Bank of England gilt leverage tweak could cut UK borrowing costs by £1bn

The news

The Bank of England could give Britain's government bond market a boost this week and lower public borrowing costs by more than £1 billion a year, banks say. Barclays has called on the BoE to stop counting banks' holdings of British government bonds, known as gilts, towards a leverage ratio which requires banks to have capital worth somewhat over 3.25% of their assets to help cover any losses. A change here could encourage British banks to hold up to £150 billion more gilts, lower average yields by a fifth of a percentage point and save the government £2.5 billion a year in debt interest at a time of stretched public finances, Barclays said. Some former regulators warn the tweak would increase financial risks.

What's at stake

The leverage ratio requires banks to hold capital worth somewhat over 3.25% of their assets. Exempting gilts from this calculation would free up balance sheet capacity, allowing banks to buy more UK government bonds without needing extra capital. Barclays estimates this could lead to banks holding up to £150 billion more gilts. That extra demand would lower average gilt yields by 0.2 percentage points according to Barclays analysis. The resulting reduction in borrowing costs would ease pressure on UK public finances, which remain stretched after years of elevated debt issuance.

On the other side, former regulators argue that carving out gilts would weaken the overall strength of bank capital rules. The leverage ratio acts as a backstop against excessive leverage across all assets. Removing a major category like gilts could encourage riskier behaviour elsewhere on bank balance sheets. This matters because UK banks hold large volumes of gilts, and any perceived dilution of capital standards might affect market confidence in the sector.

The case for

Excluding gilts from the leverage ratio would encourage banks to buy up to £150 billion more of the bonds. This extra demand would lower average gilt yields by 0.2 percentage points and save the government over £1 billion a year in borrowing costs. Barclays analysis shows the annual saving could reach £2.5 billion at current debt levels. Lower interest payments would directly ease pressure on stretched public finances and reduce the amount of tax revenue needed to service the national debt. Comparable adjustments in other jurisdictions have shown that targeted changes to capital rules can support government bond markets without undermining core stability.

The case against

Exempting gilts from the leverage ratio would weaken bank capital rules by removing a major asset class from the calculation. The 3.25% minimum would then apply to a smaller portion of bank balance sheets, potentially allowing higher overall leverage. Former regulators warn this would increase financial stability risks by diluting the backstop that protects against losses across all assets. In a future stress scenario, banks with thinner effective capital buffers could face greater pressure to sell assets or restrict lending. Maintaining the current treatment of all assets under the leverage ratio preserves a simple and transparent safeguard that has served the system since the post-crisis reforms.

Why it matters now

A decision by the Bank of England this week could quickly unlock additional bank demand for gilts and start lowering yields within months. If the change goes ahead, the government would benefit from reduced debt interest payments in the coming fiscal years when public finances remain tight. If the BoE decides against the tweak, the leverage ratio stays unchanged and banks continue to treat gilts as any other asset. The outcome will shape both the cost of UK government borrowing and the perceived robustness of bank capital standards for years ahead.

Further reading

Reuters

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