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Why the bank levy is hosing down Commonwealth Bank of Australia shares

Overnight the federal budget introduced a 6 basis points levy on certain liabilities of the big banks such as Commonwealth Bank of Australia (ASX: CBA) and Australia and New Zealand Banking Group (ASX: ANZ) in a move designed to raise revenue from the banks in exchange for the government’s effective provision of liquidity insurance.

The government is to impose the tax on deposits held by the banks over $250,000 and other debt or money market instruments commonly in the form of paper or bank bills that the banks lend to each other.

Why has the levy been introduced?

On banks’ balance sheets the deposits and other short-term borrowings are recorded as liabilities that effectively earn lucrative interest over generally shorter time periods as they are liquid securities that may be redeemed at short notice if depositors decide not to roll over funding for example.

These liabilities on the banks’ balance sheets are generally not collateralised (unlike the loans they make to property buyers for example) which is an issue as the last GFC was commonly referred to as a “liquidity crisis” as many banks in Europe and the U.S. could not meet their obligations when depositors or other institutional lenders demanded their loans back.

In response to the crisis governments were forced to bail out the banks with taxpayers’ funds and impose regulation that effectively meant central banks would act as guaranteed lenders of last resort (LOLR) to the banking system.

However, this kind of government backed “liquidity insurance” on a giant scale involves substantial fiscal risks and complex modelling or real world pre-positioning of liquidity capital or collateral requirements at the central banks.

This status quo exists in Australia with the banks’ effective liquidity risk guaranteed, while they earn interest on their liabilities and are able to lend out more than a $1 trillion at super profitable returns (much of which is low risk via collateralisation against property) with bad debts at record lows.

In turn this means Australian banks have the highest returns on equity in the world (a key measure of profitability) and can operate with relatively high leverage ratios (liquid assets, versus liquid liabilities) thanks to the implicit guarantee the taxpayer is providing via guaranteed liquidity offered by the central bank.

The consequence has been record profit after record profit for the banks and a bonanza for shareholders, all the while with the government backstopping the bankers’ liquidity risk and their treasury teams’ balance sheet risk management operations.

It comes as little surprise then that the government is now seeking some financial redress, with shares in Westpac Banking Corp (ASX: WBC) down 1.7% today and National Australia Bank Ltd (ASX: NAB) shares opening 1.3% lower at $31.

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Motley Fool contributor Tom Richardson has no position in any stocks mentioned.

You can find Tom on Twitter @tommyr345

The Motley Fool Australia's parent company Motley Fool Holdings Inc. owns shares of National Australia Bank Limited. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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