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The Sweet Drug of Bank Subsidies

The large banks that dominate the financial services sector would be making heavy losses without the implicit subsidies they enjoy as a result of the taxpayer guarantee.

The following article is by the Green-EFA members of the Economic and Monetary Affairs Committee of the European Parliament: Bas Eickhout (Netherlands), Sven Giegold (Germany), Eva Joly (France), Philippe Lamberts (Belgium), Molly Scott Cato (UK) et Ernest Urtasun (Spain)

The large banks that dominate the financial services sector would be making heavy losses without the implicit subsidies they enjoy as a result of the taxpayer guarantee. But, not satisfied with this, they are now asking for further public money to pay their contribution to the resolution funds being set up at national or (in the case of the Eurozone countries) at EU level to protect us, the European taxpayers, from having to pay to clean up the mess left by failed banks in a future financial crisis.

The IMF has recently calculated the current value of annual implicit subsidies for 'too big to fail' (TBTF) banks. Eurozone TBTF banks can borrow almost without restrictions and for unimaginably low rates due to implicit state guarantees. They are currently saving up to €200bn per year because their creditors can assume they will be bailed out by taxpayers in the event of a catastrophe. By making these vast subsidies available, governments are creating a huge moral hazard, encouraging banks to further increase in size, complexity and risky behaviour, thereby sowing the seeds of the next financial crisis. This is why regulators are working so hard to make banks resolvable in a crisis without the use of taxpayers' money so as to stop such subsidies that encourage excessive risk taking. Hence the importance of living wills, structural reform and most of all, the credibility of the resolution regime: who will bear the cost of a failed bank?

So far, Europe has decided that the shareholders and creditors of a failing bank need to be 'bailed in' up to a minimum of 8% of a bank's balance sheet, meaning that they would be immediately liable for this much in the case of a threat to the bank's viability. This is the most important tool to avoid the need for a taxpayer bailout if there is another financial crisis. It is important to remind ourselves that during the last crisis that, although their banks effectively failed, creditors did not lose any more and in many cases taxpayers were obliged by their governments to bail out wealthy shareholders. In Spain, according to the official figures of the Court of Auditors, up to €108 billion from tax payer's money was used to bail out the financial system.

During the resolution process that follows the failure of a bank - which happens when what it owns is worth less than what it owes - the resolution authority often needs cash to finance the clean up operation (e.g. setting up a "good" and "bad" bank and transferring assets and liabilities etc), provide liquidity and, in certain circumstances, even capital injections. The proposed resolution fund with a magnitude, in the case of the Eurozone fund, of €70bn in the EU-28, of which are €55bn in the Eurozone, is intended to contribute this funding process. The fund will be paid for up front by the banking industry. Behind the scenes, banks are currently engaged in an unseemly battle to determine who will have to contribute and how much.

In theory the resolution fund should work like an insurance system. The premiums should depend on the size of the institutions and on the probability of potential loss. Large banks should pay more than small banks (size of potential loss) and riskier banks should pay more than "boring" banks (probability of potential loss). The US resolution agency FDIC charges 2.5 cents per 100 dollars balance sheet for the least risky banks and 45 cents for the riskiest banks. Unfortunately, in the EU case, some member states like the Netherlands, France and Italy still understand themselves primarily as lobby groups for the oversized banks headquartered in their territories. They are trying to limit the premiums for large and risky banks so that banks with the lowest risk should pay 80% of the average premium and banks with the highest risk only 120%. This is an absurdly low spread: a factor of 1.5 times whereas in the US the factor is 18 times.

With these low spreads the run-of-the-mill banks where we many of us have our accounts would explicitly subsidise the risky behaviour of the TBTF banks creating exactly the sort of moral hazard that led to the 2008 crisis. This is simply unacceptable. Instead, the insurance charge should be constructed in a way that incentivises good behaviour. In the same way we want to tax CO2 in order to internalize the external effects on climate change, we want a fee that internalizes the external effect of risk taking on systemic financial stability. So the bank's business model, the stability of its funding position, its asset position, its level of interconnection with other banks and other easy metrics that cannot be manipulated should be used to measure a bank's riskiness. Most importantly, the fee spread between risky and non-risky banks should be of significant magnitude as it is in the US under the rules governing the FDIC.

The massive lobbying of TBTF banks against a fair and socially responsible fee structure is impudent beyond belief. In the view of the Green Group in the European Parliament, the resolution fund is actually far too small and would still leave taxpayers at risk. The €55bn will be paid into the fund over the next eight years plus potential additional capital calls. This means we are talking about an annual contribution of €6.9bn. The 124 large banks being supervised by the ECB hold 85% of all banks' assets across the Eurozone. Whether these banks pay 85% or 100% of the €6.9bn into the rescue fund is a fairly marginal question compared to the €200bn annual implicit subsidy states make available to them. The risk factor is a drop in the ocean when it comes to reducing the intolerable competitive advantage these subsidies grant them compared to the small banks. But, in terms of motivation, it is of vital importance. We must ensure that the rescue fund sets a new tone and new direction, forcing Europe's bloated banks away from their addiction to subsidy and on the path to a future of self-reliance and clean living - serving the economy, not bleeding it dry.

From our perspective in the Parliament we might ask why the Commission is taking the side of the banks against the interests of Europe's citizens. French Commissioner Michel Barnier seems to care more about member states with national banking champions than about financial stability. Barnier's staff are seeking a compromise in favour of the large Dutch, Italian and French universal banks. So it currently looks as if those stable, "boring" banks that are responsible for the bulk of the financing of the real economy will have to subsidize the risk-taking of the large European investment banks. As Greens we are taking this debate into the public domain and enlisting the support of European citizens to lobby in favour of a policy that means all European banks are obliged to work for the common good. We are encouraging you to address your concerns directly to Michel Barnier and explain to him in an email why you oppose this continued subsidy.

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