Banks might choose to pass on the costs of the new windfall tax on bank profits to their customers, leading to an increase in the cost of loans to businesses and mortgages.
Cranfield: “The main Italian stock index could recover ground after Tuesday’s slip, but it seems to have interrupted this year’s rally.”
Government Backtrack – albeit Partial – after the Drop in Piazza Affari. The windfall tax on bank profits, unexpectedly announced after the council of ministers on August 7th, will have a maximum cap that cannot exceed 0.1% of the total assets of credit institutions. The FTSE MIB gains momentum and closes Wednesday’s session at +1.31%, with FinecoBank (+7.12%), Banco BPM (+5.45%), UniCredit (+4.37%), Banca Mediolanum (+2.68%), BPER (+2.21%), and Intesa Sanpaolo (+2.33%) among the top performing stocks. However, the net result for the country’s system from the Meloni government’s move remains largely negative. Experts suggest that not only the credit giants will have to grapple with the damages of the tax.
“The government’s U-turn shows that it wasn’t the right path to take,” says the head of investments at a major European bank consulted by We Wealth. “The net result for Italy’s system is negative, with the added risk that banks, faced with such a situation, might become stricter in granting loans. So, while the tax directly affects the banks, it indirectly impacts individuals who hold bank shares in their pension funds or equity funds, and who might see an increase in the cost of mortgages and loans.” The bounce-back in Piazza Affari, he adds, reflects the news of the tax cap. However, it’s important to remember that the market shies away from volatility.
“Medium-Term Reputational Damage for Italy”
“When a stock market is more volatile, it ends up trading at a discount because many investors desert it, preferring calmer markets. So, there’s a medium-term reputational damage that shouldn’t be underestimated,” explains the expert. The effect on the country’s risk perception will be hard to nullify, confirms Mark Cranfield, macro strategist of Bloomberg News’ markets live team. “The main Italian stock index could recover ground after Tuesday’s slip, but it seems to have interrupted this year’s rally,” he observes. “The next step will probably be an expansion of Italy’s credit default swaps, reflecting increased risk during a period of European stagflation, while the ECB continues to raise interest rates,” he warns.
The echo of the reputational impact is also resonating in the international press. According to the Financial Times, Meloni’s first encounter with the markets has damaged the country’s credibility. “They probably believed it was a measure against a relatively unpopular opponent—such as banks—that could be easily sold to the public without a significant impact on the markets,” says Lorenzo Pregliasco, co-founder of YouTrend, to the British economic and financial daily. “It was a big miscalculation,” he cautions. The move, as stated in the FT, appeared as the action of a government “improvising policies on the fly,” lacking awareness of the potential repercussions on credit institutions, the economy, or the broader international sentiment toward Italy.
Windfall Tax: Impact on Profits up to -11%
Returning to the effects on banks, Piergiacomo Braganti, Director of Macroeconomic Research at WisdomTree, calculates the potential impact of the windfall tax on bank profits’ net earnings. The top five national banks—Intesa Sanpaolo, UniCredit, BPER, Banco BPM, and MPS—recorded approximately 4 billion euros of additional interest income in 2022 compared to the previous year, Braganti recalls. In the first six months of 2023, the same five institutions saw interest income increase by around +55% compared to the same period last year, creating a much broader base subject to what Braganti calls the new “Robin Hood tax.” Given that they represent about 60% of the Italian banking system, the overall system’s increase in interest income is estimated to be between 6 and 7.5 billion euros, resulting in tax revenue from the new levy between 2.4 and 3 billion euros.
“It’s difficult to say whether the new extra tax will be deductible from the taxable base subject to ordinary taxation: at the moment, it seems not, but the parliamentary process could change that. If it were, the impact on 2023 net earnings would be in single digits, ranging between -6% and -9%. If it weren’t, we could hypothesize an impact on 2023 net earnings of around -8% to -11%,” says Braganti. “The impact on 2024 might be smaller, as the growth of interest income for the entire 2023 will likely be more contained,” he adds, pointing out three reasons:
- Banks will be compelled by media pressure, competition, and customers to better remunerate their cash holdings;
- The phase of interest rate hikes by central banks, including the European Central Bank, could come to an end;
- Customers will continue to move liquidity from non-interest-bearing sight deposits to more favorable opportunities, potentially prompting banks to take liquidity retention actions based on recognizing better interests.
According to experts consulted by We Wealth, the medium- and long-term effects of the windfall tax will not only affect large banks but also smaller, purely domestic banks with less diversified activities and more dependence on interest income.
Investing in Government Bonds Will Be Less Attractive for Banks
“The government is not imposing a tax on a bank’s total profits, but only on the interest margin, which is the difference between active and passive interests. The tax doesn’t touch other activities, such as contributions to profits from fees that banks charge when selling funds or policies. The first effect of this distortion is that it will shift banks towards activities other than interest margins,” explains Francesco Giavazzi, economics professor at Bocconi University and economic advisor to the Prime Minister during Mario Draghi’s government, to Corriere della Sera. He also notes that this could pose a risk to the state’s finances. “Investment in government bonds is part of the interest margin, so it will be less attractive for credit institutions to invest in government securities. Demand for these securities will decrease precisely when purchases by the ECB are declining,” Giavazzi observes, calling it a “self-goal.”
