Like any public policy, the Obama administration's proposed bank tax will likely yield some unexpected outcomes.
The administration's 15-basis-point tax would be levied against bank assets minus Tier 1 capital and domestic deposits, so the large banks affected could soften the blow by increasing deposits. That, in turn, could drive up funding costs for smaller banks that rely more heavily on deposits for liquidity.
"There are unintended consequences of this tax that affect the entire industry, not just banks above $50 billion," said Jim Chessen, the chief economist for the American Bankers Association. "There will be a tremendous focus on deposit funding with this kind of tax. … It has ramifications for all institutions that use deposits to fund themselves."
Bob Clarke, a senior partner at Bracewell & Giuliani LLP, agreed.
"That's the obvious way, to do more of your funding through deposits," he said. "It could drive up the cost of the funding for everybody else, because the money-center banks would be paying more. So the community banks would have to match what the big banks are paying for deposits."
Large banks could also cut back on advances from the Federal Home Loan banks.
"Some traditional commercial banks use a lot of home loan bank financing, and now they will rely less on that," said Kip Weissman, a partner at Luse Gorman.
Building equity is another way to reduce the impact. Kevin Jacques, a former Treasury official who now chairs the finance department at Baldwin-Wallace College in Cleveland, noted that the industry's weakest players were forced to increase equity capital as part of last spring's stress tests.
"There is a bias that helps the banks that really got into trouble," Jacques said. "If you had to raise Tier 1 capital, you are going to have a smaller tax bill."
The administration's plan identifies the deposits being exempted as those that are assessed by the Federal Deposit Insurance Corp.
The idea is the government does not want to tax the same liabilities twice. If banks are paying insurance premiums on a deposit, they shouldn't pay a tax, too. That led many sources to assume the administration's plan focuses on "insured deposits," but the FDIC actually assesses premiums against a bank's domestic deposits, a somewhat higher figure than insured deposits.
Some sources said large banks seeking to avid the tax would face some offsetting costs if they decide to beef up domestic deposits.
"To build up deposits quickly to replace wholesale funding, you'd have to do it most likely through brokered deposits, and brokered deposits tend to be more expensive than wholesale sources, so that's a partial offset," said Jaret Seiberg, a political analyst at Concept Capital. "There could be regulatory hurdles to loading up on brokered deposits. … I'm not saying [regulators] would stop it. I'm saying this is one of the hurdles out there that needs to be resolved."
Former FDIC Chairman Bill Isaac said a bank would also have to consider the premiums it would pay on those added deposits. "Deposits carry a tax, so you need to do the math," he said.
Robert DeYoung, a professor at the University of Kansas, agreed.
"If you have to raise deposits in a hurry, you have to pay a premium," DeYoung said. "You have to start by assuming that the liability structure that they have is the cheapest one for them, and to change it is going to be expensive."
As proposed by the president, the tax would be levied against roughly 50 financial companies, including 20 to 27 U.S. commercial banks with assets of more than $50 billion. Investment banks and insurance companies as well as the U.S. units of foreign banks make up the balance of targeted firms.
The administration has said it wants to raise roughly $90 billion over 10 years — and said the 10 largest firms would contribute 60% of this total — to cover losses expected from government programs put in place to stabilize the financial system.
The administration plans to provide more detail on Feb. 1 when it releases its budget for fiscal 2011. Congress would have to approve the idea, and most sources reached Tuesday said they expect Congress to make some changes. Lawmakers may raise the bar on bank participation, limiting the tax to companies with assets of $100 billion. Congress also might include the car companies or Fannie Mae and Freddie Mac.
The President has said he would like to have the tax in place by June 30, and sources said it would likely be determined on a quarterly basis. The administration is assuming the tax would be deductible, but its final form will be determined by Congress.
Populist anger is giving the idea momentum, and the tax is expected to pass the House. Both Ways and Means and the Financial Services committees are expected to vet the plan.
Odds of passage are longer in the Senate, where the proposal would also have to get through two committees, Banking and Finance.
A wild card was the special election Tuesday in Massachusetts to succeed Sen. Ted Kennedy, who died Aug. 25.
Over the weekend, Republican challenger Scott Brown criticized the White House bank tax, saying at a rally that it would be passed on to consumers. But his Democratic opponent, Martha Coakley, supports the tax. And in his weekly address Saturday, President Obama sharply criticized the banks for opposing the plan.
"If Scott Brown comes out and wins this, it may suggest the bank tax is not as politically potent that people thought last week," said Brian Gardner, a political analyst at KBW Inc.'s Keefe, Bruyette & Woods Inc. "Even though we are living in a populist age, there are some limits to populism,"
With the tax only being proposed Jan. 14 and the details still forthcoming many institutions are still weighing the best strategy to fight it, or lessen its sting.
But industry trade groups have been vocal in their opposition. "We think it's bad, so everybody should be carved out," said Scott Talbott, the senior vice president of government affairs at the Financial Services Roundtable.
The Securities Industry and Financial Markets Association is arguing that the tax is unconstitutional, because it singles out and punishes a specific industry. The New York Times reported the group has hired Carter G. Phillips of Sidley Austin to study the plan's constitutionality.
Interestingly, community bankers — who agree the large banks could become more threatening competitors for deposits because of this tax — also oppose it.
"I think it is an outrageous tax," said James D'Agostino, the chairman and chief executive of the $1.5 billion-asset Encore Bancshares Inc. in Houston. "It is a penalty tax on a specific industry, and it is unparalleled in our history as a country."
Cindy Blankenship, vice chairman of the $300 million-asset Greater Southwest Bancshares Inc. in Grapevine, Texas, said she worries that what is starting out as a tax on large banks will be extended to community banks.
"I am all for a big-bank tax, but you can have amendments and changes and it can become a very slippery slope," she said. "As this tax policy evolves, we need to make sure it doesn't have unintended consequences on Main Street banks like mine."