Regulation: What is the right way to “tax” banks? The idea of a Tobin tax on financial transactions is fading. Gordon Brown’s attempt to give it a kiss of life at the G20 meeting over the weekend turned into a kiss of death. Attention is, instead, focussing on other ways of keeping banks from enjoying a free ride at taxpayers’ expense. One of the most promising approaches is to force banks pay insurance fees related to their riskiness.
The insurance idea, which was mentioned by Brown, is being examined by the International Monetary Fund. Although there is little consensus over how such fees would work, two sensible ideas are doing the rounds.
The first is that banks which pose a bigger risk to the system should have to hold fatter capital and liquidity cushions. This idea is sometimes known as a “too big to fail” tax on the theory bigger banks cause more collateral damage if they collapse.
The second proposal focuses on the fact that banks which fund themselves with short-term wholesale money are riskier than those which lock in long-term money or have stable retail deposits. The idea is that the more a bank relies on such hot money, the higher a fee it would have to pay. One could think of this as an insurance premium that a bank pays in return for being able to call on its central bank as a lender of last resort.
One advantage of this hot money tax is that it would give banks an incentive to pull in stable sources of funding. Another is that it could be varied through the cycle. If a central bank was worried that a bubble was inflating, it could jack up the fee — which would help deflate the bubble. Finally, the tax would create a pot of money to help pay for the next banking bail-out rather than having to call on the taxpayer for help.
There’s no need to choose either hot money tax or a too-big-to-fail tax. They achieve separate but complementary objectives. The authorities should embrace both.
