Impose a Fee on Large Financial Institutions

During the financial crisis that occurred between 2007 and 2009, the federal government provided substantial assistance to major financial institutions, effectively protecting many uninsured creditors from losses but at great potential cost to taxpayers. (Ultimately, that assistance proved not to be very costly.) That action reinforced investors’ perceptions that large financial firms are “too big to fail”—in other words, so important to the financial system and the broader economy that their creditors are likely to be protected by the government in the event of large losses.

In the wake of that crisis, legislators and regulators adopted a number of measures designed to prevent the failure of large, systemically important financial institutions and to resolve any future failures without putting taxpayers at risk. One of those measures, included in title II of the Dodd–Frank Wall Street Reform and Consumer Protection Act of 2010, established an orderly liquidation authority under the direction of the Federal Deposit Insurance Corporation (FDIC). That authority is intended to allow the FDIC to quickly and efficiently settle the obligations of a systemically important financial institution. Such institutions can include companies that control one or more banks (also known as bank holding companies) or firms that are predominantly engaged in lending, insurance, securities trading, or other financial activities. In the event that a large financial institution fails, the FDIC will be appointed to liquidate the company’s assets in an orderly manner and thus maintain critical operations of the failed institution in an effort to avoid consequences throughout the financial system.

Despite the new safeguards, if one or more large financial institutions were to fail, particularly during a period of broader economic distress, the FDIC might need to borrow funds from the Treasury to implement its orderly liquidation authority. Title II mandates that those funds be repaid either through recoveries from the failed firm or through a future assessment on the surviving firms. As a result, individuals and businesses dealing with those firms could be affected by the costs of the assistance provided to the financial system. For example, if a number of large firms failed and substantial cash infusions were needed to resolve those failures, the assessment required to repay the Treasury would have to be set at a very high amount. Under some circumstances, the surviving firms might not be able to pay that assessment without making significant changes to their operations or activities. Those changes could result in higher costs to borrowers and reduced access to credit at a time when the economy might be under significant stress.

Under this option, an annual fee would be imposed beginning in 2014 on financial institutions covered by title II—that is, bank holding companies (including foreign banks operating in the United States) with $50 billion or more in total assets and nonbank financial companies designated by the Financial Stability Oversight Council for enhanced supervision by the Federal Reserve Board of Governors. The annual fee would be 0.15 percent of firms’ total liabilities as reported in their financial statements, subject to certain adjustments, such as excluding deposits insured by the FDIC and certain reserves required by insurance policies. The sums collected would be deposited in a fund that would be available for the FDIC’s use in exercising its orderly liquidation authority. If implemented on January 1, 2014, such a fee would generate revenues totaling $73 billion from 2014 through 2023, the staff of the Joint Committee on Taxation (JCT) estimates. (Such a fee would reduce the tax base of income and payroll taxes, leading to reductions in income and payroll tax revenues. The estimates shown here reflect those reductions.)

In its current-law baseline projections for the 2014–2023 period, the Congressional Budget Office incorporated the probability that the orderly liquidation authority would have to be used and that an assessment would have to be levied on surviving firms to cover some of the government’s costs. CBO’s projections include $9 billion in receipts from such an assessment over the 2014–2023 period. Implementing this option would reduce the likelihood that such an assessment would be needed during that period. Therefore, in estimating the budgetary impact of the option, the amount of revenues ($9 billion) that the assessment was projected to generate was subtracted from the amount ($73 billion) the new fee is projected to generate, yielding net additional revenues of $64 billion from 2014 through 2023.

At 0.15 percent, the fee would probably not be so high as to cause financial institutions to significantly change their financial structure or activities. The fee could nevertheless affect institutions’ tendency to take various business risks, but the net direction of that effect is uncertain; in some ways, it would encourage greater risk-taking, and in other ways, less risk-taking. One approach might be to vary the amount of the fee so that it reflected the risk posed by each institution, but it might be difficult to assess that risk precisely.

The main advantage of this option is that it would help defray the economic costs of providing a financial safety net by generating revenues when the economy is not in a financial crisis, rather than in the immediate aftermath of one. Another advantage of the option is that it would provide an incentive for banks to keep assets below the $50 billion threshold, diminishing the risk of spillover effects to the broader economy from a future failure of a particularly large institution (although at the expense of potential economies of scale). Alternatively, if larger financial institutions reduced their dependence on liabilities subject to the fee and increased their reliance on equity, their vulnerability to future losses would be reduced. The fee also would improve the relative competitive position of small and medium-sized banks by charging the largest institutions for the greater government protection they receive.

The option would also have several disadvantages. Financial institutions might pass much of the cost of the fee to their customers, employees, and investors. In addition, unless the fee was risk-based, stronger financial institutions that posed less systemic risk—and consequently paid lower interest rates on their debt as a result of their lower risk of default—would face a proportionally greater increase in funding costs than would weaker financial institutions. Finally, the fee could reduce the profitability of larger institutions, which might create an incentive for them to take greater risks in pursuit of higher returns to offset their higher costs.