Expert Analysis: Insulating taxpayers from banking failures

When a bank is bankrupt there are three sets of potential immediate losers: shareholders can lose the money they have invested; depositors can lose their savings; or taxpayers lose income as public money is provided to support the institutions.

In the recent crisis, developed governments chose to protect retail depositors - current voters and consumers, if you will - and allowed the costs to fall on shareholders and taxpayers (in this case, future voters and consumers). Policy makers experimented with not providing financial support for Lehman Brothers. This experiment was not a success.

The result has been that a financial system which teetered on the brink of complete collapse is now in recovery - but at the price of soaring public debt levels and historically high budget deficits.

This would be reason enough for governments to reconsider their relationship with the banking sector. But the point becomes still stronger when the wider economic consequences of the systemic financial crisis - falling income, employment and living standards globally - are seen. Commonwealth countries - more open and integrated in the global economy than others - have more to gain than most from a more efficient future system.

The worry is that with taxpayer support for financial institutions fully acknowledged, the incentives to future reckless lending and crisis are strengthened. So new approaches are being proposed to insulate taxpayers and the global economy from banking sector failure. Two are attracting most attention and were high on the agenda when the finance ministers from G20 countries gathered in Washington. They will feature again when Heads meet in Toronto in June.

The first is a tax on the assets of banks which would both help rebuild the public finances now and provide the resources for future financial problems. Operating such a tax internationally would allay concerns about individual countries losing competitive advantage. But - not surprisingly - countries whose financial systems were robust in the crisis see less need for co-ordination.

The second approach revives a scheme for a tax on financial transactions, often referred to as the Tobin tax. This requires a high degree of international co-operation in the implementation of the tax and managing access to the resources it yields.

The IMF has produced preliminary analysis of these two approaches. Whilst both will raise the revenue needed to provide a buffer against the costs of future financial crisis, it is argued that the first would go further to reduce the incentives to risky behaviour in banks and would not adversely affect ordinary users of financial services. This position is disputed and will be a focus of continuing debate in the run up to decisions in the summer.

Jonathan Ockenden is Head of International Finance and Capital Markets at the Commonwealth Secretariat

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