Pre-Summit Bank Levy Proposals to Increase Cost of Banking

June 29, 2010 No Comments »

The turbulent month of May is behind us.  June has brought calm, but continued hand wrangling by government finance officials in Europe, the U.K. and the U.S. threatens to prolong the market uncertainty rather than deal with the real problems.  The latest round of public pronouncements suggest that bank levies are necessary to create a bail out pool of funds, ostensibly to shield such costs from having to be funded directly by taxpayers.  Since banks are merely conduits for the flow of capital, increased capital costs will eventually find their way to the retail side of banking.  Indirect funding by taxpayers must be acceptable in the latest government playbook.

Some news analysts are describing these latest antics as posturing before the G20 summit meetings this weekend in Toronto.  Officials always want to look and sound good when the cameras are rolling.  The new conservative leadership in Great Britain has been the most vocal about the levies since campaign promises hang in the balance.  The U.K. recently levied a one-time 50% tax on all discretionary bonuses paid by banks and collected £2.5 billion in the process.  According to budget papers, the new levies would start at £1.1 billion and rise in three years to £2.4 billion.

French and German banks have said they would support the levy system in their markets and bring the Eurozone along with them.  Proposals in the United States, twice the rate level in Great Britain, are currently tied up in the Senate awaiting approval.  However, not all banks are buying into the concept.  Notable exceptions are Canada, Japan, Australia and Switzerland.  Banks have already suggested that they would migrate activities, from global lending to Forex, away from taxing territories and favor exception countries with the their business.

The proposed levies would be applied to a bank’s balance sheet with a formula designed to exclude government securities and Tier 1 capital for the bank.  At this point, proposed legislation has had difficulty defining exactly what a bank is.  The intent is to include investment banks like Goldman Sachs.  Goldman paid $600 million in the one-time bonus tax and believes the new levy will approximate $100 million or about 1% of turnover.

Reactions from banking associations and their supporters were swift and predictable.  The private sector will have less access to credit and banks will be less competitive were the common themes.  One trade association executive remarked, “It is important to recognize that it is effective regulation, not taxation, that will help to prevent a future crisis. This tax is not a substitute for effective regulation.”

A more specific assessment of the economic impact was forthcoming from KPMG, a major audit firm with many banking clients, “The major UK banks will have to pay for the tax somehow and that will likely feed into a higher cost of borrowing for their clients, probably at the lower end of the scale. Mortgage borrowers, as well as retail and small corporate borrowers may be the worst hit.”

Levy proposals range from 4 to 15 basis points in some cases.  After adjusting for balance sheet exceptions, the resulting cost of capital increase may require a much higher cost allocation for new loans on the books. Banks would be prevented by contract from passing the levies down to all current borrowers.  Implementation issues cloud what the actual impacts would be on a loan-by-loan basis, but the assumption that loan costs will rise is inescapable. And this does not bode well for interest rates paid out by the bank for CDs, savings accounts, and money market accounts.

The new ruling government in the U.K. is not done with the banking sector.  Fresh from the victory of their bonus tax collections, officials admit that they are exploring additional “Finance Activity Taxes” on banking bonuses and profits.  However, they are quick to point out that they will not make these moves with agreement from their international partners.  Perhaps, these new conservatives understand competition after all, or they may be preparing their excuses in advance.

These new proposals may be nothing more than political rhetoric for the moment.  No one has mentioned the real issue in the developed economies of the world.  How do they plan to stimulate growth and employment in their respective domestic economies?  This “elephant in the room” will not go away.  Dealing with budget deficits always garners approval rating points, but conservatives have always stated that new taxes are no way to end a recovery or rebuild the labor pool.

Hopefully, some good will come from the G20 summit meetings, photo ops aside.  The United States has lost 8.8 million jobs over this recession, and it will take a long time to get those jobs back.  Banks need to be Banks again by loaning funds to small and medium size businesses to create new jobs.  New taxes only get in the way of that objective.

Bi line: Tom Cleveland is a market analyst for forex traders, and online resource for news on global markets and forex.

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