Windfall has too many fish hooks

A windfall profit tax on New Zealand's big banks is a seductive idea on at least three counts.

First, politicians believe banks are boosting "super profits" by refusing to pass on cuts in the official cash rate (OCR) to borrowers.

The finance and expenditure committee's report on banks this month talked about interest margins widening as markets eased funding costs and the banks refused to pass on the last OCR cut to borrowers.

The Reserve Bank has also called on the banks to pass on the last OCR cut to short-term borrowers. Fresh research from the Bank shows average overdraft rates for small businesses have dropped just 243 basis points to 9.82 per cent since mid last year while the OCR was cut 575 basis points to 2.5 per cent.

Secondly, the Government's massive deficit problem could be partially cured by taxing the banks more. The banks made a combined $4.5 billion in net profit last year so a windfall tax of say 25 per cent could generate more than $1 billion in extra tax revenues, significant even in the context of a deficit hitting 5 per cent of GDP next year.

Third, the Reserve Bank and the Government appear powerless at present to push the banks to pass on the last rate cut and essentially hand over some of their profits to their customers. The threat of a windfall tax would get the banks' attention and may even force some change.

The idea of a windfall tax has been used successfully in Britain and the United States.

The then-new Labour Government in Britain introduced a windfall tax in 1997 on privatised power, gas and phone companies to "capture" some of the monopoly profits.

The tax was levied in 1997 and 1998 and was set at 23 per cent of the difference between the stock market value of a company and nine times the average after tax value of the company. It raised £5 billion ($13 billion).

In 1980 the Carter Administration in the US introduced a windfall tax on oil producers to cream some of the super profits created by sharp rises in oil prices in the late 1970s.

This tax was structured as a levy on the difference between the market oil price and a benchmark linked to wider inflation measures. It raised US$393 billion ($614 billion) in the eight years before it was repealed by the second Reagan Administration.

But would a windfall tax on banks work here? The assumption in the wider political and public perception is that banks are creaming it. But that's not true when you look at the bank's general disclosure statements to the Reserve Bank.

They show net interest margins and profit as a percentage of assets falling over the past six years, in part due to the Government-subsidised competition from Kiwibank.

The funding costs of more than $100 billion of foreign bank debts are higher and competition for local term deposits is brutal, pushing up term deposit and therefore funding costs.

But that may not be enough to stop a windfall tax. Another problem with a windfall tax is it may weaken the banks' capital strength, in part because the Australian bank parents may want to take out capital if the profits and dividends are skimmed by the Government.

Is that really what Parliament wants? A weaker banking system?

One of the reasons New Zealand's economy will fare better than those in Europe, Asia and America is our banking system is stronger and has continued to grow lending by close to $20 billion through the recession.This idea works in a soundbite but doesn't stand up to decent scrutiny.