As Windfall Tax Calls Grow, ECB Warns of Impact on Cost of Credit

As British Prime Minister Rishi Sunak’s government attempts to move on from the short-lived Truss tenure, all signs point toward a major realignment of the British tax regime that will seek to plug a 60 billion pound ($68.7 billion) hole in the public finances.

The government’s fall statement is expected to announce up to 35 billion pounds ($40.1 billion) of spending cuts and up to 25 billion pounds ($28.6 billion) of increased taxes, per U.K. press reports on Monday (Nov. 7).

While the exact details of any changes remain to be seen, some politicians have called for a “windfall tax” on U.K. banks’ profits, similar to a legislation being pursued in Spain.

See more: Government Unfazed as Multisector ‘Windfall Tax’ Draws Ire of Spanish Banks

There, the Madrid government has moved to impose a 4.8% levy on banks’ net income from interest and commissions, considering bumper profits that have followed eurozone interest hikes.

And in both countries, the most recent quarterly earnings published by banks certainly give credence to the claim that they are profiting from higher interest rates.

The Anglo-Spanish banking group Santander, for example, posted 25% higher earnings in the first nine months of 2022 compared to the same period last year. And at UK’s HSBC, $23 billion was generated from interest alone according to its third quarter (Q3) results, up from $19.7 billion during the same time period last year.

That being said, higher earnings from greater interest margins don’t tell the whole story. Another notable similarity between the Q3 earnings reported by Spanish and British banks is that they all reported higher-than-expected expenses associated with bad loan reserves.

In fact, banks have set aside billions as in anticipation of a wave of credit defaults in the coming months, contributing to a mixed performance picture for the European banking sector.

Read on: UK Big 4 Beef Up Loan-Loss Reserves as Calls for Windfall Tax Intensify

Bank Taxes Divide Opinion in Europe

Further complicating things, the European Central Bank (ECB) recently raised concerns that Spain’s windfall tax could hit banks’ capital positions and end up increasing the cost of credit.

In an opinion published last week, the ECB cautioned that “the realisation of downside risks in the current environment may significantly reduce the repayment capacity of debtors.” Because of this, the regional financial institution argued that the effect of higher interest rates on bank profitability “might therefore be less positive, or even negative, possibly over an extended horizon.”

Meanwhile in the U.K., former deputy governor of the Bank of England Sir Charlie Bean told economic think tank Resolution Foundation’s event last week that a windfall levy on banks’ income from interest could potentially raise “tens of billions” of pounds.

Echoing Bean, the U.K.’s centrist political party, the Liberal Democrats, called on the government to introduce a temporary windfall tax and cancel planned cuts to the bank surcharge — the higher rate of corporation tax paid by banks and building societies.

Away from banks’ profits, other potential targets of tax increases in the U.K. include inheritance tax, capital gains tax and council tax. Proposals to lower the threshold for dividend tax relief and remove tax breaks for high-earning pensioners have also been floated.

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