Banking tax

In the eve of the day when Polish financial sector is encumbered with a newly levied asset tax, worth looking at whys and wherefores of the new source of revenues for the government budget.

The concept of additionally taxing financial institutions is a relatively new concept which traces back to 2009, months after several banks in developed countries had been saved by governments from going under. The general rationale for putting extra taxation on the financial sector was:

- precluding banks from getting involved in speculative transactions and

- partly compensating taxpayers whose money had been used for bank bail-outs.

The primary premise is hence not to raise more money to the government budget, but to influence behaviour of the nasty institutions. To pursue such goals, banks taxes have either:

- profits on speculative transactions or

- liabilities, other than equity and client deposits,

as tax base.

Such construction puts banks off engaging in frequent, risky speculative transactions (tax payable eats up the whole profit on a deal which renders such operations senseless) and persuades banks to seek most stable sources of funding and minimise their reliance on inter-bank loans.

Bearing in mind the above, it is hard to discern similarities Poland and developed countries where special tax for financial sector has been put in place. Firstly, the conduct of the Polish banking sector has been beyond reproach. Commercial banks in Poland have contained their business to the essence of banking, i.e. taking deposits and granting loans. No bank has been involved in speculative trading on a large scale (not fully matched client positions in banks’ books are too low to threaten banks’ solvency) nor in investments in dicey securities. No bank has ever had to bailed out from taxpayers’ money, nor even has been on a verge of insolvency. Commercial banks are strongly capitalised, have solidly performing credit portfolios and ensure clients’ deposits are safe. A bit of bitter word could be said of co-operative banks and credit unions, whose bankruptcies have been witnessed recently far too frequently. Lack of proper supervision of KNF on credit unions until 2012 and years of poor management are taking their toll on ill-run small financial institutions.

The main sin of commercial banks is that they indeed many times have not played their cards right and have not treated clients honestly. The example of CHF-mortgages foisted upon naïve borrowers, not eligible for such products, was just a tip of the iceberg. The other sin are excessive, compared to other sectors of the economy, after-tax earnings of the whole banking sector, reaching PLN 15 billion per year. An industry which produces no tangible goods for a laymen should not be allowed to continue to be a money-making machine, so let’s bring it to the heel.

The reason why banks and other financial institutions will be taxed in Poland is not to punish them for their misconduct, but to quickly raise money for merry social spending promised by the new government, actually for one 500 PLN child allowance programme. Most people believe fat cats from banks and their foreign owners are a perfect scapegoat, since it is the easiest to take away money from where there is plenty of them. Choice of tax base also reflects on taking the path of least resistance. In Poland the tax will be charged on banks’ total assets less equity less held government-issued securities less PLN 4 billion securities and the annual rate will be 0.44%.

Now let’s dissect some details on the tax:

1. State-owned banks will be tax-exempt. Currently the only bank eligible for such status is BGK (PKO BP is only state-controlled) – the government will not tax itself and its debt!

2. The PLN 4 billion allowance means favourable treatment for co-operative banks and credit unions whose conduct raises the most reservations. Good to see the government wants to enhance competition on banking services market and prevent the largest banks from growing too big to fail (top10 already are), but such mechanism means transfer of money from well-run to ill-run institutions.

3. The biggest drawback of the tax is equal tax rate for all assets, regardless of how risky they are (except for assets bearing sovereign risk). This means that the tax rate on a mortgage loan with LTV of 50% is equal to the tax rate on unsecured cash loan. This means the tax rate on a short-term loan to a prime corporate client will be equal to the tax rate on a long-term loan for a start-up (such are sometimes granted). The tax rate will be the same, while how much banks earn on different assets reflects those assets’ risk profiles. Equal tax rate is likely to push banks towards more risky lending, since income on the safest assets will not be satisfactory. Oddly enough, I have not heard this argument raised in the public discourse.

Now let’s examine where the impact of the tax will be the biggest. Common sense after reading point 3 from the paragraph below, or pure command of maths should tell you banks’ clients will feel the effects the most on products with relatively low risk and low margins. From what I observe, the costs will be passed on to customers in three ways:

1. Through higher prices of basic banking services which are inevitable for all individual and corporate clients (account fees, debit cards fees, transfer charges),

2. Through higher margins on mortgage loans, the least risky credit product offered in the retail banking. With automobile loans or cash loans where margins reach several hundred basis points and fees, commissions and obligatory insurance make up sizeable income, impact of 44 basis points banking tax will not be felt much. For mortgage loans running until now on margins even below 150 basis points the tax will eat up one third of the income. No wonder banks in unison have increased the cost of mortgage lending.

3. Through higher margins on loans for corporate clients with decent financing standing. Large companies until recently could easily obtain short-term funding for not much more than 44 basis points over WIBOR. Customers from that segment will have to accept higher cost of financing.

Now I wonder whether proponents of the tax in their calculations of budget proceeds have taken into account:

- lower CIT proceeds (higher interest cost and banking fees for businesses translates into lower tax base),

- lower VAT proceeds (households taking out new loans will spend and invest less),

- impact on GDP of worse performance of the property market (actually as a whole I view the impact positive, since cheaper properties are easier to buy without debt).

Negative selection (preference of banks to shift towards more risky assets with higher income potential) is just one aftermath of the new tax. The other is that for large-volume (>PLN 50 million) single credit exposures, especially those in foreign currencies, it will make sense to arrange the loan in Poland, but to establish as a lender another bank from a Polish bank’s capital group. Works on implementing such solutions are pending and I estimate this method of circumventing the new law might deplete the tax proceeds by several hundred million zlotys.

The only country in the EU to have followed the path of taxing banks’ assets is Hungary. The price to pay was heavy contraction in lending dynamics, spilling over to the whole economy. For no apparent reasons Hungarians are pulling out from the tax by decreasing its rate year-on-year.

Time to bite the bullet on it. Banking sector has been getting on well for many years, its returns are also impressive. The very idea of above-average taxation on it, as long as it is brought off wisely (a good example is copper tax for KGHM), would not bring banks to their knees (the very tax, passed onto clients would neither do). To make it wisely, i.e. without flawed disincentives, I would put forward two measures, more difficult to carry through than just taxing assets. Firstly, cut down on opportunities to transfer money to head offices via royalties, costs of services and other payments that artificially boost expenses and decrease pre-tax profits. Secondly, apply a higher CIT rate to financial institutions, but tax profits, not assets. I realise the latter is at odds with the former, so combining the two solutions does not appear too fortunate, but shows the direction which would bring the least harm to the economy.

The banking tax itself will not be an excessive burden, but if its effects are compounded by conversion of mortgage loans denominated in foreign currencies into PLN at “fair rate”, repercussions for the banking sector might be dire, since losses of PLN 30 billion of the industry as a whole would mean some smaller banks could go insolvent and their owners taking losses and walking away, leaving the Polish government and financial watchdog with the mess.

Worth noting what the “fair rate” is, since in the debate on president Duda’s proposal nobody has actually explained what the economic sense of this “fair rate”, calculated individually for every debtor is. In plain Polish, the fair rate is the CHF/PLN exchange rate to which CHF/PLN would need to soar right after loan disbursement and at which it would need to be fixed over loan’s life until now, to make sum of instalments in CHF and PLN (assuming the same loan margins and without discounting to account for time value of money) equal. In simple words the “fair rate” is the one at which a CHF-debtor is neither better-off nor worse-off than PLN-debtor.

Moreover next bankruptcies of ill-run credit unions are in the offing in the coming months. The Bank Guarantee Fund, with reserves accumulated since 2001, has been depleted by payments to aggrieved depositors (folks are lucky to benefit from Bank Guarantee Fund protection since recently thanks to prudent policies of the previous government) and the Fund now passes the hat round between banks to make up for the outflows.

The banking sector had its golden years in Poland. Those times will never come back and good for us, since if wealth is unequally divided between financial intermediation and real economy, economic development will not be sustainable. But if we go into another extreme and knock down institutions which facilitate flow of funds between depositors and borrowers, taking the credit risk away, we will knock down the whole economy. Bleak times ahead.