European Central Bank introduces ‘de facto bank tax’ snubbed by Reserve Bank

The European Central Bank is to pay banks less interest on their reserves - a move the Reserve Bank of New Zealand won't make.

The European Central Bank (ECB) is recouping some of the costs associated with its ‘money printing’ programme, using an approach snubbed by the Reserve Bank of New Zealand (RBNZ).

The ECB has committed to paying financial institutions no interest on the minimum amount of reserves they have to keep at the central bank.

The move is expected to save the ECB around six billion euros a year, according to an AFS Group analyst who spoke to Reuters.

Finance Minister Grant Robertson asked Treasury and RBNZ to look into whether a similar strategy could be used in New Zealand, after the Herald floated the idea with him late last year.

The RBNZ strongly opposed paying banks no interest on some of their reserves.

It basically said its job was to influence inflation, not try to save the Crown money by imposing a “de facto tax” on banks.

The problem, from a taxpayer’s perspective, is that all the ‘money printing’ the RBNZ did in response to Covid (via its Funding for Lending and Large-Scale Asset Purchase programmes) saw banks’ reserves, used to settle transactions, explode.

Because the RBNZ has to pay banks interest on their reserves at the official cash rate (OCR) – which has risen by more than was expected a few years ago – the situation is costing the RBNZ a fortune.

The RBNZ was paying banks 5.5 per cent interest on $45 billion of reserves at the end of June. That’s equivalent to $2.5b a year.

The value of banks’ reserves got as high as $56b in December. The most banks ever had in their settlement accounts pre-Covid was $11b, and this was around the time of the 2008 Global Financial Crisis.

The RBNZ told Robertson it was important it paid banks interest at the OCR, because this “creates a floor under short-term market interest rates”.

It said changing tack would call into question its operational independence, as it would be “unprecedented internationally for an advanced economy central bank to introduce tiers for reasons unrelated to their own objectives”.

Nonetheless, the ECB argued because the zero rate would only apply to the minimum amount of reserves institutions have to keep at the central bank, the move wouldn’t interfere with its policymaking.

It said the change would “preserve the effectiveness of monetary policy by maintaining the current degree of control over the monetary policy stance” and “improve the efficiency of monetary policy by reducing the overall amount of interest that needs to be paid on reserves in order to implement the appropriate stance”.

Speaking to media, ECB president Christine Lagarde said the central bank had a “public duty” to ensure the implementation of its monetary policy was “as efficient as possible”.

Coming back to the RBNZ, it told Robertson the savings associated with introducing an interest-free threshold wouldn’t be worth the risks.

It estimated if the OCR averaged 4.5 per cent over the next four years, and there was an interest-free threshold across the banking sector at the $5b mark, the Crown would save around $225 million a year.

Most experts the Herald has spoken to agree with the RBNZ.

However, one has raised concerns the large amount of interest income banks are receiving from the RBNZ could be influencing how they set interest rates. In other words, banks could be keeping rates lower than they otherwise would, because they’re receiving so much interest from the RBNZ.

While the matter is in the hands of the RBNZ, Robertson hasn’t tried to get involved beyond asking for information on the matter.

However, earlier this year, he did explore a less technical way of making banks pay more towards the Covid, and now cyclone, recovery efforts.

He sought advice on temporarily taxing excessive bank profits, but walked away from the idea on the back of Treasury’s recommendation.

The Government has since directed the Commerce Commission to do a market study of competition in the banking sector.

Jenée Tibshraeny is the Herald’s Wellington business editor, based in the Parliamentary press gallery. She specialises in government and Reserve Bank policymaking, economics and banking.