Bank taxation
To Bank Levy or Not To Bank Levy

Lida Preyma, Director, Capital Markets Research, G20 Research Group, University of Toronto

Revue Banque, November 29, 2010. Reprinted with permission.

Banks are commonly designated as faultives in triggering the financial crisis in 2008. Hence the idea that banks must pay, either for its consequences or to prevent other difficult times. Even if the global goal is widely shared, each country has taken its own tools to implement new measures for the industry.

To bank levy or not to bank levy – that has been the question ever since Alistair Darling, then chancellor of the exchequer, levied a onetime tax on British banker bonuses late in 2009 and a permanent levy was later proposed by U.S. president Barack Obama in January 2010 in order to recover some of the costs of bailing out banks and financial institutions. For the United Kingdom, the idea was to raise £550 million. The US proposal would place a 0.15% levy on financial institutions with at least $10 billion in assets to raise $90 billion. Since then, the idea of a bank levy has been brought forward time and again by different leaders in different parts of the world to differing degrees of success.

A worldwide issue

On April 16, 2010, the International Monetary Fund (IMF) proposed a bank levy as one of three options when it submitted its requested recommendations to the G20 leaders on how the financial sector could make a fair and substantial contribution toward any burdens associated with government bailouts. This led to a firestorm of activity by world leaders in the leadup to the Toronto G20 Summit in June 2010 and proved to be a highly divisive issue. Extensive lobbying on both sides led to an agreement first to take it off the table and then to readdress it on the eve of the summit. Germany, France, Britain and the European Union were the loudest advocates, stating that they would proceed with a bank levy even if consensus was not reached. Canada, Australia, Russia, China and India held steadfast against it. China and India took the view that because the crisis was created by the advanced economies it should be those countries' problem to solve; Russia predicted a levy would negatively affect the accessibility of loans and other services. Canada, where the banking system had remained stable throughout the crisis due to higher capital requirements and stricter regulation, took the position that moral hazard would result from banks taking increased risks because of assured bailouts if necessary. At the end of the Toronto Summit, the only outcome was that it would be left to individual countries.

In July 2010, the DoddFrank Wall Street Reform and Consumer Protection Act was passed by the US Congress only because the levy was taken out of the legislation. With all the new regulation that was going to come from the act, it was seen as an extra burden to financial institutions that would prove too costly to impose all at once and would hamper the economic recovery as costs would be passed on to consumers and borrowing would dry up. At the same time in Europe, levies began to receive greater support from several leaders who planned to put levies in place even without the support of all the G20 countries. With this came the increased risk of capital movement as institutions found doing business in some jurisdictions more costly than in others.

Many initiatives in Europe

The EU finance ministers met in Brussels on September 7, 2010, to discuss a range of topics including a bank levy and transaction tax. Proponents asserted that these measures would help curb risk taking and, more importantly, prevent the use of taxpayer money for bailouts should the first reasoning not be enough and in the end, the finance ministers failed to agree. The transaction tax discussions focused on a levy either on share or bond purchases or on bank profits and compensation. Consequently, no nearterm solution is in the works. No agreement was reached on the bank levy either. The EU would like a levy based on the size of banks' balance sheets with the proceeds going into a joint European fund. However, Britain, France, Germany, Hungary and Sweden had already begun to formulate their own national bank levies, with proceeds going to national funds. This nonuniform regulation has raised fears of regulatory arbitrage where banks move their operations within the EU to those countries that do not have a bank levy. The EU governments hope to reach a deal on the bank levy issue by the end of 2010.

In October, the British government announced draft legislation for a bank levy to be imposed on UK banks and UK subsidiaries of foreign banks to take effect January 1, 2011. First introduced during the emergency budget in June 2010, the government consulted industry over the summer to ensure it imposed the maximum tax possible without seeing banks flee to other jurisdictions. The government hopes to raise £2.5 billion annually by 2013 from the levy, which it feels will constitute a fair contribution by the banks to the stability of the financial system. By imposing a varying levy on different types of assets, it also hopes to encourage banks to hold less risky and longer termed assets. Upcoming corporate tax cuts will likely ease the burden on the banks and a change in the definition of a banking group ensures that insurance companies and other similar groups with business activity that is more than 50% nonfinancial are not charged the new levy.

The European Commission still supports a global bank tax, although consensus among the member states is far from close. Perhaps in an effort to gain traction, the European Commission changed its rhetoric about the use of the funds raised by any such tax to support global policies such as development and climate change.

A bone of contention in G20 discussions

It will be hard to reach agreement on the bank levy from other G20 countries since many member countries did not need to bail out their banks during the recent financial crisis and therefore do not feel the need to impose a levy. Canadian finance minister Jim Flaherty, who has been the leading opponent of a bank levy, gave his reasoning in the leadup to the G20 Summit in Seoul on November 11-12, 2010. "I do not support a global bank tax in any of the various forms in which it has been advanced for several reasons," he said. "First of all, such a tax would be passed on to customers by banks as a cost of doing business. It makes no sense to impose this tax on people who did not cause the crisis. Second, some countries, like Canada, have wellregulated and wellmanaged financial institutions. Once again, it makes no sense to impose a new tax on institutions which performed well. Third, it has been proposed that the funds obtained by a global bank tax be set aside for use in a future crisis. My experience in government tells me that governments tend to use funds for what are viewed as immediate needs. This is true particularly of governments with high debt and deficits. There is good reason to doubt that these funds would be available at the time of a future crisis. Finally, a global bank tax does not address the causes of the crisis, in particular, inadequate quality and quantity of capital standards and excessive leverage. These issues have been addressed now by financial sector reform, a great G20 success story."

In the month prior to the Seoul Summit, exchange rates and external imbalances took centre stage. With no agreement on bank levies, and perhaps no time to hash them out with a long agenda and little time, the Leaders' Declaration relegated bank levies to being simply a national option for dealing with the systemically important financial institutions (SIFIs) and globally systemic financial institutions (G-SIFIs), once again leaving the choice to the individual countries. The biggest challenge will be for the European Commission, which is looking to impose an EUwide levy. With individual countries within the EU already deciding whether to impose a levy, and with regulatory arbitrage a realistic concern and North American markets that are not on the fast track to impose a levy any time soon – if at all – the question of whether to bank levy or not to bank levy may already have its answer.