The sums behind ‘taxing’ the banks into a rate cut

Yesterday we were on the Sean O’Rourke show discussing variable rates on RTE Radio. We mentioned how doubling the ‘tax’ on banks won’t actually change anything. The mechanisms were briefly covered and we got a few emails asking for clarification so here it is.

The ‘levy’ was part of the Finance Act 2014 which imposed a new annual levy on financial institutions aiming to raise €150 million per annum for 3 years.

This sum is payable on October the 20th in each year (2014-2016) and it applies to a financial institution that is the holder of an Irish (or equivalent EU) banking licence or is an Irish (or equiv EU) building society that was obliged to pay DIRT – unless the amount required to pay in 2011 was not more than 100k.

The main outcry is centred on variable rates for primary home dwellers in particular. So how much of that debt is out there?

We know there are about 300,000 ‘loans’ but the quantum of debt is €39.638m which is about €3bn less than the outstanding debt of all trackers added up.

If the state was to ‘double’ the levy they’d be asking for an additional €150,000,000 from the banks. So apply  that (as in ‘divide it by’) to the gross outstanding debt and we see that it equates to about 0.37% or 37 basis points.

So we know the breakeven is at best about 1/3%. So if rates are generally about 4.2% then we could see them get to about 3.8(ish)% if banks respond to the threat.

What if instead they upped rates for new business instead though? Rates are currently (on front book) headed towards 3.5% and as time passes back book will respond by switching and that will bring down rates for existing business too, but if that doesn’t happen then this levy could inhibit something that would otherwise be a positive move.

A double of the levy is about one third of a percent in terms of the return on all variable rate mortgage debt for primary homes, so this ‘force’ (as media like to label it, I’d call it more like politically correct coercion) is not only marginal at best, but also unlikely to have the desired outcome.

Our best hope lies in what we know worked in the past, competition. Competition in the early 2000’s brought interest rates crashing down, that can come with its own problems, but given there is no credit bubble looming it can’t be ignored, competition works.

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