“Are banks investable?’ was a common question asked at the height of the global financial crisis 15 years ago. Back then the main concern was a complete breakdown in trust in how they valued their assets. Today, a similar question is again being asked, but this time due to political meddling in the sector.
Last year the Spanish and Czech governments introduced “windfall” taxes on banks, despite there being no windfall to tax. The UK government seriously considered such a move prior to its autumn budget. Last month the Financial Conduct Authority, the UK’s consumer watchdog, threatened action against banks that don’t raise their savings rates enough. And this week the Italian government revealed a surprise windfall tax (though the finance ministry has since announced a cap on the levy in an attempt to calm market jitters).
This political meddling in the sector is dangerous, coming at a time when economies are flirting with recessions. Governments need to tread very carefully, in part because their actions will clearly spook bank investors — thus raising the cost of capital — and in part because weakening banks isn’t a smart thing to do when those same banks may be required to maintain free-flowing credit during a downturn.
Specifically, windfall taxes are dangerous. There are numerous arguments against such a tax, perhaps most glaringly that for the majority banks there is no windfall to tax. While the recent reporting season has been full of headlines of European banks reporting “decade high” profits, basic financial analysis shows a somewhat different story. The return on the equity deployed remains uninspiring — averaging 10 to 13 per cent — for many of the banks that are in the media and politicians’ cross hairs. That barely covers their cost of equity, the return demanded by investors.
Furthermore, there may be a recession coming and when recessions bite bank profits tumble, as loans turn sour and losses soar. There is a debate — there is always a debate — on whether this time banks might be better able to cope with a downturn. But by far the most likely scenario is for impairments to rise and profits to fall. So from relatively modest starting levels, profitability will probably fall. That’s why the share prices of European banks have fallen almost 10 per cent since March despite enjoying apparent “windfalls”.
But perhaps the most powerful argument against a windfall tax is that regulators and politicians in effect argued against such a step in the recent past, albeit from a different perspective. In March 2020, at the start of the pandemic, bank regulators across Europe, encouraged by politicians, forced banks to suspend dividend payments. Their argument was simple and apparently compelling. If banks retained more of their profits, that would position them better to cope with the upcoming recession, allowing them to lend more to the real economy and to have more capital to recognise loan losses.
Indeed, in summer 2021 the European Central Bank, reviewing the dividend ban, said: “[Our] analyses suggest that the ECB’s dividend policy has been effective: banks that altered their dividend distribution plans increased provisions . . . and lending to the real economy . . . relative to banks that left their distribution plans unchanged.”
Now, that lesson appears to have been forgotten. In 2020 it was the payment of dividends that was threatening to weaken the capital base of banks, with implications for the wider economy. Yet today a windfall tax — similarly weakening capital for those same banks — is apparently a good idea.
Companies and citizens have a right to expect policymaking to be based on fact and evidence and not driven by the clamour of a baying public or a frenzied media. Grown-up politicians should rise above public demands for a windfall tax on banks and instead do the right thing. Else, sadly and ironically, their actions run the risk of making any coming recession worse.
Unfortunately, it looks like populist economics has struck again.
I think its a pretty dumb idea, especially when many large economies are flirting with recession. On top of that, they’re using this tax to subsidize existing variable mortgages which is a questionable idea to say the least.
Very dumb and really doesn't recognise that the business model of banking is meant to be very cyclical. They're supposed to make money in good times so they can build up equity buffers that they burn through when credit losses hit in bad times. Any government that wants to stop the former also needs to be ready to put their taxpayers' money on the line to clean up the mess when the latter happens.
Right, and that’s another part of the problem; they most certainly won’t be saving the money for that purpose. I conjecture they will spend it as soon as they get it.
And when shit inevitably hits the fan, the banks won’t have as much saved up as they may need which would further exacerbate a future financial crisis.
Because most banks are barely earning their cost of capital anyway.
Because taxing away banks' profits in the good times means they don't have capital to absorb loan losses in the bad times - bank profits are very cyclical.
And because windfall taxes are a fundamentally dodgy concept. In a stable market-based economy, the state should act predictably - set up the rules of the game up front (e.g. the tax system) and then apply those rules faithfully. Windfall taxes means telling industries at the start of the year that their tax rate this year will be X%, but then coming in after the end of the year to say 'actually we decided to tax you Y% instead, so now you owe us a load of extra tax on last year's profits that we didn't tell you about'. This means that next time around, businesses and investors won't be able to trust that the government is telling the truth about what taxes will apply to their profits for the next year - uncertainty that can be harmful for investment and economic activity.
Ohhhh okay. yeah that's kind of shitty I can see how this could make banks hesitate to lend if they dont even know how much cash theyre gonna have on hand
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