A better scheme to reform

Allister Heath
GIVEN the unpopularity of the City, it is no surprise that the political parties are competing to introduce a Barack Obama-style tax on banks’ balance sheets. The Tories announced their unilateral plans at the weekend, supposedly to pay for the bailout; and Alistair Darling will reiterate his support for an internationally-agreed version to pay for poverty-reducing spending at Wednesday’s Budget. Yet the costs of both schemes – probably a 0.15 per cent annual tax on assets – will be passed on to customers, penalise prudent banks as much as imprudent ones, and do nothing to tackle the too big to fail mindset.

The best way to recoup the costs of the bailout – primarily the purchase of equity stakes and any losses on RBS’ asset protection scheme ­– is to make sure the taxpayer sells its shares in RBS, Lloyds and the rest at as high a price as possible. Lloyds’ announcement last Friday that it hopes to make a profit this year will do more to help the taxpayer than any ill-thought out bank tax ever will.

There is, however, a case to be made to make all banks pay a fee into a new fund to pay off depositors in failed banks, as has been the case for many decades in America, as part of much wider reforms. Such a fee – under my favourite scheme, a combination of a pre-paid deposit insurance scheme for consumers as well as a temporary financing fund for bust investment banks – could form a key component of a new bankruptcy system which would allow even giant financial firms that fail to be wound down and dismantled without endangering the rest of the economy.

Taxpayers and depositors would be protected; shareholders, bondholders and top staff would all be wiped out. Think of the way engineers are able to demolish a tall building with a controlled explosion while protecting all surrounding buildings; that is what we need to achieve in the City. A levy that helped pay for this wouldn’t be a tax in any meaningful sense of the world – and it would help introduce real profit and loss constraints into a financial system corrupted by moral hazard and misguided government intervention.

We should study the US model and improve and extend it to cover all UK banks. Seven US banks were declared bust this weekend, bring the 2010 tally to 37. The Federal Deposit Insurance Corporation (FDIC), in charge of seizing bust banks, estimates the cleanup cost for the industry will be $100bn from 2009 to 2013. Bank failures are a cost to the deposit insurance fund (DIC) because the FDIC, the receiver of failed banks, must liquidate assets that have declined in value while reimbursing depositors. The fund is prefunded; the banks have to pay a compulsory insurance levy, allowing the DIC to hold around 1.5 per cent of the value of the insured deposits.

Insurance makes depositors less prudent. To tackle this, the new UK fee could be charged to the consumer directly and vary according to their bank’s risk. This would make depositors less likely to bank with a riskier institution. The fee from the consumers could be collected by the bank and paid into the fund. There are even better ways forward, of course. But this sort of change is what the Tories should consider if they are serious about taking on vested interests and fighting corporatism. Reform should be about tackling the causes of the crisis, not its consequences; it is not about playing to the gallery with half-baked tax hikes for the sake of it.