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.