Wednesday, March 5, 2014

Make banks less risky with a tax -- one they don't have to pay

I wrote recently in Bloomberg about a really cool proposal to introduce a new kind of tax on financial transactions. The tax would be specifically linked to how much systemic risk a transaction -- say a loan from one bank to another -- creates. It's easy to roll your eyes when you hear about transaction taxes, thinking A. it will never happen and B. it might not do much good even if it did. There are real reasons to believe that a transaction tax might damage market liquidity. But the thing I'm writing about here is VERY different.

This is a tax institutions DON'T HAVE TO PAY. Institutions that work hard to borrow and lend in a way that doesn't increase risk to the overall financial system (by piling up debt on particular institutions, for example) would end up paying no tax. The idea is to bring systemic risk into the pricing system so institutions have an incentive to avoid it. In so doing, you provide a mechanism for the entire financial network to reconfigure itself to have lower systemic risk. The paper I'm writing about proposes a concrete method to do this, although it would in practice require giving central banks more information on financial transactions of many kinds.

This is the kind of really creative thinking we need a lot more of. Read more here.

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