This Maple Leaf Doesn’t Crumple

blitt chandan 30 This Maple Leaf Doesn’t Crumple

Real estate bankers, be on guard: The International Monetary Fund has set its gaze on a share of your firms’ profits. More than six months after the Group of Twenty (G20) leading nations put forward a global bank tax, the I.M.F. presented its interim report on April 16. Titled “A Fair and Sustainable Contribution by the Financial Sector,” the report proposes a Financial Stability Contribution (FSC) that would offset the cost of future bank crises, as well as a Financial Activities Tax (FAT).

An updated report on the global bank tax is due from the I.M.F. in June. Given the apparent dysfunction characterizing the current financial reform debate in the United States, one might dismiss the idea of near-term coordination on the global stage. Observing the rhetorical buildup to last week’s G20 meeting in Washington, my peers at The Economist concluded that “any banker who assumes [the I.M.F. proposals] are another bit of theoretical wonkery should think again.” In explaining the broad support for the I.M.F. proposal, they added that “many hard-up Western governments now have a recipe for raising levies that are lucrative, wildly popular, and [that] come with the imprimatur of capitalism’s policeman.”


A Tax on Liabilities

In reaction to the events of the past two years, recognition of the systemic risks presented by large bank failures is at the heart of the proposed Financial Stability Contribution. In fact, the FSC is designed to reduce the incentives for banks to take on liabilities and, as described by the I.M.F., should be “linked to a credible and effective resolution mechanism.” This resolution mechanism calls for receipts to be paid into a fund that will cover the costs of bank failures. As I described in last week’s column on Senator Dodd’s proposed financial reform bill, the creation of a fund has been a major point of contention between Democrats and Republicans. The latter have expressed concerns about the potential for moral hazard.

In the assessment of policy makers, banks that are perceived as being too big to fail face lower borrowing costs, since the risk of outright failure and a default on debt obligations is lessened given the assumed backstop. In effect, the expectation of government intervention when and if a crisis arises acts as a subsidy on the banks’ cost of capital throughout the cycle. But this subsidy, by definition, distorts behavior. In this case, the subsidy creates an incentive for large banks to take on more debt. While the I.M.F. proposal does not make it explicit, the taxation of large banks’ liabilities offsets the subsidy.

The tax is hardly perfect. Among its potential stumbling blocks would be a proposal to tax the full range of financial institutions, and not just large, systemically important banks. After an initial period during which the tax would be assessed using a flat rate, the tax should ultimately evolve, the I.M.F. proposes, to become sensitive to banks’ risk-taking. Any risk officer who has followed the travails of the New Basel Capital Accord (known commonly as Basel II) can speak to the conceptual and implementation complexities of a risk-based capital regime.

Apart from a tax on debt, the I.M.F.’s proposal would also tax banks’ profits before salaries and bonuses. The Financial Activities Tax is not designed to correct any particular behavior in the market. Inasmuch as the I.M.F. proposes that receipts should be paid into governments’ general revenues and not into a resolution fund, its relevance for financial stability is unclear.


Consensus Will Prove Elusive

In seeking to address banks’ incentives to take on risks, levies are a poor substitute for effective regulation. It would be naïve to assume that the implementation of the I.M.F. plan will serve as a panacea. Moreover, bank levies may be altogether unnecessary if sound regulation is able to bring banks’ incentives into alignment by addressing market-structure issues directly. And so it should come as no surprise that Canada has been among the countries objecting to the proposal as it now stands. In both Canada and Australia, relatively healthy financial institutions have not required stabilizing capital injections.

At last week’s meeting of the G20 nations’ finance ministers and central bank governors, Canada’s objections held sway with many of the participants among emerging economies. Going into the meetings in Washington, Canada was largely on its own in opposing the bank tax. By the meeting’s close, a number of emerging economies had apparently offered support to Canada’s position. Canada’s dissent could scuttle the proposal, since anything short of universal implementation opens the door for regulatory and tax arbitrage.

In the United States, the creation of the specific fund may prove to be the I.M.F. proposal’s Achilles’ heel. The British government has expressed concerns about moral hazard that parallel the Republican Party’s opposition to the “bailout” fund. Britain’s chancellor of the Exchequer, Alistair Darling, has said that “a systemic risk levy should not be seen as an insurance policy to benefit individual institutions, shareholders or creditors. To minimise moral hazard, the proceeds of a levy should go into general taxation rather than a stand-alone fund.”

The Institute of International Finance (IIF) disagrees. “The IIF sees no merit in the idea that any levy on the financial sector should be paid into general revenue. Neither do we believe that an ex-ante levy on the banking system should be used to finance the bailing out or recapitalization of failing institutions,” it wrote in an a statement released over the weekend.

In sending the I.M.F. back to the proverbial drawing board, the G20 conceded substantive disagreements on the fund’s proposal: “We call on the IMF for further work on options to ensure domestic financial institutions bear the burden of any extraordinary government interventions where they occur, address their excessive risk taking and help promote a level playing field, taking into consideration individual countries’ circumstances.”

Not since February’s Olympic hockey final has Canada wielded so much power on the rink. The Canadians hold the advantage: The G20 heads of state will revisit the I.M.F. proposal when they reconvene for their summit meeting in Toronto in late June.


Sam Chandan, Ph.D., is global chief economist and executive vice president of Real Capital Analytics and an adjunct professor of real estate at Wharton.

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