If you are lucky enough to have piles of money earning interest in a bank account, one thing you don’t want to be doing is facing the dreaded tax bill on the interest earned. It is for this reason that many wealthy people put their savings into bank accounts in Switzerland and other countries with strict secrecy laws. Countries, such as Liechtenstein, Switzerland, Andorra, Liberia and the Principality of Monaco have previously had laws in place to prevent the effective exchange of information. This had meant that you could keep your money in an account there and the UK authorities would be unable to obtain any information for their tax records.
However, as part of an ongoing OECD initiative against harmful tax practices, more and more countries have been opening up to the exchange of information. In recent developments, Switzerland and the UK have signed an agreement, which will see them begin to negotiate on improving information exchange. In particular, the UK will be looking at the possibility of the Swiss authorities imposing a tax on any interest earned in their accounts by UK residents. This tax would be on behalf of HM Revenue and Customs. One concern, however, with this attempted crack down on tax evasion is that ‘innocent’ taxpayers could be the ones to suffer.
The following articles consider this recent development. It is also a good idea to look at the following link, which takes you to the OECD to view some recent agreements between the UK and other countries with regard to tax policy and the exchange of information. (The OECD)
Articles
UK in talks over taxing Britons’ Swiss bank accounts BBC News (26/10/10)
Doubts on plans to tackle tax evasion Telegraph, Myra Butterworth (21/10/10)
HMRC letters target taxpayers with Swiss bank accounts BBC News (25/10/10)
Spending Review: Can the taxman fix the system? BBC News, Kevin Peachey (22/10/10)
Britain, Switzerland agree to begin tax talks AFP (26/10/10)
Treasury to get £1 billion windfall in Swiss deal over secret bank accounts Guardian, Phillip Inman (26/10/10)
Swiss to help UK tax secret accounts Reuters (25/10/10)
Reports
The OECD’s Project on Hamful Tax Practices, 2006 Update on Progress in Member Countries The OECD, Centre for Tax Policy and Administration 2006
A Progress Report on the Jurisdictions surveyed by the OECD global forum in implementing the internationally agreed tax standard The OECD, Centre for Tax Policy and Administration (19/10/10)
Questions
- Is there a difference between tax avoidance and tax evasion?
- If there is crack down on tax evasion, what might be the impact on higher earners? How could this potential policy change adversely affect the performance of the UK economy?
- If tax evasion is reduced, what are the likely positive effects on everyday households?
- Is clamping down on tax evasion cost effective?
- What might be the impact on people’s willingness to work, especially of those on higher wages, if there is no longer a ‘haven’ where they can save their money?
- How could tax reform help the UK reduce its budget deficit?
Under the Basel II arrangements, banks were required to maintain particular capital adequacy ratios (CARs). These were to ensure that banks had sufficient capital to allow them to meet all demands from depositors and to cover losses if a borrower defaulted on payment. Basel II, it was (wrongly) thought would ensure that the banking system could not collapse.
There were three key ratios. The first was an overall minimum CAR of 8%, measured as Tier 1 capital plus Tier 2 capital as a percentage of total risk-weighted assets. As Economics 7th edition page 509 explains:
Tier 1 capital includes bank reserves (from retained profits) and ordinary share capital, where dividends to shareholders vary with the amount of profit the bank makes. Such capital thus places no burden on banks in times of losses as no dividend need be paid. What is more, unlike depositors, shareholders cannot ask for their money back. Tier 2 capital consists largely of preference shares. These pay a fixed rate of interest and thus do continue to place a burden on the bank even when losses are made (unless the bank goes out of business).
Risk-weighted assets are the value of assets, where each type of asset is multiplied by a risk factor. Under the internationally agreed Basel II accord, cash and government bonds have a risk factor of zero and are thus not included. Inter-bank lending between the major banks has a risk factor of 0.2 and is thus included at only 20 per cent of its value; residential mortgages have a risk factor of 0.35; personal loans, credit-card debt and overdrafts have a risk factor of 1; loans to companies carry a risk factor of 0.2, 0.5, 1 or 1.5, depending on the credit rating of the company. Thus the greater the average risk factor of a bank’s assets, the greater will be the value of its risk weighted assets, and the lower will be its CAR.
The second CAR was that Tier 1 capital should be at least 4% of risk weighted assets.
The third CAR was that equity capital (i.e. money raised from the issue of ordinary shares) should be at least 2% of risk weighted assets. This is known as the ‘core capital ratio’.
Before 2008, it was thought by most commentators that these capital adequacy ratios were sufficiently high. But then the banking crisis erupted. Banks were too exposed to sub-prime debt (i.e. debt that was excessively risky, such as mortgages on property at a time when property prices were rapidly declining). Much of this debt was disguised by being bundled up with other securities in what were known as collateralised debt obligations (CDOs). On 15 September 2008, Lehman Brothers filed for bankruptcy: the largest bankruptcy in history, with Lehmans owing $613 billion. Although its assets had a book value of $639, these were insufficiently liquid to enable Lehmans to meet the demands of its creditors.
The collapse of Lehmans sent shock waves around the world. Banks across the globe came under tremendous pressure. Many held too much sub-prime debt and had insufficient capital to meet creditors’ demands. As a result, they had to be bailed out by their governments. Clearly the Basel II regulations were too lax.
For several months there have been discussions about new tighter regulations and, on 12 September 2010, central bankers from the major countries met in Basel, Switzerland, and agreed the Basel III regulations. Although the overall CAR (Tier 1 and 2) was kept at 8%, the Tier 1 ratio was raised from 4% to 6% and the core Tier 1 ratio was raised from 2% to 4.5%, to be phased in by 2015. In addition there were two ‘buffers’ introduced.
As well as having to maintain a core Tier 1 ratio of 4.5%, banks would also have to hold a ‘conservation buffer’ of 2.5%. “The purpose of the conservation buffer is to ensure that banks maintain a buffer of capital that can be used to absorb losses during periods of financial and economic stress. While banks are allowed to draw on the buffer during such periods of stress, the closer their regulatory capital ratios approach the minimum requirement, the greater the constraints on earnings distributions.” In effect, then, the core Tier 1 ratio will rise from 2% to 7% (i.e. 4.5% minimum plus a buffer of 2.5%).
The other buffer is a ‘countercyclical buffer’. This will be “within a range of 0% – 2.5% of common equity or other fully loss absorbing capital and will be implemented according to national circumstances.” The idea of this buffer is to allow banks to withstand volatility in the global economy. It will be phased in between 2016 and 2019.
The Basel III agreement will still need to be ratified by the G20 countries meeting at Seoul on 10 and 11 November this year. That meeting will also consider other elements of bank regulation.
So will these extra capital requirements be sufficient to allow banks to withstand any future crisis? The following articles discuss this question.
Articles
Global bankers agree new capital reserve rules BBC News (12/9/10)
Q&A: Basel rules on bank capital – who cares? BBC News, Laurence Knight (13/9/10)
Basel III and Sound Banking New American, Charles Scaliger (17/9/10)
Wishy-washy rules might come back to haunt regulators Financial Times, Patrick Jenkins (18/9/10)
Basel III proposal released Newsweek, Joel Schectman (17/9/10)
New Bank Rules May Not Prevent More Meltdowns FXstreet, Henrik Arnt (16/9/10)
Basel III CBS Money Watch, Mark Thoma (14/9/10)
Basel III: To lend or not to lend Investment Week, Martin Morris (16/9/10)
Taming the banks The Economist (16/9/10)
Basel’s buttress The Economist (16/9/10)
Do new bank-capital requirements pose a risk to growth? The Economist, guest contributions
Myners: New rules ‘ignore bank liquidity’ BBC Today Programme, Robert Peston and Lord Myners (18/9/10)
Official press releases and documents
Group of Governors and Heads of Supervision announces higher global minimum capital standards Bank for International Settlements Press Release (12/9/10)
The Basel iii Accord Basel iii Compliance Professionals Association (BiiiCPA)
Details of the new capital requirements Bank for International Settlements
Details of the phase-in arrangements Bank for International Settlements
Questions
- What impact will a higher capital adequacy ratio have on banks’ behaviour?
- For what reasons may the Basel III regulations be considered too lax?
- When there is an increase in deposits into the banking sector, banks can increase loans by a multiple of this. This bank deposits multiplier is the inverse of the liquidity ratio. Is there a similar bank capital multiplier and, if so, what determines its size?
- Why will Basel III be phased in over a number of years? Is this too long?
Taxpayers may actually be in profit by several billion pounds, following reports from Lloyds that their profits are up in the first three months of 2010. At current share prices, the taxpayers are in profit by approximately £2 billion and this figure is expected to rise, as share prices continue to rise. Lloyds is 41% owned by the public, after a £17 billion bail-out rescued the debt-ridden bank. These profits follow two years of losses by Lloyds TSB and HBOS of over £6 billion in 2008 and 2009.
So, what has caused this change in fortunes? First, there has been a fall in the number of loans, which have gone bad. The bank said, “In our wholesale division, the level of impairments has been significantly lower than the last quarter of 2009 and is also at a lower level than our initial expectations for 2010″. Second, there has been a widening gap between the interest charged on a loan and the interest paid to depositors. However, despite this good news, this bank (and others) are still not lending enough to stimulate economic growth. Furthermore, as Lloyds still remains heavily dependent on loans both from British and overseas taxpayers, it could be some time before taxpayers see any return on their ‘investment’.
Lloyds: Black is the colour of spring BBC News, Peston’s Picks, Robert Peston (27/4/10)
Lloyds Banking Group returns to profits Guardian, Jill Treanor (27/4/10)
Lloyds profits revive as bad debts imorive Reuters, Edward Taylor and Clara Ferreira-Marques (27/4/10)
Lloyds Bank returns to profit Telegraph (27/4/10)
Lloyds and RBS shares to rise to give taxpayer potential £9bn profit Guardian, Jill Treanor and Larry Elliott (26/4/10)
Questions
- How have fewer bad debts and different lending and saving rates contributed to rising profits for Lloyds?
- If profits are back up, why are British banks still not lending enough?
- What factors will determine when the taxpayers actually see the return on their ‘investment’?
- In the Guardian article, ‘Lloyds Banking Group returns to profit’ what does it mean by “The bank did not change its earlier guidance that it expected to achieve £2bn of synergies and other operating efficiencies from the HBOS takeover by the end of 2011”?
- To what extent is the news about profits at Lloyds Banking Group and RBS a useful tool for the government in the upcoming election?
- Why is it so important that banks begin to increase their lending? What will determine the size of the effect on GDP of any given increase in lending?
The problem with banks and the financial sector is that we need them. Who knows what might have happened if the government hadn’t stepped in to bail out the banks. And that’s one of the key arguments for continuing to pay bankers’ bonuses. If they left their jobs and the banks ceased to exist, we’d be looking at a very bleak future.
The truth is: ‘we need them’ and, what’s worse, they know it. As Frank Skinner said in a Times article: ‘during the crisis bankers will be thinking, “Don’t panic. The public have got short memories. Show them the slightest hint of recovery and most of them will forget their moral indignation and we can start where we left off – making the biggest splashes we can and not worrying about the ripples” ‘.
Despite the argument for continuing to pay out bonuses, a large proportion of the public are understandably angry that bankers are still receiving enormous bonuses. Not only are banks and the financial sector largely responsible for the current recession, but it is taxpayers who have bailed them out and who now pay their bonuses. However, things could be about to change.
The FSA is set to get powers, allowing it to ‘tear up’ bankers’ bonus contracts, especially for those taking reckless risks that threaten the stability of the financial sector. The new regulations will be found in the Financial Services Bill, which, if approved by Parliament, will apply to all British banks, as well as the British subsidiaries of overseas banks operating in the UK. Multi-million pound payments will be able to be blocked and fines will be imposed on banks who offer unjustified ‘mega-bucks pay-outs’.
Despite this impending regulation, not everyone thinks it will be successful. Sir George Mathewson, the former Chairman of RBS, has said that interfering with bankers’ contracts is a ‘dangerous route to go down’. Read the following articles that consider this contentious issue.
Bankers bonuses’ ‘will soar to £6bn’ after government bailouts and rising profits Times Online, Katherine Griffiths (21/10/09)
Bonus crackdown plans dangerous BBC News (16/11/09)
Financial regulation ‘has broken down’ BBC Today Programme (16/11/09)
Roger Bootle: Bank reform hasn’t gone far enough (video) BBC News (25/12/09)
FSA to get powers to tear up’ bankers’ bonus contracts Citywire, Nicholas Paler (16/11/09)
It’ll be tough for bankers on a £200k bonus Times Online, Frank Skinner (13/11/09)
Prince Andrew defends bankers’ bonuses even as economy stays mired in recession Mail Online, Kate Loveys (24/10/09)
Curb on bankers’ bonuses to be unveiled in Queens’ speech Mail Online (13/11/09)
Bankers warn laws on pay and bonuses will scare off talent Telegraph Angela Monaghan (13/11/09)
Labour to overturn bonus deals at risk-taking banks Guardian Patrick Wintour (13/11/09)
Banking on the State Guardian (17/11/09)
Queen outlines new banking laws BBC News (18/11/09)
Queen’s Speech: what the Financial Bill really means for bankers’ bonuses Telegraph, Tracy Corrigan (18/11/09)
Brown Puts Deficit Curbs, Bonus Limits on U.K. Agenda Bloomberg, Gonzalo Vina and Thomas Penny (18/11/09)
Queen’s speech 2009: financial services bill Guardian, Jill Treanor (18/11/09)
Questions
- What is meant by ‘regulation’ and what forms does it take?
- Why are banks and the financial services largely blamed for the current recession? Will financial regulation of bonuses prevent a repeat of the current crisis?
- What are the arguments for and against further regulation? Why does the former Chairman of RBS argue that cracking down on bonuses could be ‘dangerous’? Do you agree?
- Why are bankers paid so much? How is the equilibrium wage rate determined in this sector?
- Should bankers receive bonuses? Think about the incentive effect; the effect on productivity. What are the possible consequences for those working in banking of bonuses being reduced and possibly removed if they are deemed to threaten financial stability?
Northern Rock seems to have had a fixed place in the news for the past year or so. Unfortunately, the advertising it’s been getting hasn’t been positive. The usual picture was one of a Northern Rock branch and a few hundred people queuing outside, ready to withdraw their savings.
In the financial crisis, the banking sector has been at the forefront of economic policy and billions of pounds of public money have been invested in banks simply to keep them afloat and encourage them to keep lending. But now the government, in a measure approved by the European Commission, is considering selliing part of Northern Rock, by splitting it into a ‘good bank’, which will be returned to the private sector, and a ‘bad bank’, which will have to remain nationalised. This bad bank would gradually run down its assets and eventually be liquidated. Similar plans are being considered for the part-nationalised Royal Bank of Scotland and Lloyds Banking Group.
Northern Rock’s loan book will be cut from £100bn pre-crisis to just £20bn to ensure that a bank which enjoyed state support should not have “an unfair competitive advantage”. Savers with Northern Rock will find themselves in the ‘good’ bank, while mortgage customers with arrears and those who are regarded as risky, will be seen as ‘bad’ bank clients.
The buyers of these banks remain unknown. Tesco was considered to be a possible buyer of Northern Rock but has pulled out, with plans to build a new full-service bank itself. Established banks, such as Barclays, will not be allowed to make a purchase and the FSA has stated that standards will not be dropped to allow new competitors to enter the market, especially given that much of the banking crisis is due to poor standards and insufficient regulation. National Australia Bank, the owners of Yorkshire and Clydesdale, is a possible buyer, as too is Virgin Money, even though it would require new finance and possibly new partners. Some potential bidders may be ruled out by competition considerations. So let the games begin!
The following articles look at the banking situation and the possible developments.
Where Gordon Brown feared to tread, Kroes is ready to trample Telegraph, Alistair Osborne (28/10/09)
Lloyds eyes capital raising plans BBC News (29/10/09)
Tesco rules out Northern Rock takeover Guardian, Julia Finch (28/10/09)
EU approves Northern Rock split BBC News (28/10/09)
The Business Podcast: The break-up of Northern Rock Guardian (28/10/09)
Lloyds Banking share price could scupper offer SME Web, Roberta Murray (29/10/09)
Roll up, roll up, for the great bank sell off Independent, Richard Northedge (8/11/09)
Treasury says Northern Rock may lose savers as Government pulls out The Times, Francis Elliott and Suzy Jagger (5/11/09)
Union fears for 25,000 jobs as EU insists Lloyds and RBS must shed branches Guardian, Jill Treanor (3/11/09)
Decision time for Lloyds shareholders BBC News, Money Talk, Justin Urquhart Stewart (11/11/09)
The Business podcast: The break-up of Northern Rock Guardian (28/10/09)
Details of the European Commission ruling on the restructuring of Northern Rock can be found at:
State aid: Commission approves restructuring package for Northern Rock
Questions
- What started all the trouble at Northern Rock?
- What are the arguments (a) for and (b) against the break up of Northern Rock and the other banks that received state aid? Do you think the right decision has been made?
- The BBC News article ‘Lloyds eyes capital raising plans’ refers to 43% of Lloyds being owned by the tax payer. What does this mean and how has it happened?
- Why do you think Tesco has decided not to put in a bid to take over Northern Rock?
- Consider the potential bidders for these new ‘good’ and ‘bad’ banks. In each case, consider the (a) advantages and (b) disadvantages. Then, explain the type of take-over or merger this would be and whether there could be any competition considerations.
- One of the aims of recent developments in the banking sector is to increase competition. Why is this so important and how will it affect consumers and businesses?