Nigel Farage’s dangerous proposal on central-bank reserves

At Davos last month Nigel Farage was in his usual pugilistic form. Asked about his proposal to stop paying interest on reserves held at the Bank of England, the populist-right leader of Reform UK was unapologetic. “Some of the banks won’t like it,” Mr Farage said, “Well, I don’t like the banks very much because they debanked me.” This mix of spite and disdain was vintage Farage. Yet the policy has surprising allies, from left-wing Greens to centrist Liberal Democrats. Even two former deputy governors of the Bank of England have backed versions of it.

Mr Farage argues that these interest payments are “free money” for banks. In 2024 his party claimed that stopping them could save the government £35bn a year ($45bn, about 1% of GDP). The idea may sound less reckless than some of Reform’s other proposals, like permanently enforcing net-zero immigration. But closer inspection shows it to be fiscal fool’s gold: the sums are overstated, the damage to central-bank independence real and there are more efficient ways to tax bank profits.

In the past deposits held at the central bank, known as reserves, earned no interest. This incentivised commercial banks to minimise their balances, keeping just enough to settle daily payments. The bank itself kept the supply of reserves scarce, exploiting commercial banks’ fear of ending the day short to ensure they lent to each other at rates close to the bank’s policy rate. Scarcity, however, created volatility, with interest rates periodically spiking when banks misjudged their needs.

To reduce these fluctuations, in 2006 the bank began paying interest on reserves, to encourage banks to hold more. In 2009 it started buying industrial quantities of government bonds through “quantitative easing” (QE), lowering long-term interest rates and stimulating demand. It paid for these by creating reserves, which rose from £20bn in 2007 to a peak of £978bn in 2022 (see chart 1). Market interest rates could no longer be influenced through reserve scarcity. Instead, the bank anchored them through the rate paid on reserves, as no bank would lend overnight for less than it could earn, risk-free, from the central bank.

QE left the government’s coffers exposed to changes in interest rates. Until 2022 this was lucrative, as interest earned by the bank on bonds exceeded interest paid on reserves. But when rates soared post-pandemic, these profits turned to losses, which averaged nearly £1bn a month in 2025-26 (see chart 2). It is these losses that angered Mr Farage, prompting his call for a return to the good old days of unpaid reserves.

In theory, abolishing interest on all reserves in 2024—when they exceeded £750bn and rates were above 5%—might have raised about £35bn. But the rate paid on reserves has fallen to 3.75%, markets expect further declines and QE-related reserves are likely to fall below £300bn by 2030. At that point the policy would probably raise only around £10bn a year.

Even that assumes an implausibly radical approach: paying zero interest on all reserves, which would cripple the bank’s ability to steer rates. To avoid this, some proponents favour “tiered remuneration”, under which only a small slice of a commercial bank’s reserves—say the last 5%—earns interest. By anchoring lending decisions to that marginal rate, the bank would retain control over rates while leaving most reserves unpaid. The European Central Bank uses this system, but leaves only a small fraction of reserves unremunerated.

Yet tiered remuneration doesn’t solve two other problems. The first is the threat to central-bank independence. Unremunerated reserves would, in effect, become interest-free debt—fiscal catnip for a government short of cash. This could lead to governments leaning heavily on the bank to run large future QE programmes that replace gilts, on which interest must be paid, with zero-yielding central-bank money. Over time, this would subordinate fighting inflation to funding the government, increasing the risks of rapidly rising prices.

The policy’s second problem is its harm to consumers. If most reserves paid no interest, banks would seek to minimise their reserve holdings once more. Preventing this while maintaining the ability to influence market interest rates would require mandating banks to hold more reserves than they want—in effect a tax, since it compels them to forgo income from loans.

Proponents of the tax say banks could absorb the losses through lower profits. Britain’s four largest banks made £46bn in profit in 2024, up from £31bn in 2022. But if that’s excessive, it implies a lack of competition, with little to stop banks passing the tax on to consumers through lower savings rates and higher borrowing costs. So the policy would be a tax not just on banks but also on bank users. And it would be arbitrary, changing in severity depending on interest rates and reserve size.

If Mr Farage wants to raise taxes on bank profits, there are easier ways to do it. He could increase the existing corporation-tax surcharge on banks, which targets profits directly without threatening central-bank independence. This would be cleaner, but would tear him away from his oddly broad coalition of populists and technocrats. Such cross-party consensus is rare for Mr Farage. It is a pity that it has formed around a bad idea.■