2.1.1 Taxing banks and incentivising lending
The government brought two new pieces of banking legislation onto the statute book during 2008 and 2009 to address issues related to the management and operation of the UK banking system exposed by the financial crisis.
The Banking (Special Provisions) Act 2008 gave the Treasury the power to nationalise banks or force their takeover by another institution if they were deemed to be in material financial difficulty.
The Banking Act 2009 builds upon and revises certain parts of the 2008 Act by defining the processes for bank and building society takeovers, the administration of those parts of a bank or building society that remain unsold after a takeover has been agreed and the determination of compensation to those investors that lose money as a result of a takeover.
Arguably, lessons about how to nationalise or arrange such takeovers were very much learnt ‘on the hoof’ as a result of dealing with, in particular, Northern Rock and Bradford & Bingley in 2007 and 2008. The new legislation, however, has established clear principles about how to deal with banks that are in financial trouble in the future.
Taxing the banks
Following the 2010 general election, the coalition government announced that a new tax was to be imposed on banks. The so-called bank levy was unveiled by the then Chancellor of the Exchequer, George Osborne, in his first budget statement in June 2010. The levy was first applied in 2011, with smaller banks and building societies exempt. The rate for the levy is based on the size of the banks’ balance sheets. In 2015 the levy was 0.21 per cent of short-term liabilities and 0.105 per cent of long-term equity and liabilities. The current plan is to reduce this levy to 0.1 per cent (on short-term liabilities) by 2021, with it only being applied to UK banks. However the government has introduced, from 2016, an 8 per cent surcharge on bank profits.
The case for such a bank tax, to provide funds for future possible bail-outs of financial institutions, is also being advocated by the International Monetary Fund and President Obama’s administration in the United States. This development was quickly followed by the announcement by the EU internal market commissioner, Michel Barnier, advocating that all EU member states introduce a bank levy. This would provide member states with funds to ensure that the costs of managing future banking failures would not have to be met by taxpayers. Certain EU member states have also called for the establishment of a tax on financial transactions – also known as a ‘Tobin tax’ after the economist who advocated this. This is currently being firmly resisted by the UK.
The period after the financial crisis saw various initiatives by the government to encourage more lending to households and businesses. The rationale was that this lending would help the UK economy to recover from the economic downturn that the crisis had helped to instigate.
Project Merlin was an early initiative which was linked to the deal done with banks on bonus regulations. This committed the banks to lend circa £190 billion to UK businesses in 2011, including £76 billion to small firms. Project Merlin was not a huge success – partly because even if banks were willing to lend, many businesses did not want to borrow given the uncertain economic climate.
This initiative on bank lending was followed in 2012 by the Funding for Lending Scheme (FLS), which was launched by the Bank of England with the government’s support. This scheme has offered banks and other lenders the opportunity to borrow funds from the Bank of England at very low interest rates (0.25 per cent), provided the funds are used to support increased – and cheap – lending to businesses and households.
After a slow start in 2012, the volume of borrowing from the Bank of England under this scheme grew sharply. By June 2015 48 institutions had collectively borrowed £61 billion in total under the scheme and, with its growing success, the government announced its extension to 2016 (Bank of England, 2015). The latest news is that the scheme will run until January 2018, with the focus on lending to small and medium sized enterprises (SMEs). Since 2014, the scheme has entirely focused on lending to businesses and is no longer applied to lending to households. This decision reflected the improving credit conditions for those seeking mortgages to buy homes, particularly as a result of the Help to Buy scheme. The scheme has particularly helped first-time buyers get onto the housing ladder.
FLS has not been without its adverse side effects: with ready access to cheap funds, the banks and building societies have become less dependent on personal savings, with the result that rates offered to savers have fallen to very low levels (well below 2 per cent per annum in most cases). Clearly the overarching objective of getting the economy moving has been to the benefit of borrowers – but to the clear disadvantage of savers.