A senseless tax on big financial institutions

At the height of the crisis, it became clear that there are some banks that are "too big to fail".

That means that these institutions have, in effect, a guarantee that the government will rescue them, since they are so large that a bankruptcy of that size would be intolerable because of the impact financially and socially (i.e. on unemployment).

In such a situation, there are two principal options that make sense:

1. Force or incentivise the institutions to break up, or

2. Socialise the banks (put them in government ownership - on the grounds that, as citizens must pay for any bankruptcy, it is citizens who should benefit from the profits made by such an institution)

Instead of these logical options, the global body responsible for banking supervision, The Basel Committee, proposed a capital surcharge of 3 percentage points on major banks.

You could think of this as a sort of insurance premium.

Two questions arise in relation to this: (a) on what ground is the 3% suggested: political or actuarial - in other words, is 3% too little or too much?; and (b) if the 3% surcharge goes to the government, does it end up in the government's general account to be frittered away on whatever the government fancies at any time, or is it put into a special account, so that it is clear at every point how much money is avaiable for any necessary rescue?

The answers to these questions are clear: (a) 3% is a figure that is snatched out of the air and has no logical or actuarial basis, and (b) the money collected by means of the surcharge will not be put into any special account and will indeed be frittered away.

In spite of all the above, now that Basel has pronounced on the issue, national governments will tend to go along.

The US Federal Reserve has apparently just come out in support of the proposal. When Fed Governor Daniel Tarullo recently discussed the proposed surcharges, observers interpreted his statement to mean they could be as high as 7 percentage points. My view is that this is mere politicking: it is unlikely that the eventual figure will be much higher than three per cent.

However, till the matter is settled, financial institutions will play safe - and are wise to do so. Sphere: Related Content