Bank tax is ‘flawed’, says white paper on systemic risk

The idea of imposing a levy on large financial firms is a “flawed policy”, with economic costs outweighing any potential benefits, according to a recent white paper prepared by Washington, DC-based Nera Economic Consulting.

The white paper, prepared for the Property Casualty Insurers Association of America, was distributed to members of the Senate Committee on Banking, Housing and Urban Affairs last month. Democrats and Republicans on the committee are wrangling over proposals for financial regulatory reform.

In December, the House Financial Services Committee passed measures requiring large financial firms to contribute to a fund that would be used in case systemically important firms collapse. Banks with assets of more than $50 billion and hedge funds with assets of more than $10 billion would be made to contribute to the so-called systemic dissolution fund.

According to the white paper, “such a process is not only subject to gaming by firms, but is conceptually flawed”. Its application would result in a distortion of the market for financial services, increased costs for consumers, greater systemic risk and even job losses, it says.

The white paper’s chief argument is that size should not be equated with systemic risk, despite the fact the most significant recipients of bailout cash have been larger firms. “In essence, a perceived correlation between institution size and bailouts is stretched to reach the conclusion that size equals systemic risk,” says the white paper.

Liquidity risk is another important factor, the white paper adds. Firms with liquidity mismatches – investment banks that support long-term assets with short-dated wholesale funding, for instance – pose a greater systemic risk, it says.

Furthermore, companies that are less transparent about their operations are also more likely to pose a systemic risk, as this will have an impact on the willingness of investors to continue holding debt and equity in those firms.