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The European Central Bank (ECB) is set to evaluate a proposed "windfall tax" on banks, commonly associated with the leftist political party AKEL, in Cyprus.
According to Panayiotis Rougalas' article published in Kathimerini Cyprus in Greek, this marks a significant moment as the ECB's stance will influence the potential implementation of the tax, a measure previously adopted in several countries.
This is not the first instance where European regulators have been called to comment on such proposals. Last year, on September 12, the ECB responded to a request from Italy's Ministry of Economy regarding a legislative decree aimed at urgent consumer protection measures and economic activities. The ECB's authority to provide feedback stems from regulations affecting financial institutions that are crucial for market stability and the ECB's responsibilities for prudential oversight.
While it remains unclear how the ECB will respond to the AKEL proposal, analysts suggest it may echo its previous guidance concerning Italy's tax. In December, ECB President Christine Lagarde had issued opinions on Spain's temporary tax measures targeting energy companies and banks, as well as on Lithuania's solidarity contribution for financial institutions. Both opinions evaluated similar legislative efforts in terms of monetary policy, financial stability, and oversight.
Historically, the ECB has expressed concerns that imposing a windfall tax on banks could hinder their ability to build capital reserves, reducing their resilience to economic shocks. Such taxes could adversely affect banks' capacity to extend credit, leading to less favorable borrowing conditions for consumers. As the ECB noted, a robust capital base is essential for banks to effectively mediate credit within the economy, and increased costs or diminished credit availability could impede economic growth.
According to the ECB, the proposed tax would impact both significant banks directly supervised by the ECB and smaller institutions overseen by national authorities within the Single Supervisory Mechanism. The latter are likely to be more affected due to their focus on lending activities compared to larger institutions that derive more income from fees.
The ECB also raised concerns about the basis for calculating the windfall tax, which does not account for the full business cycle, including operational costs and credit risk. This could result in a tax that does not reflect a bank's long-term profitability or capital-generating capabilities. Consequently, smaller banks or those with weaker solvency may struggle to absorb potential downturns during economic recessions.
Interest rates are another factor, with the ECB noting that while rising rates could initially boost net interest income, they might also lead to increased financing costs and potential losses from defaulted loans. Long-term, higher interest rates could negatively impact borrowers' financial health, raising credit risk. The design of the windfall tax does not adequately consider these dynamics, which should be thoroughly evaluated to ensure banks remain capable of weathering future losses.
Ultimately, the ECB warns that a windfall tax may make attracting new equity and wholesale funding costlier for banks. Domestic and foreign investors might hesitate to invest in institutions in jurisdictions imposing such taxes, especially if their future prospects seem uncertain. Additionally, introducing a retroactive tax could create undue policy uncertainty, undermining investor confidence and possibly affecting the financing costs for non-financial enterprises. The retrospective nature of the tax might also contribute to perceptions of an unpredictable tax environment, leading to potential legal disputes and regulatory uncertainty.
