QE Reserves: Why UK Banks Are Getting Paid 4.5% on Money Created from Thin Air

The government needs funds for a project, so it instructs the Treasury to issue a *£1M bond* that pays *2% interest annually* and matures in 10 years. NatWest takes Alice’s money and buys this bond.

The Bank of England decides banks should hold more liquid assets. However, interest rates are already very low and can’t be reduced further. Still, they want to encourage liquidity in banks.

So, they introduce the concept of *QE (Quantitative Easing) reserves*.

Here’s how it works: The Bank of England credits NatWest’s account with *£1M in reserves* and uses that money to buy the bond NatWest holds. Effectively, NatWest sells the bond to the Bank of England in exchange for £1M in reserves.

These reserves function like a form of secondary money that can only be exchanged between banks and can never leave the Bank of England’s system.

Because the Bank of England controls monetary policy, they simply type `+£1,000,000` in their system, and voilà — *£1M is created out of thin air*.

To encourage banks to keep their money in reserve form, the Bank of England pays them *5% interest* on these reserves.

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### The 2009 Indemnity Agreement

Per the 2009 indemnity agreement, the Treasury committed to cover any losses the Bank of England incurs from creating these QE reserves.

So, the Bank of England holds a *£1M bond paying 2% interest* but must pay NatWest *5% on the £1M reserves*. This results in a *3% loss* on that £1M for the Bank of England.

The government steps in and raises taxes to cover this loss — about *£30k* in this simplified example (in reality, taxes cover billions lost on hundreds of billions of QE reserves).

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Next, Alice wants to buy a house and asks NatWest to transfer *£1M to Bob*. Before QE, NatWest might have struggled with liquidity since bonds aren’t easy to quickly convert into cash. But now, NatWest holds reserves instead of bonds.

So, NatWest simply instructs the Bank of England to move *£1M in reserves from NatWest’s account to Barclays*. The money never leaves the Bank of England’s ledger, but it’s instantly liquid, and Alice’s transaction goes through smoothly.

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### Why this feels like a double whammy for Brits:

The reason bonds pay *2%* is that you give up control of your money for a fixed period. But here, banks receive *5% on reserves* and still have full liquidity to use that money for transactions. That sounds like interest generated out of thin air — banks are getting paid just for holding money, not for actually working or lending it.

Meanwhile, Alice and Bob don’t realize that by depositing their life savings in banks, they indirectly fund a tax increase. This tax covers the government’s payments of 5% interest to banks on the QE reserves that originate from Alice’s and Bob’s money.

On top of that, this extra liquidity drives inflation, squeezing Alice and Bob from both sides — through higher taxes and reduced purchasing power.

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### Closing thoughts:

*You either have liquidity or you earn interest. If you have both simultaneously, someone else is footing the bill.*

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### Bonus:

Look at recent UK bank earnings reports — much of their profit is fueled by interest on QE reserves. It’s eye-watering.