Taxing time for banks – lessons that still need to be learned

There has been a lot of anguish and complaints from bankers about Obama’s tax on banks, and complaining why they have been singled out. Some of this is the usual self interested financial posturing (they are bankers!), some of it is in response to unfair political criticism, typified by last week’s focused grilling of Lloyd Blankfein, a successful CEO of a successful bank (Goldman Sachs). Ignoring the emotional sides of the argument what about the tax itself?

In principle it looks like a fair idea. If the government acts as a lender of last resort, financed by the tax payer, then the beneficiary of that guarantee, the banks’ shareholders, employees, and customers should share the fee. The difficulty of course is implementing the tax in a global financial system, and determining the appropriate fee. Fortunately for Obama, the threat of relocating your banking operations outside the biggest capital market in the world is not credible so implementation should be successful. Setting the level is a different matter, too low and the state effectively subsidises risk taking, too high and the state stops appropriate risk taking. However, this should not  stop attempts to set an appropriate rate, as having no insurance indemnity will eventually distort markets.

A tax policy on its own is not the only answer to pricing risk correctly, you have that other government tool to help or interfere in the economy (depending on your political view): regulation.  After all if you’re an insurance company providing insurance you tend to set out the terms and conditions to your customer to stop reckless behaviour.  That’s one of the things that financial regulation sets out to achieve, and indeed if done successfully mitigates the need for setting an insurance premium.  However insurers and regulators have to work closely in tandem, otherwise the risk takers will find ways round the regulations.

Given the chaos that has occurred following the run on Northern Rock, the bail out of major banks around the world, and the Icelandic bank failures, you would have expected the regulator, the lender of last resort, and the tax payer to have learnt a thing or two, and to stop the danger of free riding of bank shareholders, bank employees, and bank customers. However on reading the papers this weekend I came across an article about a one year sterling high yielding deposit account paying 4%. The catches to this offer referred to in the article included a lack of an https address and padlock symbol on the bank site, and an unproven customer service. On the other hand the article referred to the fact that account holders would be fully covered for £50,000 under the UK’s Financial Services Compensation Scheme.  Pre October 2007, the compensation scheme used to extend to 100% of the first £2,000, and a further 90% would be guaranteed from £2,000 to £35,000 (so customers would take some degree of risk if a bank failed). On checking the website of the bank this morning to investigate further I was greeted with the comment that the website was being upgraded due to the unprecedented demand for its online deposit product.  A rate of 4%, 8 times the official Bank Rate, where can you invest to get a relatively low risk free return on that type of cost of funding? Even Lloyd Blankfein and his team would have difficulties.

Isn’t there a danger that we have made no progress from where we were 2 years ago with Icesave, and the Icelandic banks paying up for deposits, lending them on to high yielding risky ventures? Don’t worry customer,  the taxpayer will bail you out!  Whether you’re right wing and dislike state subsidies, or left wing and hate distribution of tax revenues from the poor to the rich this does not look politically right. Things need to change, on the insurance front progress has been made, on the regulation front work still needs to be done, and sadly in the UK the incentive to take risk, with your deposits and tax payer money, has been increased.