A smart way to force banks to pass on higher interest rates

WHEN official interest rates rise, as they have relentlessly during the past year, borrowers are typically punished much more quickly than savers are rewarded. This leads to accusations of profiteering by banks when their net interest margins balloon. For once, governments have come up with a way of using market forces rather than the blunt instrument of regulation to force financial institutions to increase their savings rates.

(NS&I), the UK state-owned savings bank, is offering paying 6.2%, the highest interest rate available since the institution took over government-backed savings programs in 2008. Not only is this more than the 6% from some smaller commercial lenders, it’s also government guaranteed. By offering nearly a full percentage point more than the current Bank of England rate, it doesn’t get much better for income-starved savers who don’t require instant access.

has also sold longer-term retail savings bonds this year, with its Prime Minister Alexander De Croo stating that the nation’s banks will be forced to “ for savers. Italy has long offered a wide range of government bonds targeting retail investors with tax benefits. Muscling into the savings marketplace by governments with burgeoning borrowing needs might just catch on, employing competitive carrots rather than regulatory sticks.

The UK annual savings ratio, which measures the amount households retain of their disposable income after consumption, soared to more than 20% during the pandemic. It’s still at an elevated level compared with the long years when official rates were stuck close to zero. The Office for National Statistics estimates Britons accumulated £200 billion ($250 billion) of excess savings during lockdowns. While that will be reduced during the current cost-of-living crisis, it’s clear there is plenty of money kicking about. The question is who gets to it first?

Retail savings in private financial institutions are only assured by the UK deposit guarantee program up to £85,000. These latest NS&I offerings are available from a minimum of £500 up to £1 million — so it’s aimed squarely at bread-and-butter savers. It’s a bold move that steps right on the toes of recalcitrant banks and building societies (the UK equivalent of savings and loans companies). The only catch is likely to be reduced allocations, NS&I will undoubtedly have to cap this deal as it will be hugely oversubscribed. It might prove easier to get Taylor Swift tickets than park a million pounds risk-free and earn more than 6%. But that’s a good thing: There ought to be limits on how much of the savings pool the state can capture from the marketplace, to prevent crowding out by unfair competition.

Typically, NS&I is careful to position its offerings in the middle of the pack to not compete too directly with mainstream lenders, but facing the largest government financing needs on record, the UK Treasury is keen to pursue all options. This rate on this latest bond is more than 100 basis points above its prior offer. NS&I has a target of raising £7.5 billion this year, though it will as it did last year. It has also increased rates for existing longer-term savers, which reduces the of potentially lower rates when current deals expire. The message is: Invest with the state and you’ll get preferential rates for longer. Parking government tanks on the banking sector’s lawn will undoubtedly cause some gnashing of teeth in the finance industry.

Nonetheless, with inflation running at 6.8%, the offer remains shy of a positive real return. Furthermore, for higher-rate taxpayers a is buying UK government bonds that trade below their face value. But for most savers, this is a welcome respite from the long years of nugatory interest income on savings.

How to encourage banks to act fairly — when consumers are struggling with much higher prices — is troubling all around Europe. Italy recently adopted a windfall tax on its banks’ excess profits, in line with several other nations. The UK has long had a banking surcharge rate, which was reduced to 3% from 8% in April. The Bank of England pays interest on the reserves that commercial banks have to leave with it at the official rate of 5.25%. In an alternative approach, the European Central Bank will no longer pay interest on those reserves from Sept. 20, after a decade of subsidizing banks heavily. So there are many differences in how banks are taxed, regulated, and able to compete; it’s the overall mix that matters.

Is it really better to claw back windfall bank taxes into the state’s coffers, or to introduce rules that force banks to narrow the gap between savings and borrowing rates? Such government intervention is fraught with unintended consequences. Equally, there are anti-competitive risks if the state crowds out challenger banks and smaller players. There’s no simple solution — but a little bit of healthy competition can go a long way. It’s fair to say that a warning bell has been sounded to institutions managing consumer money: Up your game, or the government will steal your lunch.

BLOOMBERG OPINION