Monday, April 5, 2010

Global bank levy I

Problem: taxpayer funded bail-outs (or private gains and social losses; or bank “pollution”)

Proposed Solution: Countries would impose a bank levy to recover past and future bail-out monies. It may be charged on banks, insurance companies, PE and hedge funds, depending on local preference. Could be applied to ‘risky activities’ as in the US by wholesale funding, or on turnover, profit or remuneration. Currently under discussion in the US, Germany, France and the UK, with implementation possible in other G20 countries.

Benefits: Repays bail-out money to the taxpayer. Helps restore public finances. Pays for future bail-outs in advance. Changes banks’ social and economic contract with society. Promotes social and financial stability by reducing excess bank profits. Could reduce systemic risk if levied on wholesale funding. Could address bonus culture if levied on remuneration. Incentive for banks to self-regulate if levy is set according to peer group risk levels, or banks’ individual systemic importance. Could lead to voluntary structural reform (eg narrow banking) by penalising bank holding companies. Could lead to international cooperation in other areas of financial reform.

Disadvantages: Only recovers a portion of public losses as it excludes GDP costs of recession. Slows down the rebuilding of bank balance sheets and their ability to lend. Worsens moral hazard by making the public guarantee explicit. Easy to pass through to bank customers and shareholders. Implementation could favour bigger banks and discourage new entrants to the industry. Needs agreement on what constitutes systemic importance or risky activity. Needs agreement on whether the purpose is to raise revenue or change behaviour. Encourages regulatory arbitrage between countries. Does not address rentier behaviour or agent/principal problems. Dissipates the momentum for structural reform of finance.

Suggestion: Implement primarily as a revenue-raising measure with a sunset clause after ten years. Separate the levy entirely from structural reforms, to avoid wasting political momentum, but leave it as a bargaining chip against the bank lobby for structural reform if needed. Implement with resolution and recovery regimes (living wills) to contain moral hazard, and with a competition review to minimise pass-through to customers and shareholders. Implement unilaterally with scope for subsequent coordination with other countries.

The election has turned the global bank levy into a marketing gimmick for politicians. No one opposes the levy, not even banks, so instead, the Tories and Lib Dems are busy differentiating themselves from Labour by whether they go ahead internationally or unilaterally.

Don’t be taken in. Just as the implementation distracts from real policy differences between the parties, so the levy itself distracts from real structural reform in financial services. The starting point is to ask what this measure, one of the few to gain international momentum, is meant to achieve.

As a standalone measure it could serve several purposes: repayment of bail-out money a la Obama, retribution for the crisis, reform to avoid another, or insurance in case it doesn’t. So far there’s little sign of agreement on what exactly a levy would achieve.

If it is just to recover bail-out money, then it will be very modest. The bail-outs were big numbers but small in national accounting terms, dwarfed by the structural budget deficit. Add to that the GDP losses from recession and the levy looks like a drop in the ocean. Make it bigger? Sure, but that will worsen the trade-off between rebuilding capital reserves and lending to the economy, as the BBA will no doubt point out.

If it’s for retribution, it could be short-sighted. Reformers need time and the public on their side to beat the banking lobby. Momentum for reform is too precious to squander on election promises. There might be some symbolic value in marking Gordon Brown’s idea of a new social and economic contract between banks and society (an idea with cross-party appeal), but if the levy claims to be about justice then it is on slippery ground from the start. Not all banks caused the crisis or benefitted from the bail-outs; plenty of bail out money in the US went to the motor and mortgage industries; many institutions benefitted indirectly without taking a penny in government money. The bank lobby will make good use of these inconsistencies if the levy is framed as a moral measure.

If the levy is to change behaviour, it has some potential provided it can be designed so costs are not simply passed through to customers and shareholders. Charging the levy on holding companies could encourage demergers. If well targeted, it might even promote the voluntary adoption of narrow banking business models. Charging it on wholesale funding and gearing would de-risk the system, while a charge on pay ratios could start to change bank pay culture. If the levy increased with failures, it would encourage the industry to self-regulate, rewarding bankers for de-risking their business and pushing for the same at their peers.

If it’s for insurance, it won't help at all. Charging upfront for an explicit public guarantee is like making moral hazard part of the constitution. Darling and Sarkozy think channelling the levy's proceeds into general taxation will avoid this, but once the guarantee is priced and paid for, it’s too late. An explicit guarantee will be priced into every trade in the City.

A levy would need to be carefully modelled to check for unintended consequences. For example, if it were linked to systemic risk (assuming the academics can agree what this is, see 16 April IMF conference), this could mean the tax falling equally on shallow and deep pockets, distorting the market in favour of large organisations.

Whatever people decide the purpose is, the biggest danger of a levy is that it might substitute for real, structural financial reform.

Bob Diamond told the Telegraph recently that size is not the same as systemic risk. The comment suggests he is far more worried about having to break up BarCap than about paying a levy.

Diamond is right, both about systemic risk and about size being his main battleground. The Bank of England’s Andy Haldane cited research in a speech on financial pollution that scale economies in banking are not as great as people claim. He spoke at length about how prohibitions on bank sizes could bring social benefits in excess of the private cost. Others commentators have noted that size is anti-competitive when it leads to bundling and cartel pricing, that it creates a temptation to miss-use capital, circumvent capital rules and shelter proprietary trading under the taxpayer umbrella. In other words, size is well worth fighting over.

No wonder the banks are suspiciously quiet about the global levy. It would restore them some moral high ground and distract opponents from the real debate.

Any levy should therefore be treated with caution, and only implemented as a complement to, not a substitute, for structural reform.

No comments:

Post a Comment