a result of payments to the Bank of England’s APF.
“These payments, recorded as capital transfers, began in October 2022 and occur every three months. This month saw a payment of £9.1 billion to the APF, £8.3 billion more than in October 2022,” the release said.
Much larger than expected
The scale of the losses has surprised some economists, including Jagjit Chadha, director of the National Institute of Economic and Social Research (NIESR), a U.K.-based think tank, who argued earlier this year they could constrain a pre-election budget due to being much larger than initially forecast by the Office for Budget Responsibility (OBR), the U.K.’s fiscal watchdog.
“There is a concern about the perception that the Treasury could be seen as bailing out the Bank of England itself (as the APF effectively sits with the Bank even if it is indemnified by the Treasury),” the NIESR wrote in response to a Treasury Select Committee consultation on quantitative tightening in March this year. “Such a perception would not only be embarrassing for the Bank but could raise some concerns about its independence.”
The NIESR economists added in the submission that had the APF profits been kept in a contained facility, rather than used to improve the government’s fiscal position, current APF losses would not be so badly perceived, nor could they be “so easily weaponized”.
Ramsden, however, urged the Select Committee to view the losses in context. “As we discussed with you back in May, we transferred gains of £123 billion, cumulatively, up to 2022. And that was always anticipated as set out in the original exchange of letters back in 2009,” he said.
While the composition of the bank’s portfolio and quantitative tightening had caused the BoE to materialize losses more quickly than some counterparts, Governor Bailey said other central banks had also been accruing very large liabilities.
“There is not a distinction between central banks in respect that one lot has discovered the sort of the magic answer as to how to make no loss and the others haven’t,” Bailey told the committee.
Asked if the government indemnity made it more of a fiscal issue for the U.K. that could eat into public spending elsewhere, the BoE bankers replied this was a matter for government.
“When the OBR, who, unlike last September will be fully involved in this fiscal event, publish their outlook, they will fully account for the cash flows,” Ramsden said. “But there’s no mechanistic read-across from what happens on the cash flows to the overall fiscal stance — that will be a decision for the government.”
New bank levy not a factor
Bailey denied that a new bank levy power brought in under this year’s Financial Services and Markets Act could be used by the BoE to raise funding from banks directly to cover losses.
The levy, he said, replaced the Cash Ratio Deposit mechanism, which was overly exposed to interest rates, opaque and “not a very great way to fund your budget”, and should help to make the BoE’s funding structure more transparent. It would also be limited to covering policy functions such as monetary policy, financial stability and markets.
“You couldn’t make the Bank of England’s funding of the running costs of the bank any more complicated if you tried, but that’s 200 years of history,” Bailey said.
