February 04, 2010

Please tax me too with this too big to fail tax!

Sir as an Executive Director of the World Bank during a risk management conference in 2003 I told the regulators “Knowing that the larger the banks are the harder they fall on us if I were a regulator, I would be thinking about a progressive tax on size”.

What I now see reported by Patrick Jenkins and Brooke Masters in “US impetus drives Bank regulators” as a tax of 15 basis points on assets more than $50bn, is not what I had in mind. 15bp for what seems to be the right of officially being termed too big to fail, clearly earning a triple-A rating is ludicrous, most small businesses or entrepreneurs, would gladly pay much more if given the chance.

To understand the magnitude of the tax we might use how the bank regulator seems to value the difference between an ordinary fallible business and a triple-A rated entity. When lending to the first, a bank is required to have 8 percent in equity while when investing or lending to anything related to a triple-A rating it is only required to have 1.6 percent. Supposing the cost of bank equity is 5 percent more than the cost of deposits, then the previous difference of 6.4 percent in equity amounts to a cost difference of 32 basis points; and which strangely enough the regulator feel should benefit those already benefitted by being perceived as having low risks and affect those already affected by being perceived as more risky.

How much less would a bank deemed as too big to fail be required to pay for its funds when compared to the rest of the humanly fallible banks? If we are to tax the too big to fail banks is it not supposed to hurt them instead of benefiting them?