7 ways the Bank Levy could be improved

Implemented two and half years ago the bank levy is currently undergoing a much needed efficiency review. Gerald Montagu, a consultant in the tax department at Davenport Lyons, examines what the impact of the levy has been to date and how it could shape the future economy. Has it achieved what we wanted it to and how could it be improved? And the question on everybody’s mind, is it here to stay?


The alignment of the bank levy with the current regulatory framework and the operation of specific design features are among the elements being consulted on in the government's review of the levy's efficiency. The levy took effect on 1 January 2011, with the assurance of a review in 2013. The government is now consulting on the parameters of the review. Those wishing to comment should do so by 26 September 2013.

What is the bank levy and why was it introduced?

The Chancellor of the Exchequer explained in June 2010 that the bank levy would have two aims:

  • ‘encourage banks to move to less risky funding profiles’, and
  • ensure banks provide ‘a fair contribution in respect of the potential risks they pose to the UK system and the wider economy’

The levy was inspired, in part, by an IMF report, A fair and substantial contribution from the financial sector (June 2010).

To the extent that a bank’s (or banking group’s) chargeable equity and liabilities exceed £20bn, the bank levy is chargeable from 1 January 2014 at the full rate 0.142% in respect of ‘short term’ liabilities and a reduced rate 0.071% in respect of ‘long term’ liabilities and equity. The differential in rates is intended to encourage funding using sources like Tier 1 capital and protected deposits (which are both exempt from the bank levy) and long-term liabilities and equity which are subject to the levy at the lower rate.

Are the ‘overarching objectives’ of the bank levy being achieved?

The government believes a ‘fair contribution’ amounts to at least £2.5bn. The bank levy has operated not unlike a medieval ‘benevolence’ (where the Crown let it be known to certain wealthy subjects that they were expected to periodically contribute certain sums to the Exchequer)—and the rates have virtually trebled between January 2011 and January 2014 having been raised on no fewer than six occasions. Despite this, in both 2011 and 2012 the amount raised by the bank levy undershot the revenue-raising target set for it. A measure that over its first two years has generated, according to the Office of Budgetary Responsibility (OBR), only 68% of the anticipated revenue is hardly a resounding success in fiscal terms.

As an illustration of bank levy’s impact, the Royal Bank of Scotland’s balance sheet shrank from £2.4tr to £1.3tr between the end of 2008 and 2012. However, less than 6% of the balance sheet shrinkage took place in 2011 and 2012—suggesting a considerable reduction in the risk posed to the wider UK economy was achieved before the bank levy came into force. One can only speculate to what degree the bank levy (as opposed to regulatory initiatives) influenced the bank’s behaviour, but RBS reduced its liability to the bank levy from £300m in 2011 to £175m in 2012. A similar tale may be told at Lloyds, which reduced its liability by £10m over the same period. Yet, if these two state controlled banks, who in 2011 accounted for more than 27% of the revenue raised by the bank levy, reduced their bank levy liabilities by £135m in 2012, other institutions should be facing increased liability. This suggests that the bank levy punishes the whole sector for past misdeeds, while it is far from clear to what extent changes to funding models are attributable to the levy or regulatory pressure.

Slow progress has been made in entering into arrangements with other jurisdictions to prevent double taxation. To date, such arrangements have only been concluded with France, Germany and the Netherlands (notwithstanding that, as at June 2012, Austria, Belgium, Cyprus, Iceland, Hungary, Portugal, Romania, Slovakia, Slovenia, Sweden, South Korea and the United States also have introduced or intend to introduce a bank levy or similar measure).

On 4 July 2013, the Treasury and HMRC issued a consultation document (the July Condoc) which reviews how the bank levy is operating. The consultation does not, however, cover whether the bank levy’s original policy objectives are appropriate, as the government believes those objectives are by-and-large being met and does not wish to reconsider the appropriateness of those objectives.

How does the bank levy interact with changes to the regulatory framework imposed on banks including, for example, Basel III?

Not particularly well. The bank levy is just one of host of measures, including CRD IV, the ‘ring fencing’ of retail banking which underlies the Financial Services (Banking Reform) Bill and reforms in other related areas in the wake of the financial crisis, such as the finalisation and prospective adoption by the EU of IFRS 9.

Sir John Vicker’s Commission advocated that the bank levy should be abolished once ring fencing has been introduced. The Parliamentary Commission on Banking Standards (PCBS), for its part, concluded that ‘Tax rules are misaligned with regulatory objectives in that they reward banks for financing their activities through issuing debt rather than equity and so increase leverage, and create a disincentive for banks to hold capital in the most loss absorbent form’ the PCBS recommended that an allowance (ACE) should be introduced for corporate equity.

In the run up to Budget 2014 the government is considering whether an ACE would be desirable (and affordable). In preparation for the draft Finance Bill 2014, the Treasury and HMRC have proposed the exclusion from the bank levy which currently applies to all Tier 1 equity should be restricted to common equity to address this disincentive.

The desire to discourage excessive risk-taking is a theme which resonates both with regulatory reforms and the bank levy’s pursuit of more robust approaches to funding.

There are many facets to the multitude of initiatives which have been and are being undertaken, but a common theme is an intention to alter the structure and culture of firms by, for example:

  • reducing risk taking in the sector (eg, bank levy or remuneration deferral)
  • reducing the likelihood of firm failure (eg, capital and liquidity measures in the Basel III framework)
  • creating firebreaks by using the variants of ring-fencing (ie, Liikanen, Vickers and Volcker, as well as French and German alternatives), and
  • causing a cultural shift towards a bail in ather than bail out insolvency regime

The bank levy’s ‘behavioural’ objective could be aligned in particular with the first two points. On a political level, however, the bank levy also meets a need as being seen to be doing ‘something’—to improve consumer confidence and reprimand the banking sector. In terms of changing behavior, the bank levy can be seen as being at the punitive end of the spectrum in that it is chargeable on certain balance sheet equity and liabilities, some of which relate to past risk-taking. That said, while the intention behind the bank levy and regulatory measures may be aligned in certain respects, it does not mean the impact or practical effects of the bank levy necessarily complement and reinforce regulatory changes.

Could the bank levy be improved?

The July Condoc suggests several changes to the bank levy while emphasising that any package of reforms should be ‘cost neutral’.

The suggested changes include:

1.   either:

better targeting the exemption which applies to protected deposits by adopting a better analogue of ‘sticky’ deposits with regard to developments in the regulatory environment and banks’ systems (eg, by reference to all retail deposits, or retail deposits up to a cap [£50,000 is suggested]—interestingly, bank systems are likely already to target the $50,000 and $1,000,000 thresholds adopted for FATCA purposes under the intergovernmental agreement between the UK and USA), or

simplifying how existing rules are applied by removing links between the amount excluded from the bank levy and the fee paid under a foreign scheme which is equivalent to the Financial Services Compensation Scheme

2.    simplifying how netted exposures are treated to better accommodate ‘fail safe’ transactions, tripartite clearing arrangements and client clearing arrangements

3.    excluding assets held in a bank’s liquid asset buffer (rather than, as at present, excluding high quality liquid assets)—albeit this approach was not adopted because of the anticipated compliance burden which would arise given the fungible nature of funding (and, the odds must be, that it will not be adopted now for exactly the same reason as it was originally rejected)

4.     excluding transactions with a central-counterparty, the low margin on which can render such transactions uneconomic for a bank by virtue of the bank levy and seeking to provide more favourable treatment under the bank levy in respect of collateral upgrades and liquidity swaps, the efficacy of which has been recognised by the Prudential Regulatory Authority. The government wants to understand the benefits of such transactions better, is interested in whether the term of a short term reverse-repo or swap bears on its efficacy (and ascertaining at what point in time the position may change) and identify any implications in this context of the different ways in which central clearing is being implemented in the EU and US

5.   treating all deposits from authorised persons as short-term liabilities to ease the compliance burden

6.    seeking ways to reduce the compliance burden for UK branches of foreign banks—the government wants to better understand:

  •  in what ways extracting solo accounts is more difficult (eg, for US banks) in the bank levy context than for corporation tax purposes, and
  • the compliance issues that can be associated with a branch receiving information from its foreign head office
  • whether the allocation methodology could better reflect the risk posed to the UK economy
  • whether UK branches of entities which are not banks but which are part of a foreign banking group should be brought within the scope of the bank levy (as, indeed, is already the case in relation to a UK subsidiary of a foreign banking group)

7.    removing certain non-funding liabilities owed to HMRC (eg, with respect to PAYE, VAT and the TDSI) from the scope of the bank levy—this would seem eminently sensible

The government has also noted representations from some banks that certain types of transaction may become uneconomic if non-netted liabilities remain subject to the full bank levy rate. The government is concerned, however, that extending the netting rules would give rise to greater complexity (quite possibly giving rise to litigation) and has noted that regulation is focusing more on gross than net exposures. Against this background, the government has asked for views as to whether netting provisions should be removed from the scope of the bank levy and, on the basis that derivative contracts are often netted, instead impose a significantly lower rate of bank levy on derivative contract liabilities. Perhaps less radically (and probably less attractively), the government is also open to subjecting all derivative liabilities to the bank levy at the higher rate, while recognising that this would not reduce the administrative burden and further decrease the viability of lower margin transaction

How does the consultation affect regulatory specialists?

Two elements of the July Condoc are highly relevant to them:

  • it examines whether changing the way the bank levy operates would better align the levy with the government’s objectives, and
  • it seeks to ensure the bank levy remains aligned with current regulatory requirements and that it is sufficiently flexible to cater for proposed changes to the regulatory environment

The government is seeking evidence to highlight aspects of the bank levy where there is an actual or potential conflict between behaviour it is intended to encourage, and conduct that regulation is seeking to enforce. If, for example, the bank levy discourages banks from holding higher quality, better loss absorbing capital, then clearly this is an area for improvement. Firms wishing to improve the operation of the bank levy may want to submit evidence on which measures are better at driving the outcomes the government wants to achieve.

In terms of regulatory future proofing, the Banking Reform Bill is particularly relevant. Banks may want to see to what they need to (and can) ‘join the dots’ when considering what changes could be made to the bank levy to minimise their administrative burden.

A key point (which the July Condoc broaches directly at Q3.3) is whether banks want any more change at this point in time. The scope of regulatory change requires system changes and banks would welcome some joined-up thinking at a regulatory/government level so systems and process change requirements necessitated by amendments to the bank levy are linked into, for example, those changes caused by preparedness for CRD IV or EMIR.

Finally, it is worth noting that according to the OBR in 2011 the bank levy raised only £1.8bn, and the amount raised in 2012 was only £1.6bn—well short of the target of ‘at least’ £2.5bn and heading in the ‘wrong’ direction. Although the July Condoc delicately states the revenue raised was ‘smaller’ than expected, the shortfall is surely significant given the government’s explicit revenue target and it is therefore noteworthy that the government wants to understand whether the most significant factors in reducing banks’ exposure is expected to be changes to a bank’s balance sheet (eg, presumably having regard to the promulgation of IFRS 9 by the IASB and the FASB’s proposed accounting standard update 'Financial Instruments - Credit Losses' (Subtopic 825–15)), regulatory factors, economic factors and incentives set by the bank levy itself.

Given the complexity of the issues involved, it is worth noting that the government is planning an open meeting (London, 5 August 2013) to give participants an opportunity to make high level comment. Banks are also able to request involvement in three working groups for detailed discussion of protected deposits, netting and the other remaining issues arising from the consultation. Written responses should be sent by 26 September 2013.

Introduced as a response to the economic crisis, do you think the bank levy is here to stay?

Politically the bank levy was, in part, a counter-weight to the government’s decision not to impose a tax on banker’s bonuses and while banks have yet to recover public affection it would be surprising if the bank levy was to disappear.

The enthusiasm for imposing bank levies elsewhere has been muted (as evidenced by the relatively limited number of jurisdictions introducing similar measures) and the bank levy does not appear to have caused major banks to flee the UK—consequently, there is no significant ‘competitive’ pressure on the government to abolish the bank levy. Calls to abolish it, such as that by the Vickers Commission, have fallen on deaf ears. Ultimately, the government continues to wrestle with the structural deficit and the bank levy provides a useful (albeit, in the overall scheme of things, fairly modest) contribution to achieving this aim. The bank levy also now has a heightened importance, as the proposed Recovery and Resolution Directive (RRD) moves forward. At the moment the UK has a discretion (which the July Condoc stressed the government intends to make use of) not to set up a separate resolution fund (a feature of the RRD model proposals) provided the bank levy remains in place.

The bank levy is, in all likelihood, here to stay.

This piece, which includes comment from Caroline Bystrom, was first published as a Legal Analysis news item on Lexis®PSL Financial Services.

The views of our Legal Analysis interviewees are not necessarily those of the proprietor.


Filed Under: Tax

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