State faces conflict of interest over planned bank tax

The Icelandic state faces a conflict of interest over a planned increase in the bank tax because it also owns Landsbankinn, the country’s largest bank, mbl.is reports. The government expects the tax increase to raise state revenue by six billion Icelandic krónur, while the 2027 budget assumes Landsbankinn will pay the state 22.1 billion krónur in dividends.

The state is therefore on both sides of the issue. It decides the level of taxation while also exercising ownership control over Landsbankinn and can influence how much money is withdrawn from the bank through dividend payments. The position of other banks is different because their dividend payments are not controlled by the state.

The special tax on financial companies is planned to rise from 0.145% to 0.254%. It is charged on financial companies’ liabilities exceeding 50 billion krónur. According to the explanatory memorandum accompanying the budget bill, the increase is expected to generate six billion krónur in additional state revenue, bringing total state income from the tax to 13.9 billion krónur in 2027.

Landsbankinn is the country’s largest bank, so more than one-third of the increase is expected to fall on the state-owned bank. Taking this into account, the state’s net revenue gain from the tax increase would be just under four billion krónur.

At the same time, the state has set profitability targets for Landsbankinn. The state’s guidelines on the bank’s profitability, capital structure and dividend payments call for a return on equity above 10% and a dividend payout ratio of 50%.

Impact on bank values estimated at 45 billion krónur

An IFS analysis published this summer estimated that a six-billion-krónur increase in the bank tax would reduce the value of the banks by around 45 billion krónur if the entire cost were borne by shareholders. The impact on Landsbankinn was estimated at around 17.4 billion krónur, while the impact on pension funds’ holdings in the banks was estimated at around 13 billion krónur.

On that basis, the state and pension funds would bear around 30 billion of the 45-billion-krónur impact of the tax increase on the banks’ value. The estimated effect on their market value would therefore be several times greater than the state’s expected net revenue gain.

Customers most likely to bear cost

In the explanatory memorandum, the government itself points out that the tax increase could affect bank customers. The cost could appear through wider interest margins, higher lending rates or lower deposit rates. Other consequences could include higher service fees, a reduced supply of credit or stricter lending requirements.

In an example presented in the memorandum, where the entire cost is passed on to customers and divided equally between borrowers and depositors, lending rates could rise by 0.06 percentage points and deposit rates could fall by 0.09 percentage points. For a household with a 50-million-krónur inflation-indexed loan with variable interest rates, that would amount to around 30,000 krónur in additional annual interest costs. The government stresses, however, that the example is not a forecast of the most likely outcome.

If the effects of the tax increase instead appear as lower bank profits, the owners would bear the cost. Pension funds are significant owners, meaning that the public indirectly owns a substantial share of the banking system through its pension savings.

The increase also comes as greater attention is being paid to the effects of political risk and changes in Icelandic banks’ operating environment on their credit ratings.