Balancing the Regulation and Taxation of Banking

Balancing the Regulation and Taxation of Banking

Sajid M. Chaudhry, Andrew W. Mullineux and Natasha Agarwal

This concise book gives a unique overview of bank taxation as an alternative or a compliment to prudential regulation or non-revenue taxation. Existing bank taxation is reviewed with a view to eliminating distortions in the tax system, which have incentivized banks to engage in risky activities in the past. The authors analyse the taxation of financial instruments trading, as well as the taxation of banking products and services to gauge whether this could finance resolution mechanisms and also help to ensure the stability of banks.

Chapter 3: Some lessons from the Global, or Great, Financial Crisis

Sajid M. Chaudhry, Andrew W. Mullineux and Natasha Agarwal

Subjects: economics and finance, financial economics and regulation, international economics, money and banking


In an environment of historically low interest rates, low returns and plentiful liquidity, investors actively sought higher yields; often through capital gains from rising asset prices. Risk was widely mispriced due to lax internal controls at banks and other financial institutions. As a result, an increased number of innovative and complex instruments were designed to offer more attractive yields, often combined with increased leverage. Specifically, financial institutions securitized their loans into mortgage-backed securities, which were subsequently converted into collateralized obligations (CDOs and CLOs), generating a dramatic expansion of leverage within the financial system as a whole. Financial institutions engaged in very high capital leverage ratios in pursuit of historically high returns on their equity; leaving them highly vulnerable to even a small decline in underlying asset (property) values, or even their rate of increase. The institutional shareholders came to expect banks to pursue high returns on equity, leading to large dividend pay-outs, and governments, particularly in the UK, where the financial sector was nearly four times GDP, were happy to reap the consequently substantial tax revenues form profits, high salaries and large bonuses. Meanwhile, the real wages of the middle- to low-income earners in the US had been stagnant for a number of years and so there was a ‘growth imperative’ and a need for easy access to credit to boost the consumption levels of this important set of voters (Rajan, 2011).

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