The Edge

Richard Northedge takes on corporate finance

A tax on banks could backfire

Taxing the banks is popular but every pound removed from their balance sheets weakens their capital ratios. That either means weaker banks – and surely we don’t want to go there again – or lower lending.

And for the Treasury-owned banks, the levy on liabilities is government taxing government. By reducing the value of the banks it owns, the state is reducing the price for which it will be able to sell those banks.

The chancellor estimates his yield from the annual bank levy at a modest £2bn, rising to £2.5bn in subsequent years. But for banks being told to raise their tier-1 capital ratios to around 13 per cent, taking that much from the banks’ reserves mean they will have to reduce lending by around £30bn. That’s not going to help business or economic growth.

However, stockbrokers at Nomura calculate that Lloyds Banking Group will have to pay £366m of the levy and Royal Bank of Scotland some £635m. So more than £1bn of the proceeds will come from two banks substantially-owned by the government. This is a transfer of money from one state pocket to another.

Banks will benefit from the cut in corporation tax so long as they are back in profit, but the full reduction will not come through until 2015 and the chancellor claims the banks will be net losers. However, within days of his budget announcing the bank levy, the Bank of England warned that banks need to bolster their capital ratios even further because of the threat of defaults by eurozone nations.

The troubled banks are paying no dividends to hang onto their valuable capital. If they paid less in bonuses they would hang on to even more, and the last government’s tax on bonuses was intended to encourage them to preserve capital.

But the assault on banks is not necessarily over yet. The G20 has decided against a global bank tax because of the damage it could do, leaving it to individual countries to impose their own taxes. France and Germany have agreed to a tax on banks but may still opt for a Tobin tax on transactions so UK banks could find themselves squeezed on turnover abroad but on their wholesale funding at home. And they may also be caught in the much higher planned US tax on their balance sheets.

And the UK government admits it is planning an additional tax on banks – a Financial Activities Tax levied on profits and pay, thus taxing British banks’ P&L accounts as well as their asset statements. Note that that abbreviates to a FAT levy! Surely the chancellor has not dreamt it up for reasons of popularity rather than fiscal prudence?

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