« June 2018 | Main

July 2018

July 16, 2018

Strengthening the Relationship between the UK Treasury and the Bank of England

Posted by Neeraj Patel[1], Mario Pisani, Nathanaël Benjamin[2] and William Durham

On 21 June 2018, the UK’s Chancellor of the Exchequer and the Governor of the Bank of England unveiled new reforms to the Bank's financial framework, intended to boost transparency, reinforce the Bank’s resilience and independence, and strengthen its capacity to support the financial system.


The Bank of England, or “the Bank” to insiders, is the world’s second oldest central bank. For much of its history, it operated as a private institution, although always acting in the national interest. The UK government nationalised the Bank in 1946, at which point HM Treasury (the UK’s finance ministry) became its sole shareholder.

The Treasury has granted new powers to the Bank over time, from monetary policy independence in 1997 to prudential supervision in recent years. But the financial relationship between the Treasury and the Bank has remained broadly unchanged throughout this period.

Following the financial crisis, the Bank’s own finances have faced two key challenges:

  1. Capital: the Bank’s capital (or equity) has become low relative to the risks and exposures it currently faces, with its capital-to-asset ratio falling as its remit has expanded. The Bank’s total loss-absorbing capital now covers only about 1 percent of its non-indemnified risks. This means that the Bank has limited scope to implement a full range of monetary policy or financial stability tools using its own balance sheet.
  2. Income: The Bank’s principal income sources, derived from investment returns on a sterling bond portfolio, have become more variable in recent years. The Cash Ratio Deposit Scheme, which funds the Bank’s monetary policy and financial stability functions, required the Bank to fix its income and expenditure projections at the beginning of each 5-year period. The increase in the Bank’s responsibilities since 2013, twinned with volatile investment returns, which affect the Bank’s income over this period, have resulted in a mismatch between its income and expenditure.

Affecting both capital and income are the Treasury and Bank’s historic shareholding arrangements, where all the net income from the issuance of Banknotes (seigniorage) is passed directly to the Treasury, and the rest of the Bank’s net profits are shared with the Treasury in the form of dividends. Limited capacity to generate income from new sources means that the Bank cannot readily boost its profits, nor replenish its capital base through retained earnings.

Recognising the case for reform, the Treasury and the Bank worked together to address these twin challenges:

  1. New capital framework: the authorities agreed a new financial framework to make the Bank’s balance sheet, including total loss-absorbing capital, more resilient to shocks. This included, for the first time, a target level of capital for the Bank, based on the risks that the Bank expects to bear on its balance sheet under severe but plausible scenarios. This innovative framework, which will be reviewed every 5 years, injects flexibility into the Bank’s income-sharing arrangements, giving the Bank a mechanism to converge to its capital target organically over time (see chart). This provides certainty that the Treasury stands behind the Bank in the event of a significant capital loss, with a codified process for recapitalising the Bank if needed.
  2. New income arrangements: fixing income and expenditure for a 5-year period created uncertainty on how the Bank’s investment returns on deposits would materialise. Following consultation with market participants, a revised scheme was launched with a variable funding approach, allowing the Bank to review deposit rates every 6 months, and to respond to any changes in the market environment for investment returns.

The Bank of England’s Capital and Income Sharing Framework (Click on the image for a better resolution)

 With the agreement of the Chancellor and Governor, and to support better public transparency, the authorities have published a new Memorandum of Understanding (MOU) between the Treasury and the Bank, setting out the future financial relationship between the authorities.

The MOU includes a set of capital principles that clarify for the first time the types of operations that the Bank will undertake off its balance sheet (backed by its own capital), rather than through seeking a Treasury-backed indemnity as it has done in the past. It also includes better information sharing arrangements between the Bank and the Treasury on the Bank’s financial and capital position.

In June 2018, the Bank’s total loss-absorbing capital stood at £2.3 billion. But stress testing of the Bank’s balance sheet under severe but plausible scenarios implied a target level of capital of £3.5 billion. In a letter to the Governor, the Chancellor noted his intention “to provide a £1.2 billion capital injection from the Exchequer to the Bank’s balance sheet in the 2018-19 financial year”, to return the Bank’s capital to target in a fiscally neutral manner.

In line with the capital principles set out in the MOU, this injection will also enable the Bank to transfer the £127 billion Term Funding Scheme (TFS) onto its own balance sheet, removing the Treasury’s indemnity on this portion of the lending facility.

The Governor explained in his Mansion House speech on June 21 that “The additional capital will significantly increase the amount of liquidity the Bank can provide without needing an indemnity from HM Treasury to more than half a trillion pounds” to meet its monetary policy and financial stability objectives.

As a package, the new arrangements will support a stronger UK economy through a more stable financial system, as well as better transparency, accountability and reporting from the UK’s public institutions Regular reviews of the parameters of the framework will ensure that it is kept up to date in an evolving environment.

And as the Governor remarked in a letter to the Chancellor, by building a balance sheet that is fit for the future, the capital framework “will better align the Bank’s financial resources to its mission”, leading the way internationally for the finance ministry and the central bank to work together.

[1] Debt & Reserves Management team, HM Treasury, United Kingdom

[2] Financial Risk & Resilience Division, Bank of England, United Kingdom

Note: The posts on the IMF PFM Blog should not be reported as representing the views of the IMF. The views expressed are those of the authors and do not necessarily represent those of the IMF or IMF policy.

July 09, 2018

How to Manage the Fiscal Costs of Natural Disasters

Posted by Serhan Cevik, Guohua Huang, and Alexander Tieman[1]

The world is a dangerous place. The frequency and severity of natural disasters, including extreme weather events, have exacerbated across the world over the past few decades, with significant adverse effects on socioeconomic conditions. Myriad studies find negative effects of natural disasters on the fiscal front because of the damage to human and physical capital and post-disaster relief and recovery efforts. Between 1950 and 2015, 40 countries have been hit by a natural disaster that caused economic damage in excess of 10 percent of GDP, while for small island states about one in ten natural disasters involves economic damage of more than 30 percent of GDP (see chart below). 

Natural Disasters: Maximum Damage (Click on the map for a better image resolution)

(Maximum Annual Impact, 1950-2015, in percent of GDP)

Natural disasters present a unique challenge to fiscal management because of their exogenous nature and the potentially overwhelming scale of fiscal costs. They worsen a government’s fiscal position—directly and indirectly—by eroding the revenue base and increasing expenditures on disaster relief, recovery and reconstruction. An example from Japan was discussed in a recent blog article. Without a robust PFM framework governments may face fiscal crisis in the aftermath of natural disasters.

A new paper on “How to Manage the Fiscal Costs of Natural Disasters” has been published by the IMF. The paper focuses on how governments can build fiscal resilience against natural hazards and strengthen fiscal management after a disaster. It discusses both budgeting frameworks and other fiscal policies.

Three questions lie at the center of the fiscal management of natural disasters: How large should fiscal buffers be? How should fiscal buffers be built up? And how should fiscal buffers be used efficiently and transparently once a natural disaster has struck? To address these questions, this paper discusses fiscal strategies for financing the recovery effort – including by building up natural disaster funds - and considers various fiscal approaches for mitigating disaster impact. It also provides guidance on how to conduct regular risk analysis of potential fiscal effects of natural disasters, and outlines best practices in defining and accounting for contingent liabilities related to natural disasters in budgeting frameworks. In addition, approaches for risk reduction, disaster risk financing strategies, and risk transfer mechanisms – such as different insurance instruments – are also discussed in the paper.

[1] Serhan Cevik and Guohua Huang are Senior Economists with the IMF’s Fiscal Affairs Department (FAD). Alexander Tieman is a Deputy Division Chief in the same department.

Note: The posts on the IMF PFM Blog should not be reported as representing the views of the IMF. The views expressed are those of the authors and do not necessarily represent those of the IMF or IMF policy.

July 06, 2018

Tribute to Mario Pessoa by Brazil Eighth International Congress of Accounting, Cost and Public Expenditure Quality


During the course of the 8th Brazil International Congress of Accounting, Costs and Public Expenditure Quality – to be held during August 15 – 17, 2018 in Belo Horizonte, state of Minas Gerais, Brazil (www.congressocq.net) the organizers will pay tribute to our late and greatly missed colleague Mario Pessoa.

Mario was a greater supporter of the accounting and cost initiatives over the Latin America countries, especially in Brazil. We are happy to share a sample of this tribute prepared by his friends and colleagues ahead of the Congress here

 From FAD staff, we are very grateful for this tribute to Mario.  

July 05, 2018

Gender Budgeting in South Asia

ThinkstockPhotos-618067068_Horizontal (002)
Posted by Teresa Curristine[1] and Udaya Pant[2]

The first IMF Asian regional workshop on gender budgeting (GB) was held in India in March 2018. Twenty-eight delegates from ten Asian countries participated (Bangladesh, Bhutan, Korea India, Indonesia, Maldives, Nepal, Philippines Sri Lanka and Thailand) as well as representatives from six Indian states. The workshop brought together representatives of ministries of finance, ministries of women, and spending ministries. It was organized by the IMF’s South Asia Regional Training and Technical Assistance Center (SARTTAC) and its Fiscal Affairs Department (FAD) in collaboration with the Fund’s Technical Assistance Office in Thailand (TAOLAM) and the UN Women’s India Office.

Continue reading " Gender Budgeting in South Asia " »

Back to top of page
©2007 IMF. All Rights Reserved. About Us | Terms of Use