LONDON, April 20 (Reuters) – The International Monetary Fund has proposed two new taxes on banks to fund the cost of any future bailouts, according to a leaked document published on the BBC’s web site on Tuesday.
This seems likely fairly big news to me. There are two taxes being proposed here, to be extended across the globe.
The first is a Financial Stability Contribution.
“The FSC would be paid by all financial institutions, with the levy rate initially flat, but refined over time to reflect institutions’ riskiness and contributions to systemic risk,” the document said.
The second is a tax which is intended to hit both bank’s profits and banker’s bonuses called the Financial Activities Tax.
The funds raised by FAT would be paid into a global reserve. Its purpose would be to raise revenue for potential bailouts and to reduce the incentives to take excessive risks by hitting bonuses.
Personally I quite like the sound of these. There’s a possibility they will reduce the power of banking without significantly reducing the ability of banks to do what they should do:
- Trading money now for money later: people who want to save now and spend later can make win-win trades with people who want to spend now and save later.
- Risk: people who are unusually averse to risk in general can make win-win trades by trading off some of the risks that they are bearing to people who are unusually tolerant of risk in general.
- Insurance: people who are holding a lot of one big risk can reduce the risk of catastrophic loss by paying a great many others to each take a small piece of that risk.
- Information: people who have information that prices are going to rise can make win-win deals with people who have information that prices are going to fall–although here the win-win is not for the participants in the trade: for them it is zero-sum, and the winners are those others who observe the market price at which the trades occur.
While promising I also have some concerns. What immediately springs to mind is that there appears to be no explicit mention of a form of deposit insurance on the wholesale money markets. The FSC sounds like one, but it sounds more general and less targeted at stemming panics than I would like.
We insure bank deposits because when banks fail it is possible that contagion will spread to others and to turn into a widespread panic. To prevent this government backing resulting in Moral Hazard we regulate the banks to prevent them taking on too much risk or debt.
Many banks fail across America even when not in the midst of a financial crisis but since the 1930s that rarely results in bank runs or systemic crises. (UPDATE: Krugman’s post is useful on financial reform).
What we saw in our crisis was a mass panic in the wholesale money markets which many banks had come to rely on for funding. A lot of banks were doing banky things without the backing banks have; when they failed there was nothing holding back the floodgates of panic. Panics helps do this to NGDP. This is bad.
Of course the funds raised by these taxes will be presented as insurance against future failures but there’s nothing explicit there. Although there would be “a” guarantee, when markets are panicked this “a” guarantee might not prove strong enough compared to “the” explicit guarantee of whole sale money market insurance.
I also await the inevitable, interesting and highly amusing volte face by many leftists who will now declare that the IMF is no longer an evil capitalist stooge but a glorious ally in our struggle. Sigh.
UPDATE II: I believe I’ve found the report, so in between leafleting for the Lib Dems, writing a post on immigration I’ve been so very slowly putting together and continuing my wine A-Level I can have a more in depth look. It is here.
UPDATE III: Interesting.
17. Reduce the probability and the costliness of crises. Measures should reduce the incentives for financial institutions to become too systemically important to be permitted to fail. This requires, importantly, the adoption of improved and effective resolution regimes—to resolve weak institutions in a prompt and orderly manner, including through a process such as official administration (Box 2). Such regimes are emphatically not for bail outs: the crisis has shown that they are essential to reduce the likelihood that governments will be forced to provide fiscal support to shareholders and unsecured creditors. Moreover, taxes and contributions can supplement regulation in addressing the adverse externalities from financial sector decisions, such as the creation of systemic risks and excessive risk taking.
Box 2 An empowered resolution agency (which may be a function within an existing financial oversight agency) would intervene as soon as there is a determination (usually by the supervisor) that an institution is insolvent or unlikely to be able to continue as a going concern. Upon intervening, the resolution agency would take the failing institution into “official administration” and exercise all rights pertaining to the board of directors and shareholders (including by replacing managers, recognizing losses in equity accounts, and, as necessary, exposing unsecured creditors to loss). The objective would be to stabilize the institution, assess its true state, and contain loss of value. The role of a resolution agency would address the common failing in most countries that for financial institutions (particularly those that are systemically important) the public interest in financial stability, which often leads to the need for bailout, is not among the interests specified in insolvency legislation.
Liquidity support (which typically is made available to viable institutions) would not be the purpose of a resolution scheme that is meant to deal with solvency problems. A solvent institution that is facing liquidity problems would be expected to apply for liquidity support from the central bank only (not the resolution agency), provided it has adequate collateral. The resolution scheme would allow the intervened institution to continue operating and to honor secured contracts; this would limit the disruption and value destruction of an ordinary bankruptcy procedure and limit spillovers to other parts of the financial system and the real economy. It would allow time for an orderly resolution, which may involve recapitalization, spin-offs of business lines, “purchase and assumption” transactions, and the liquidation of unviable units and business lines. The objective should be to return the institution’s viable operations rapidly to private ownership and control.
Working capital would be required in the course of the resolution process, notably for bridge financing. The gross financing needs can be sizable, and could come from fiscal sources, an industry-financed fund, or a combination of the two. If established, the industry-financed resolution fund—discussed in Section III.B— would be a first recourse for these cases. In addition, a government back-up line of credit should be available.
The necessity and scope of reforms to current resolution regimes would depend on the present system’s ability to handle quickly and efficiently (without the need for judicial intervention) the restructuring and/or bankruptcy of financial institutions. The resolution regime and deposit guarantee scheme should be closely integrated to
support a holistic approach to failing financial institutions, particularly as there may be overlaps of stability and the protection of depositors. Moreover, the resolution regime should have application to at least those nonbank
financial institutions that could be systemic, which would bring a new challenge given the differences in balance sheets and regulatory frameworks. In practice, experience with resolution of nonbanks is quite limited and confronts many legal complexities. Moreover, regimes ideally would be compatible across countries.
The United Kingdom has recently established such a Special Resolution Regime for banks (Brieley, 2009). The United States legislation is considering a special resolution regime that could be used for systemically important financial institutions (which would include nonbanks). Related to this work, the IMF (at the request of the G-20) is preparing a paper addressing issues pertaining to cross-border bank resolution.