Tax à La Carte
Europe’s Robin Hood tax needs a temporary carve-out for the funding of banks through repurchase agreements, known as repo financing. Over the longer term, it is a good idea for lenders to reduce the instant gratification that short-term wholesale funding provides. But with sovereign debt concerns lingering, it is too early to pull the rug out from under them.
The financial transaction tax in its current version may snuff out much of the European repo market – a key source of banks’ short-term funding. A study commissioned by the International Capital Markets Association, a lobby group, reckons the tax would shrink Europe’s repo market by two-thirds and make maturities of less than a year uneconomic. The European Commission had anticipated the industry’s gripe: it believes exemptions for secured loans and transactions with central banks will keep credit lines open.
Both these alternatives to repo financing have limitations, however. A secured loan provides creditors with less legal protection in the event of default than a repo. Lenders of last resort, meanwhile, are already providing too much financing to the banking sector. And without a private repo market to lean on, central banks could find it hard to drain that excess liquidity.
Besides, repo is a low-margin business for banks that they often provide for free alongside other services. ICMA provides a value for outstanding European repo contracts in its six-month surveys (5.6 billion euros as of December), but no figures for annual turnover or profit. This lack of transparency led Europe’s tax authorities to overstate the amount the tax might raise by hitting repo, while underestimating its potential damage to the market.
The repo exception should be just that – an exception. Else the transaction tax, which only 11 countries say they will implement, risks becoming a joke. Exempting all fixed income market-makers, as the ICMA study also advocates, would reinforce distorting tax advantages for debt instruments. It would also unduly benefit the investment banks that the tax is intended to hit.
There’s no doubt that European lenders need to cut their reliance on short-term financing: the International Monetary Fund warned last year that the region’s dependence on it raises the risk of future bank runs. But the stringent capital controls recently imposed in Cyprus are a reminder of the fragility of some of the region’s banks. For that reason primarily, the repo market deserves a stay of execution.