rose to move, That the Grand Committee do report to the House that it has considered the Cash Ratio Deposits (Value Bands and Ratios) Order 2008.

The noble Lord said: The purpose of the order is to reduce from 0.15 per cent to 0.11 per cent the ratio that is applied within the cash ratio deposit scheme, which is itself defined in the Bank of England Act 1998. In so doing, it will revoke the Cash Ratio Deposits (Value Bands and Ratios) Order 2004. The ratio applies to eligible liabilities above the £500 million minimum threshold, and this change will benefit all institutions that make such deposits with the Bank. It is estimated that the change will result in a one-off reduction in the amount of cash ratio deposits held of around £700 million.

It may help the Committee if I briefly outline what the cash ratio deposit scheme is. Before 1998, banks maintained cash ratio deposits at the Bank of England on a voluntary basis. As part of the 1998 reforms of the Bank of England, the Government confirmed that they believed it was right that those who benefited from the relevant operations of the Bank should make a financial contribution to its costs. They therefore placed the cash ratio deposit scheme on a statutory footing.

Under Schedule 2 to the Bank of England Act 1998, eligible institutions—broadly, banks and building societies—may be required to place non-interest bearing deposits, known as cash ratio deposits, with the Bank of England. The Bank then invests these deposits and the income earned on them is used to fund its monetary policy and financial stability policy functions. Under Schedule 2(4) the amount that an eligible institution must deposit with the Bank is calculated by multiplying so much of its average liability base as falls into each of the different value bands of the scheme by the ratio applicable to that band, and then taking the sum of those amounts.

The scheme was last reviewed in 2003, and at that time the minimum threshold of the scheme was increased from the figure of £400 million that was set in 1998 to £500 million. This change to the scheme was enacted through the Cash Ratio Deposits (Value Bands and Ratios) Order 2004. As part of the 2003 review, the Government committed to conducting a further review by 2008 at the latest.

The review was conducted last year in consultation with the Bank of England. As part of the review, the Treasury conducted an informal consultation with all institutions currently eligible for the scheme and a formal 12-week consultation. To the former it received 66 responses and to the latter four responses, two of which were from the British Bankers’ Association and the Building Societies Association.

The review reached the following conclusions. The cash ratio deposit scheme continues to be a suitable method of funding the Bank of England’s monetary policy and financial stability operations. The ratio applied to those eligible liabilities above the £500 million threshold should be changed from 0.15 per cent to 0.11 per cent but all other variables should stay the same. As an input to reaching this conclusion, the Court of the Bank of England, which is responsible for ensuring the most efficient use of the Bank’s resources, endorsed as a working assumption for the review an estimate of the costs of the Bank’s policy functions of £563 million over the five-year period, which is based on 2 per cent annual spending growth. The investment yield has been forecast to average 5 per cent over this timeframe, and the future growth of eligible liabilities has been assumed to be 4.5 per cent. Under these assumptions, changing the ratio to 0.11 per cent, while maintaining the minimum threshold at £500 million, would result in forecast income from the CRD scheme of £575 million, which is very close to the £563 million required.

A number of the assumptions made in reaching this conclusion are subject to uncertainty, which is why the Government have committed to keeping the parameters of the scheme under active review. This uncertainty is in part reflected through the outcome of the previous five-year period. The previous review projected that £575 million would be required to fund the policy functions of the Bank but the outcome was only £531 million. This is principally attributable to the Bank of England taking steps to focus on core activities and improve efficiency. In addition, the cash ratio deposit income for the same period was higher than expected, in the region of £613 million, which is mainly as a result of the growth in eligible liabilities being higher than expected.

In the published response to the consultation the Government stated that, subject to parliamentary approval, which this order seeks, they would aim for the change to the ratio to come into force on 2 June this year. Not to meet this date would mean delaying the implementation of this change and for the Bank of England to continue holding a higher level of deposits than it requires. Therefore, I hope that noble Lords will see the merit of the order. I beg to move.

Moved, That the Grand Committee do report to the House that it has considered the Cash Ratio Deposits (Value Bands and Ratios) Order 2008. 17th report from the Joint Committee on Statutory Instruments.—(Lord Davies of Oldham.)

I thank the Minister for introducing the order. I will not give him a lot of trouble on it but I have one or two questions. I was grateful for his clear explanation of cash ratio deposits which are one of the more arcane bits of the Bank of England’s arrangements, representing a compulsory, interest-free deposit by the banking community with the Bank. If CRDs did not exist, clearly the Bank would have to be funded in some other way and since it is not selling any service that anyone would voluntarily buy, the only likely alternatives would be a statutory levy or grant in aid. The rather convenient argument for CRDs is that they enhance the independence of the Bank but the truth is that they avoid explicit and doubtless controversial charging mechanisms or, alternatively, increasing public expenditure.

It is also an especially convenient outcome from CRDs that if they are set at a level which produces a surplus, which they have, the Treasury gets to grab half the surplus as a dividend. The Minister did not mention that in his explanation of the financial system which applies in the Bank of England. So the Treasury has an incentive to set CRD levels at too high a level in order to create a surplus. Indeed, the Bank may well have an incentive to maintain the CRD level because it avoids getting into all those messy discussions with the financial community about what the level of costs should be. The Minister explained that the Treasury did some kind of consultation on the CRD system.

A Division has been called. The Committee stands adjourned for 10 minutes.

[The Sitting was suspended for a Division in the House from 5.24 until 5.34 pm.]

Before I was interrupted, I was talking about the consultation that the Treasury has been carrying out and I was about to remark that there was unsurprising support in that consultation for reducing the ratio to 0.11 per cent because of course any reduction was bound to be supported by the financial community. The summary of responses produced by the Treasury also noted that respondents advocated that either changes should be made to other parameters of the scheme or the CRD scheme should be replaced by alternative arrangements. But it was clear from the consultation document that other changes and alternatives were not at all to the Treasury’s taste and were not pursued. So much for consultation.

I have mentioned that the Bank has achieved surpluses of income over expenditure. As the Minister mentioned, that was due in part to overachievement against the forecasts that were produced when CRDs were last set. The total of the surplus, which I do not think the Minister mentioned, was £100 million. Even after paying quasi-dividends to the Treasury, the Bank increased its retained earnings by around £50 million, which is not a small sum. The Bank’s reserves in its most recent audited accounts to the end of March 2007 stood at around £1.7 billion, and there have to be questions asked about whether the Bank needs to be in such a comfortable financial position. My question, therefore, is: have the Government looked at whether the Bank could operate on a leaner financial basis and reduce the annual call it makes on the financial community via CRDs? I am conscious, however, that the Bank may well have to adjust its activities upwards as a consequence of the Northern Rock failures, where we are clear that the tripartite arrangements, which included the Bank of England, failed at their first real test. While most of the opprobrium is aimed at the FSA, who by the account of its own internal audit department handled Northern Rock very badly, I do not think anyone would pretend that the Bank’s procedures were perfect.

The Treasury’s plans were set out in the financial stability consultation document in January. They included strengthening the Bank of England, although it was not clear precisely what that would involve in practice. To me it is clear that it will not involve doing less and spending less; it is likely to involve doing more and spending more. In addition, the Treasury Select Committee in another place was clear that the Bank rather than the FSA should be in charge of the special resolution regime for failing banks. That is the regime proposed in the document which came out in January. If the Government accept that, it would potentially increase the Bank’s costs still further. Perhaps the Minister would share with the Committee the Government’s current thinking on how the special resolution regime will operate and, indeed, how it will be funded.

Does the Minister believe that the CRD funding scheme is robust enough to cope with future scope changes in the Bank’s activities? Do the Government expect to look again at funding mechanisms or indeed the quantum in the light of the emerging financial stability proposals? If they are doing that, it is rather odd that we are bothering with the order before us.

I am grateful to the noble Baroness and for the benefit informally of the comments of the noble Lord, Lord Newby, on this order, which he is not able to present since he has to be elsewhere. I know that he shares some of the anxieties of the noble Baroness about it. Perhaps I may make the obvious point that of course there is more than one way of funding the Bank of England. Central banks are funded in different ways in different administrations. However, we are basically of the view that the main beneficiaries of the monetary policy and financial stability functions of the Bank should continue to contribute towards it. So we are broadly in favour of the present scheme.

I marked carefully what the noble Baroness had to say. Last time round, the Bank’s actual costs were lower than predicted—the take was higher, as it were, the product was higher—after it had limited its activities more to core activities and improved efficiency. But we live in different times. As the noble Baroness rightly suggested, the Bank may have a more intensive and extensive role to play, which could involve higher costs. Any significant change to the scheme will certainly be considered within the framework of the consultation and the work being done on the banking reform Bill, which is in process, but at this stage, we have had a review of the mechanism, which clearly indicated that the Bank could be operated on a lower impost than had obtained before, which is what the order involves.

Will the forecast position be better then it was last time? Forecasting in this area is always hazardous, as the noble Baroness will recognise. In any case, we have a second all-encompassing and comprehensive look at the role of the Bank and regulation of financial institutions to be contained in the Bill, so those issues will be considered within that framework. For the moment, it is clear that there is a case for adjustment, which is all that the order proposes.

I hear what the noble Baroness says: that the Treasury may have an interest in the surplus, because it receives a percentage of it. The mechanism was not designed to yield surplus but to meet necessary costs. This reduction is against that background. She herself has suggested that that may be an underestimate of the amount of work that the Bank of England has to do. If it were, she would then be saying that the Treasury had made a proposal that was not directly in its interest by being overgenerous about the potential gap between the two. If the Bank of England's costs increase, there will be a reduction for the institutions paying. By definition, the surplus is likely to be more limited.

This is a modest adjustment to a scheme which is viable, which works and which gets the necessary functions of the Bank of England paid for in a way that avoids exactly the issues that the noble Baroness rightly identified would come from any other funding. We propose to continue with the scheme. Of course she is right that there may be a much more extensive revision of the position of the Bank of England in the Bill, on which the Government's conclusions are not yet ready to be made public, which may change the framework of the scheme. For the time being, we must work with the certainties we have, which are that we do not need the same amount of resources from the institutions for the work of the Bank of England as we thought that we did four years ago. That is why the order is here to reduce the levy.

On Question, Motion agreed to.