Banking Environment and Financial Sector Levies

Seminar on Value Based Management in Financial Institutions

Gdask, June 17, 2010

Mark Allen
Senior IMF Resident Representative for Central and Eastern Europe

Financial markets recovered faster than expected until recently

Euro Area Equity Markets ( Jan 1, 2007 = 100) 120 110 100 90 80 70 Selected IBoxx Spreads 1/ (all maturities, basis points) 800
A rated AA rated AAA rated All maturities BBB rated

700
600 500

400
300
S&P index FTSE index

60 50 40
2

200 100
2009 2010

Euro Stoxx 50

1/ IBoxx corporate bond rates over German benchmark bond yields.

2007

2008

2007

2008

Source: Bloomberg

2009

2010

Most financial markets are returning to normal

Heat map

Subprime RMBS
Money markets Financial Institution Commercial MBS Prime RMBS

Corporate credit Emerging Markets

Jan-07
3

Jan-08

Jan-09

Jan-10

Source: Global Financial Stability Report, April 2010

Bank balance sheets have strengthened

(billions of US$)
1000

800

Expected additional writedowns / loss provisions (left scale) Realized writedowns / loss provisions (left scale) Tier1/RWA capital ratio end-2009 (right scale) Implied cumulative loss rate (right scale)

20 18

16
14 12 10

600

400

8 6

200

4 2

0
United States 4 Euro Area United Kingdom Other Mature Europe Asia

but funding maturities have shortened

Mature Market Bank Bond Maturities (Percentage of initial stock)

18 16 14 12 10 8 6 4 2 0
1
5

6/30/2007

1/1/2010

7
Years

10

11

12

13

Source: Global Financial Stability Report, April 2010

 and credit supply remains restrained.

Private Credit Growth (annualized percent change of 3mma over previous 3mma)
United States Euro Area Latin America United Kingdom Developing Asia

120 100 80 60 40 20 0 -20 -40 -60 -80

Central and Eastern Europe

Source: Bank of England; European Central Bank; the Federal Reserve Board; IMF IFS

EM mutual funds are flush with cash

Cumulative Net Flows to EM Mutual Funds (Billions of USD) 80

60
40

20
0

-20

Source: Global Financial Stability Report, April 2010

..and capital flows to EMs have resumed.

Emerging Market External Bond and Equity Issuance (Billions of USD)

140 120

Middle East / Africa Developing Europe

Latin America Emerging Asia

100 80
60 40 20 0
8
Source: World Economic Outlook, April 2010

2006

2007

2008

2009

2010

The banking system is no longer providing net resources to CEE

External positions of reporting banks (billions of USD, estimated exchange rate adjusted changes)
60000 50000 40000 30000 20000 10000 0 -10000 -20000 -30000 -40000
Other Emerging Europe Baltics NMS2 CEE3

Source: Bank for International Settlements

but FDI is still positive.

Net capital flows to CEE (billions of USD)
25 20 15 10
Other Investment

FDI
Portfolio Total

5 0
-5 -10 -15

10

Source: Haver Analytics; IMF International Financial Statistics

The crisis is becoming one of sovereign finances.

The Four Phases of the Crisis (10-yr sovereign swap spreads, percent)
250 200 150
USA

I. Financial crisis Buildup

II. Systemic outbreak

III. Systemic response

IV. Sovereign Crisis?

100
50

Germany

Italy
UK Japan

11

Source: Bloomberg

Fiscal deterioration in some countries has become evident...

Public Debt (Percentage of GDP)

120

100
80 60 40

Advanced economies

20
0
12

Emerging and Developing economies

1995

2000

2005

2010

2015

Source: World Economic Outlook, April 2010

and sovereign borrowing has increased sharply.

Net Borrowing Needs (percentage of GDP)

16 14

12
10 8 6 4

2
0
13

2003-08 average United States

2009 Euro Area

2010 (est)

2011 (est) United Kingdom

Source: Global Financial Stability Report, April 2010

Some Government borrowing cost are rising.

10-year government bond yields 14
Czech Rep. Hungary Greece Poland

12
Germany

10 8 6 4 2

14

Source: Bloomberg

CEE banks have complex interconnections

2008-2009 Concern

15

European banks claims on the peripheral eurozone are substantial

USD 100 bln

Source: BIS

16

The direction of concern has changed

2010 Concern

17

Bank creditworthiness is connected with that of the sovereign.

200
Average percent change in local senior financial CDS
Greece

150 100
Ireland Portugal Spain France Germany United Kingdom

Italy
Norway Austria

50
0

Denmark Sweden

Switzerland Netherlands Belgium

-50
0

50

100

150

200

250

300

18

Percent change in sovereign CDS October 2009 to March 2010

Source: Global Financial Stability Report, April 2010

Taxing the Financial Sector

A

fair and substantial contribution from financial sector Various motives G20 asked IMF to study issue Objectives:

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reduce systemic risk tax rents in the financial sector

Financial Stability Contribution (FSC)

Direct support to financial sector 2.5% of GDP in advanced G-20 Guarantees averaged 25% of GDP FSC would cover this as business cost Levy on some on and off balance sheet items to encourage risk reduction Permanent and for all financial institutions Could feed resolution fund or general revenues

20

Financial Activities Tax (FAT)

FAT tax base

Pros and Cons

Profits and remuneration paid by financial institutions. Remuneration above some level, and abnormal profits Only profits above some highly abnormal level.

Similar to VAT and correct undertaxation of financial services Proxy for a taxes on return above competitive levels (rents). Correct for any tendency to excessive risk-taking from underestimating outcomes in bad times.

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Financial Transactions Tax (FTT)

FTT

paid every time a financial instrument or foreign currency is bought or sold. Some forms of FTT may be feasible Poor way to meet objectives of reducing systemic risk and taxing rents. Incidence may be on consumer. Easier to circumvent than FSC or FAT
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Fate of the Proposals

Leaked

at April deputies meeting Objections from Canada, Japan and emerging markets at June G20 meeting US and EU still plan to go ahead with levies New channel for arbitrage created?

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The impossible trinity

Financial Stability

Integration/Free trade
24 After Schoemaker

Sovereignty

Thank you!

25