Can the ‘bank tax’ be the final answer for preventing banks from failing?
2010/04/28 5 Comments
Many people agree that the global financial crisis was caused by growth competition among banks, which led them to invest risky derivative products to make more profits. In line with this view, many governments, such as the U.S., the U.K., Germany, France and Sweden, as well as the International Monetary Fund (IMF) are trying to introduce the ‘bank-tax’ to global finance system expecting to collect bail-out money for the means controlling and regulating financial institutions, especially the huge banks. In G-20 Finance Ministers meeting, which was held on 23rd of April in Washington D.C, adapting the ‘bank tax’ to financial companies was discussed as the main agenda and the IMF submitted reports about what kind of method of levying banks would be most appropriate and acceptable world wide.
Four mainly considered ways of taxing banks
Currently, four main methods of charging tax to banks are considered and researched by the IMF. The four techniques are:
- Balance Sheet Tax;
- Excess Profits Tax;
- Financial Trading Tax; and
- Insurance Levy.
Let’s look through briefly about those methods.
The first method is ‘Balance Sheet Tax’. It is that a government charges a fixed ratio of taxes in terms of its level of assets or liabilities of each financial institution. The U.S. government and many other countries are positively considering using this method since it is considered as effective way of keeping under control of increasing banks’ assets and liabilities. The purpose of charging taxes for assets is a kind of burden of risks, particularly big banks because if they fail, the consequences will be substantial. Also the reason for taxing liabilities, mainly on non-deposit except long-term stable fund: is to restrain the unreasonable attempts to fund capital from borrowings.
The second one is ‘Excess Profits Tax’, which was proposed by Strauss-Kahn, the managing director of IMF. It is considered as the most efficient way of recollecting the bailout money, because it does not affect the bank’s operational strategy and prohibits moral hazard. However, it is realistically hard to measure the excess profit of banks, also there is a likelihood of negative effects to bank’s efforts of making profits.
The third one is ‘Financial Trading Tax’; also known as ‘Tobin tax’, which is mostly favored by some European countries. It charges for foreign currency trading or a certain financial transactions to prevent the flowing of short-term investment. However, it is an unrealistic way since it is difficult to monitor and charge everyday financial transactions. Also there is a possibility of distorting the flow of funds to escape the fees because of these reasons, the IMF and the U.S. and Canadian governments have negative attitudes toward this method.
The last one is ‘Insurance Levy’. It charges banks a compulsory amount of insurance fee, which is similar to the current deposit-protection rule. But this method is not welcomed by the IMF and to many governments because of the chance of incurring unfair competitive gains and the moral hazard of investing in higher-risk products to cover the insurance tax.
Prospects for bank tax
It is expected that the ‘Balance Sheet Tax’ will be the main plan chosen by the IMF and many other governments. However, there is a big difference in the view of the bank tax not only between developed countries and developing countries, but also the interests of each country. Especially, the Canadian government who is the host of June G-20 meeting, has strong objection to bank levy since they didn’t go through a serious financial crisis. Hence, it is likely to take more time to make globally accepted agreement.
Possible side-effects of introducing bank tax
The profits of banks are expected to be affected banks directly. Morgan Stanley expects that introducing bank tax will affect the EPS by decreasing it 3 to 6 % during 2010 – 12 to the U.S. and European banks. Also, there is a likelihood of reducing loans to public because of decreasing risky assets investment. This might have negative effect on the improvement of banks’ corporate governance and the economic recovery process. On the other hand, banks can invest to more risky assets to recover their profit reduction and to pay for the taxes. Moreover, banks can transfer the service cost to customers to share the burden of taxes with customers.
Alternative approach in changing the internal problem of banks
Banks are not just a company, which operates for making profits. They are the substantial components of one country’s economic system. So they need to be safely operated with social responsibility. However, managers and directors have been trying to pursue a short-term achievement for their remunerations, such as unimaginably high salaries or stock options etc. For these reasons, banks lacked in long-term strategic planning, which leads them to poor risk management. Also, the managers and directors’ social responsibility and ethical behavior needs to be refined. Therefore, a long-term strategic management planning and directors/managers who have socially responsible minds will be required.
Can the ‘Bank tax’ be the final answer for preventing banks from failing?
The purpose of trying to introduce the ‘bank tax’ is to be prepared for any future financial crises. Many governments and the IMF recognize the current crisis is caused by the huge banks’ aggressive investment to risky assets and derivatives also funding capital by increasing liabilities. So they charge tax on banks’ level of assets or liabilities on their balance sheets to achieve a control of banks and to restrain their operational strategies. Also, for enhancing the stability of banks’ activities, it is considered necessary to improve banks’ internal management system by restructuring corporate governance, long-term strategic operation plan, and the directors/managers’ socially responsible minds. However, it is still a controversial issue because each country’s benefit will be affected differently by adopting the ‘bank tax’. Therefore, global consensus, which should be a generally accepted agreement, must be reached during the upcoming G-20 meetings and as the host of 2010 G-20 meeting, Korea is required to wisely negotiate different opinions between developed and developing countries.
So do you still think that the ‘bank-tax’ can be the final answer for preventing banks from failing?
How do you think about this issue?