Despite Q110 results that comfortably beat consensus estimates, two developments over the past week mean that bankers are looking nervously over their shoulders instead of enjoying the fruits of their labours. The SEC set the tone by charging Goldman Sachs with fraud, and the public’s ire against the banks was worsened when Goldman announced on the next day that it had set aside around $5.5bn in Q110 compensation and benefits. And now the IMF has trumped these stories by proposing two new global bank taxes.

The IMF received a mandate from the G20 to consider “how the financial sector could make a fair and substantial contribution towards paying for any burden associated with government interventions to repair the banking system”. The goal, then, is to protect taxpayers from the cost of future financial crises. To this end, the IMF has proposed a combination of two taxes: a Financial Stability Contribution (FSC) supplemented by a Financial Activities Tax (FAT). The IMF said that countries could raise 2-4% of GDP from these taxes over the long term.

The IMF’s research suggests that the FSC should be broad (i.e. include all types of financial institution) to avoid pushing risk into the non-banking financial sector. It should be a flat-rate levy on wholsesale liabilities (excluding securities like sub debt and government guaranteed securities; we believe that it would also make sense to exempt long-term debt to encourage higher liquidity levels).The IMF argues that the money raised should be paid into a fund rather than general revenues. This would ensure that the money is available to tackle future crises – if put into general revenue, governments would surely be tempted to spend it on other projects, leaving taxpayers just as exposed to the effects of any future problems. Meanwhile, the supplementary FAT would be levied on financial institutions’ profits and remuneration and would be paid into general revenue. The alternative to the FAT is a Financial Transactions (or “Tobin”) Tax. The FAT was considered the better option because the burden of a Tobin tax would probably fall on consumers rather than on bank(er)s’ earnings.

The IMF’s moves have shocked a financial industry that was unprepared for such aggressive proposals. But the move towards a greater tax burden on the financial industry appears inexorable.. In the US, President Obama proposed a tax on uninsured wholesale liabilities (see blog), while the British and French governments recently imposed one-off taxes on bonuses. The Germans, too, have spoken about the need to tax their financial institutions. But the IMF’s proposals carry more weight. The report was prepared at the behest of the G20 and will be discussed at its June meeting. Implementing the proposals would certainly be popular as well as generating much-needed revenue for indebted sovereigns. A report by Credit Suisse estimates that the taxes could reduce European banks’ pre-tax earnings by 20% (see article). No wonder the financial sector is so worried.

However, there are reasons to believe that these proposals will be on ice for some time. One is the desirability of international coordination, at least on the principle of a bank tax. Not only are the Canadians (who host June’s meeting of the G20), Japanese and Australians sceptical of its value, but there are major financial centres outside the G20 – such as Switzerland and Singapore – who would not be involved in the discussions but whose participation in any new tax regime would be important for ensuring success. And while the proposed taxes would protect taxpayers, critics can argue that they do little to discourage risky behaviour. The Basel Committee is working on new rules in this area, but these will not be finalised until end-2010 (see blog). So although the IMF report has generated plenty of headlines and a global bank tax may now be a bit closer to becoming reality, it still looks a long way off. The key point, though, is that, while the better than expected Q1 bank results suggest that the banking sector is on track to return to the sort of stellar profitability seen pre-2007, there is little doubt that governments, egged on by angry electorates, will eventually look to grab a significantly greater proportion of these profits.

Nick Smallwood - Credit Analyst

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