ROME // Ever since financial markets began to stabilise late last year, the idea of making the financial sector pay for the costs incurred by taxpayers to keep it afloat has gained increasing support among policymakers and the wider public. France and the UK have introduced a temporary tax on financial-sector bonuses, and the US government has proposed legislation envisaging a "financial crisis responsibility fee" to recover the costs of America's Troubled Asset Relief Programme. There is also a discussion about how best to reform taxation of the financial sector, which is on average lighter relative to other corporate income and unduly favours borrowing over equity financing.
But a lump-sum charge to recover past costs will not change the financial sector's incentives concerning excessive risk-taking. Furthermore, it is unclear what, precisely, the costs are that are to be recovered. While the direct fiscal costs of supporting the financial sector were 2.5 per cent to 3 per cent of GDP in developed countries (with peaks of about 4.5 per cent), the total fiscal impact of the crisis is much larger, amounting to the total expected increase in public debt: an estimated 40 per cent of GDP. And even larger yet is the total cost suffered by the economy, including output and job losses, and the attendant destruction of material and immaterial capital, which, according to Andrew Haldane, a Bank of England director, and others, could rise to a multiple of annual GDP.
More recently, the debate has changed tack: taxing the financial sector is now seen as a convenient way to set aside sufficient resources to pay for the next financial crisis. The idea of a tax on the financial sector has become closely associated with that of a crisis-resolution fund. This would pay for the residual costs of a large institution's failure after its capital has fallen to zero and, presumably, creditors' claims have been wiped out, although some proposals are ambiguous, leaving room for at least some relief for creditors.
The IMF presented one such proposal to the leaders of the Group of 20 developed and emerging economies when they met in Washington in April. Other versions were recently put forth by the committee on economic and monetary affairs of the European Parliament and the European Commission. These proposals seem poorly conceived, for two reasons. The first is obvious: any bailout fund for financial institutions creates an implicit promise of a bailout. Sooner or later, someone will call upon that promise. If the fund is public, it will encourage private beneficiaries to free ride on taxpayers. If it is privately financed, swindlers will be encouraged to free-ride on honest bankers.
The only way to avoid this undesirable result is to exclude all support for shareholders and creditors of a financial institution heading towards bankruptcy. They must realise that government will not ride to their rescue. Only in this manner will shareholders and creditors have a sufficiently strong incentive to monitor management and keep a tight lid on risk-taking by banks or other financial intermediaries.
Deposit-insurance fees are the appropriate instrument by which to make banks pay both for their intrinsic riskiness and the risks they impose on the rest of the system. The second, often less readily recognised objection to a resolution fund is that banking losses were huge in the recent financial crisis because regulators closed their eyes to misdeeds in order to ensure bankers' international competitiveness or, more simply, because they had been "captured" by them.
If supervisors behave as they should, large residual losses from bank failures become unlikely. So, in order to keep residual losses small, supervisors must be obliged to undertake early corrective action when a bank's capital weakens, which is how the US Federal Deposit Insurance Corporation operates. If a bank cannot be recapitalised, it should be resolved and liquidated. In the effort to build a strong and coherent regulatory system for financial markets, the idea of a resolution fund is at best a distraction - and at worst a harbinger of further financial instability.
Stefano Micossi is director general of Assonime, a business association and private think tank in Rome * Project Syndicate
