Can the ‘bank tax’ be the final answer for preventing banks from failing?

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?

How will the ‘Free-bond’ system affect the Korean external bond market?

More than 90% of domestic bonds have been traded on the external market, but there has been no formalized trading system they are usually dealing via private messengers or a home trading system (HTS). Buying and selling through messengers or HTS has the competitive advantage over the dealing via phone such as fast transaction time, however, there is a structural problem that is difficult to adapt to the needs of market for participants. For this reason, Korea’s Financial Services Commission announced the ‘Reformation of bond trading market’, which is mainly about the establishing of the specialized bond trading system, on last October.

Building the system

Korea Financial Investment Association (KOFIA) has been listening the needs of the market from a variety of experts to set up the ‘Free-bond’, which is specialized bond trading system. It had been developed for 5 months to implement BQS to external bond trading market and had simulated the system for 2 month (February and March) to improve the stability and friendliness to market of new developed system.

From 1st of April, ‘Free-bond’ system has been officially operated and it consists of two main components: trading board and messenger.

User Perspective

The new formatted messenger and chatting room services are expected to provide users convenience in exchanging information about price and market circumstances of bonds. Also, the new system will increase the specialty in trading bonds by restricting users to only who works for bond trading in financial institutions. Moreover, the problem caused by private messengers such as errors and hacking believe to be solved and it will increase the security and stability of the system.

Market Perspective

Free-bond’ will make the pricing process more clearly, which will reduce the difference between the actual and intrinsic value of bonds. It is expected to reduce the transaction costs and it might increase the volume of bond trading. The increase in volume will support the market to be able to introduce variety of bonds related derivatives and this will offer the different kinds of investment opportunities to the investors.

Regulatory Perspective

The ‘Operations of Finance and Investment Institutions’ Act was reformed to control and operate ‘Free-bond’ system more effectively and efficiently. This will improve the completeness and competitiveness of bond market.

Expected Future Outcome

Currently, ‘Free-bond’ system is not linked to electronic transaction process, so KOFIA is planning to connect their new system to Korea Security Depository (KSD), which will allow people to make authorized transactions electronically. Introducing and settlement of the ‘Free-bond’ system will play an important role when Korea joins the World Government Bond Index (WGBI). It will increase the efficiency of bond transactions and the level of access to information. Also, it will strengthen the connection between Korean and developed countries’ bond markets, which is expected to attract the foreign investment to the bond market.

How Korean companies will be affected by adopting IFRS

 

Over 100 countries around the world either have adopted or will adopt the International Financial Reporting Standard (IFRS).  In line with this global trend, Korea announced its own roadmap for convergence with IFRS in March 2007 in order to reform its local capital markets and enhance transparency in financial reporting. 

At the end of 2007, the Korean International Financial Reporting Standards (K-IFRS) was released. The K-IFRS are a word-for-word translation of the full IFRS issued by the International Accounting Standards Board (IASB) and will become mandatory for Korean listed companies with asset over 2 trillion won, from 2011, with voluntary early adoption for all companies from 2009 except financial institutions. However, companies, of which asset is less than 2 trillion won, is allowed to keep their current accounting system until 2013. 

What has changed?

Revaluation of assets 

One of the main changes incurred by introducing IFRS is that unlike K-GAAP, K-IFRS generally uses historical cost, but intangible assets, property, plant and equipment (PPE) an investment property may be revalued to fair value. Derivatives and certain other financial instruments and biological assets are also revalued to fair value. Because of these changes, if revaluation makes profit, companies are able to expect to a decrease in liabilities. Therefore, companies owning many of fine tangible assets such as land, buildings are expected to get benefits by adopting IFRS to their current accounting system and it will make their books more attractive. 

Changes in the recognition of A/C Receivables 

However, under IFRS, accounts receivables are recognized as liability to the companies until the actual cash inflow occurs. For example, construction and shipbuilding companies were able to recognize certain percentage of their completeness of works as sales or revenue, but from next year, those receivables are only recognized when the actual cash inflows are incurred and works are completed. Therefore, companies in those industries are likely to have more liabilities than current accounting system on their books. 

Combined financial statements 

After adopting IFRS, the balance sheet and income statements are reported as consolidated statements quarterly. By implementing worldwide used of a single set of high quality financial reporting standard, it is expected easier to compare domestic and foreign companies that mainly use consolidated financial statements. Also, it will not be necessary for companies to duplicate similar external financial statements; hence it will reduce the costs and time of making two types of financial statements. 

Increase in the amount of notes 

From 2009, 11 domestic companies tested the external financial statements by IFRS, 50 ~ 60% of accounts were resulted to reduce but notes were increased twice than before, since IFRS recommend to simplify the accounts and make notes for further explanation. Simplified financial statements might cause the confusion when the external users interpret the financial statement. Companies need to be clear when they make notes on their financial statements, also external users will be needed to look reports more carefully. 

Need IFRS experts

When the whole adoption is completed, it is expected that companies demand IFRS experts for more efficient work process. Also, external auditing companies and financial regulators will require IFRS experts. To meet these demands, Korea will need professional and systematic training system for the current and future accountant. 

Supports from Financial Services Commission

For smooth adoption of IFRS, Korean companies will need stable finance/accounting regulatory system. Financial Services Commission (FSC) helps them by making and exercising those regulations. FSC made and run IFRS consulting team, which consists of worldwide renowned professional and IFRS experts. FSC is also running task force team that helps IFRS adoption and settlement. FSC is also supporting relatively small companies, of which asset is less than 2 trillion won, by considering their current situations and allowing them to adopt IFRS until 2013 because cost of changing accounting system is too demanding for those companies. Under those supports, by using K-IFRS, Korean companies are expected to get benefits, as more capital will be gathered from investors around the world. 

by Taewon Jang (taewon.jang83@gmail.com)