EU bank levy idea is circular — and dangerous

January 12, 2011

By Peter Thal Larsen and Neil Unmack
The authors are Reuters Breakingviews columnists. The opinions expressed are their own.

LONDON — Forcing banks to bail out countries may have the ring of poetic justice. But Europe’s idea of using a bank levy to capitalise a sovereign crisis fund is circular — and dangerous.

Brussels has floated the notion of a one-off 50 billion euro tax on lenders to fund the so-called European Stability Mechanism (ESM), the new sovereign bailout facility due to take shape in 2013. It is just one among several ideas and doesn’t appear to be being pushed hard. That’s just as well — whacking banks so that governments can continue to prop them up makes little sense. Worse still, such a scheme could reinforce the moral hazard the European Union wants to end.

The plan is misguided in at least three ways. First, it is circular. One of the main causes of the euro zone’s peripheral crisis is that governments have felt compelled to stand behind their banks. Ireland’s decision to support the liabilities of its banking system overwhelmed the public finances, and has undermined investors’ confidence in Spain, Portugal and Belgium. A blanket levy on bank assets would make weak lenders more likely to seek state support.

A second problem is that the levy would come on top of existing national taxes. At least 10 European countries, including the United Kingdom and Germany, have introduced or are contemplating bank levies to help raise revenue or finance bailout funds. Though most banks could easily cope with the EU’s levy — a mooted 0.2 percent of assets — the cumulative effect of other taxes and new capital rules would provide a further brake on lending.

Perhaps the biggest objection is that this type of levy would reinforce the link between banks and governments. One of the main contributors to the current crisis is that bank creditors assumed — correctly — that governments would not allow large lenders to go bust. The levy would cement the expectation of future bailouts, while recouping only a fraction of the financial benefit that banks derive from being too big to fail.

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And how exactly is the EU going to accurately predict the benefit from the one or two occasions when it would prove a lifesaver, compared to the detrimental effect on lending and spending by not drawing that liquidity away from the market? And won’t this put a burden on successful banks and prop up unsuccessful member states [and indirectly, their banks].

At least without a safety net, banks and member states will be more inclined towards a less risky stance.

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