By Hilary Schmidt, International Banker
In early August, Italy shocked financial markets by announcing its decision to slap a one-off 40-percent windfall tax on its domestic banking sector. Following in the footsteps of Spain, Hungary, the Czech Republic and Lithuania, all of which have taken similarly firm fiscal measures against their respective commercial-lending institutions, this trend of banking-sector taxation may continue to sweep across Europe—and even beyond—amid challenging economic conditions that look set to persist until at least next year.
After it was unveiled by Italian Prime Minister Giorgia Meloni’s right-wing coalition government on August 7 as a scheme to tax banks’ excess profits, the deputy prime minister and minister of Infrastructure and Transport, Matteo Salvini, explained to reporters that a measure of “social equity” was needed in response to the series of interest-rate hikes implemented by the European Central Bank (ECB). Indeed, banks throughout the eurozone have earned substantial profits this year from rising net interest margins (NIMs), as central banks have continuously raised interest rates as part of their struggles to tame inflation. The ECB, for instance, implemented its 10th rate hike in a row on September 14, lifting its benchmark deposit rate from 3.75 percent to 4.0 percent.
In many ways, the tax is a reprimand meted out by authorities to Italian lenders, the bulk of which have not sufficiently rewarded depositors in line with those rising interest rates. While the income banks earn from lending in such a monetary climate has undoubtedly been fruitful, they have failed to correspondingly distribute more interest payments to depositors. According to Meloni, “banks’ unfair interest rate margins” slowed the economy. On August 9, the prime minister stated that “banks should behave fairly, and that’s not what they are doing”, arguing that introducing a tax on net interest margins “was the only way we had to intervene”. The Ministry of Economy and Finance (MEF) did, however, assure those banks that had sufficiently raised interest rates on savings accounts “as recommended in a note by the Bank of Italy in February” that the new tax would not meaningfully impact them.
Nonetheless, the move prompted a massive sell-off of Italian banking stocks on August 8, the day after Rome’s initial announcement of the scheme, with major lenders such as Intesa Sanpaolo and UniCredit losing 8.6 percent and 5.9 percent, respectively; Monte dei Paschi di Siena (BMPS) and BPER Banca shedding a whopping 10.8 percent and 10.9 percent, respectively; and Banco BPM’s shares declining by 9 percent. In total, an estimated €10 billion was wiped off lenders’ market capitalisation by the end of the day.
However, the sector did stage a decisive recovery on August 9 after the government sought to clarify that the tax would be capped—a move widely perceived as having been taken to calm markets after 24 hours of confusion. According to the Ministry of Economy and Finance, the revised implementation would provide “a ceiling on the contribution, which may not exceed 0.1 percent of a bank’s total assets”, to preserve banking institutions’ stability. Such a limit would thus significantly reduce the levy’s impacts, with Jefferies suggesting that the government would collect less than €3 billion instead of the estimated €4.5 billion without the cap.
Moreover, several additional modifications have been proposed since the tax was first announced to sweeten the deal further. For instance, the tax will now apply to 40 percent of banks’ NIM earned in 2023, but only if the margin has grown by at least 10 percent from 2021 levels. This ruling replaces the minimum 5-percent NIM growth in 2022 and 10-percent NIM growth in 2023 from the 2021 NIM levels initially slated. The tax will also reportedly now be capped at 0.26 percent of risk-weighted assets (RWAs) instead of the 0.1 percent originally announced. And Rome will now allow lenders to boost their non-distributable reserves by 2.5 times the levy amount, an alternative to paying the tax. That said, Italy’s larger banks are still expected to pay the tax. “The top-tier banks will probably opt to pay the windfall tax rather than allocate the amount to capital, as the impact of the tax is manageable and payment would seem more ethical,” Société Générale explained to Reuters on September 25.
These more recent appeasements seem to be aimed at quelling the considerable dismay over the levy voiced by the banking sector. “The policy is tragic,” David G. Herro, chief investment officer at US investment manager Harris Associates, the sixth-largest shareholder in Intesa Sanpaolo (Italy’s biggest bank), told the Financial Times on August 10. “For years, the banks struggled in a low interest rate environment. No one begged, nor should they have, for subsidies. Now we finally have some normalisation, and the government confiscates profits.” And Oliver Collin, co-head of European equities at Invesco—a top-20 shareholder in the second-largest Italian lender (UniCredit), added that the tax reflected “a combination of a lack of clarity and a complete volte-face in terms of policy”.
Even the ECB cautioned against implementing the tax, warning that it could leave some banks in precarious positions should the economy weaken further. According to a legal opinion issued by the central bank, the basis for establishing this tax does not consider the full business cycle, thus omitting important considerations pertaining to operational expenses and credit-risk costs. “As a result, the amount of the extraordinary tax might not be commensurate with the longer-term profitability of a credit institution and its capital generation capacity,” the opinion published on September 12 read. “Credit institutions that have lower solvency positions or are more focused on lending activity (such as small banks) or have challenging capital projections could become less able to absorb the potential downside risks of an economic downturn.” The ECB also warned that the tax’s “retroactive nature” might also create problems of legal uncertainty that could spur extensive litigation.
But Prime Minister Meloni has stood firm on her policy since then, confirming that she does not want to “backtrack” on her decision. The prime minister maintains, however, that changes to the strategy remain possible, provided that overall proceeds stand firm at a minimum of “just under” €3 billion. This revenue will reportedly be used to support small and medium-sized Italian enterprises via state guarantees and tax cuts.
Italy follows in the footsteps of other European countries that have opted to implement charges on their banking institutions. Spain, for instance, introduced a levy at the beginning of the year—a 4.8-percent charge on banks’ net interest income (NII) and net commissions over an €800-million threshold—that was designed to raise €3 billion by 2024 to ease a cost-of-living crisis largely brought on by skyrocketing food and energy prices. Hungary launched a similarly extraordinary windfall tax last year, which mandated that banks pay a 10-percent charge on net revenue in 2022, followed by an additional 8 percent in 2023 (in two equal tranches), in a bid to raise around 1.6 trillion forints (US$2.6 billion) in total across both years.
And with the Czech Republic and Lithuania having also targeted banks’ profits in a similar mould to that of Italy, there is an increasing likelihood that such banking levies could become more of a rule than an exception throughout European economies, especially if another economic downturn materialises. That said, some economies are committed to exploring other routes. The United Kingdom, for instance, reduced its banking-sector surcharge on profits from 8 percent to 3 percent, a move that came into effect on April 1, whilst also increasing corporate tax from 19 percent to 25 percent and the diverted profits tax—taxes considered to have been diverted from UK shores—from 25 percent to 31 percent. As such, the moves are believed to have raised the overall tax burden for UK lenders from 27 percent to 28 percent.
The UK Government is also demonstrating a clear preference for regulatory measures over the use of taxation to urge banks to raise the interest rates they pay to depositors, with the Financial Conduct Authority (FCA) recently outlining its 14-point plan in support of such efforts. “The regulator is leaning on banks to explain whether they are getting [the] balance right or if they need to raise rates further,” Giles Edwards, senior director of S&P Global Ratings, told the Financial Times. “I imagine they would want to let that process play through rather than necessarily adding additional bank taxes, which doesn’t seem to be the immediate priority.”