Tuesday, January 19, 2010

Bank fee has merits but lacks financial clout

Mohamed El-Erian in the Financial Times

Thursday's announcement by the US administration of a "Financial Crisis Responsibility Fee" has turbo-charged an already heated debate – not just on the merit of an incremental tax on banks, but also on its design and the distortive manner in which it could impact on individual institutions.

While interesting, these are no longer the relevant issues. We have left the realm of what should happen and are now embarked on what is going to happen. Specifically, Thursday's announcement marks the beginning of the era of banks being targeted for selective incremental taxation in advanced economies round the world.

Seldom will you find a tax proposal that is viewed by so many as having so much going for it. Consider just four arguments.

First, it is politically popular.

At the simplest level of analysis, the tax offers an immediate signalling device for governments eager to respond to the anger in the streets about bank bonuses and the surge in unemployment. At a deeper level, it marks the end of the flawed vision that a finance-dominated economy is a natural stage in the maturation of post-industrial societies.

Second, it targets a sector whose visibly higher earnings have benefited enormously from the exceptional measures taken in 2008 to save it.

This is not just about banks' receipts of capital injections, most of which have been repaid, and of guarantees to back their market borrowings. It is also about a monetary policy stance that pins policy rates at an exceptionally low level to counter the collapse of credit. The resulting steep interest rate curves are extremely powerful in generating high earnings for deposit-taking institutions in advanced economies.

Third, it is consistent with longer-term regulatory objectives.

The fee targets large banks and, also, their balance sheet leverage. As such, it supports the authorities' desired intention to reduce systemic risk and counter the "too large to fail" syndrome.

Fourth, it generates budgetary revenues at a time when fiscal deficits have soared, domestic debt is growing at unprecedented rates, and the scope for corrective measures is limited.

In themselves, these four issues make higher selective taxation of banks a done deal. So, rather than argue about it, we should be focused on how the phenomenon will expand, in the US and beyond.

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