European Windfall Tax: Where will the Lightning Strike Next?

Fact

Over the past few months, clouds have formed over the European banking sector’s sunny uplands. The sector, which has been one of the winners of the great comeback of inflation since 2022, has reaped the fruits of central banks’ toughest fight against inflation since the Volcker era.

There are unfortunately only a few sectors whose levels of profitability are as political as bank earnings. With the cost-of-living crisis bolstered by the combination of post-COVID pandemic consequences and the Ukraine war hitting almost every European country, governments have increasingly been looking at the banking “cornucopia” as a means to fill budget gaps created by the crisis and to build political and electoral capital.

The Hungarian tax, voted through in Summer 2022, consisted of a 10% tax on banks’ net revenue in 2022 and an 8% tax on net revenue in 2023, and complemented already existing measures in the form of an interest cap on mortgages to limiting the impact of rising rates on households suffering from raging inflation.

While such taxes were initially implemented by a populist government, several European countries have followed Hungary in imposing windfall taxes on the banking sector. Among them are several CEE countries such as the Czech Republic, Croatia and Slovenia or Baltic countries, such as Lithuania and Latvia, with the common denominator for both groups of countries being a double-digit inflation rate in 2022 induced by the war and energy costs. The idea was also floated in Western European countries, first in Spain where the government imposed a 4.8% charge on net interest income above a €800m threshold per bank over 2 years. However, the bank-focused windfall tax Damocles’ sword became really mainstream among European governments when the Italian government decided to implement this tax on its banks.

The Italian tax law being voted on, while looking harsh at first glance as it seeks to tax 40% of the net interest income earned in 2023 if NII has grown by 10% or more from the 2021 levels, is in reality mitigated by cancellation measures if banks boost their reserves by an amount equivalent to 2.5 times the tax. The true impact of the law has however been felt by the whole European banking sector this time as majorities and oppositions are taking a stance on such laws in every European countries.

Since then, the oppositions in several countries have designed their own banking windfall tax laws, with some succeeding in passing the law through their lower house, as was the case for the Netherlands, while others have failed to do so, as was the case in Sweden.

Analysis

The question is now where the bank windfall tax storm will hit next. On further examination of the countries where such laws have been implemented, we see several risk factors which could help to assess the probability of banks being affected by windfall tax measures.

Amongst these risk factors, the most important is the strength of the impact of higher interest rates on households’ purchasing power as they remain the main political motivator for governments and oppositions seeking either re-election or election.

Countries which have witnessed double-digit inflation rates as was the case for the Baltic countries have implemented either windfall tax measures or specific measures to tax the banking sector more (Estonia). As such we see a high risk of similar measures being implemented in countries having been through similar tidal inflation waves; this category includes Romania (high risk), Poland (high risk) and Bulgaria (medium risk).

Another source of pressure on households’ purchasing power linked to rising inflation and policy rates likes in the proportion of variable mortgage rates in stock and production. Looking at the OECD 2018 data, we find countries such as Sweden (high risk with c.70% of variable-rate mortgages in the 2018 production), Estonia (high risk with c.90% of variable-rate mortgages in the 2018 production) or Poland (high risk with c.100% of the 2018 production at variable-rates combined with a high proportion of foreign-currency-denominated loans).

This issue is even more serious for households when their debt burden is elevated as a proportion of disposable income, as is the case for many Scandinavian countries. Sweden (high risk with 202% of household debt as a percentage of disposable income in 2021), the Netherlands (high risk with 211% of household debt as a percentage of disposable income in 2022) and Norway (medium risk with 247% of household debt as a percentage of disposable income in 2021).

Finally, another explanatory factor relates to the political volatility of the countries assessing the law as well as the political mileage from such measures for electoral purposes. Thus, countries with no clear majority such as the Netherlands (high risk, as the government collapsed last summer) or countries approaching elections (Poland, high risk) constitute good candidates for windfall tax measures. Such measures look even more politically advantageous in countries such as Poland as the banking landscape is controlled by foreign-owned entities (BNP, Santander, BCP, Commerzbank and ING, etc.).

Combining all the factors, we can triangulate potential locations where the windfall tax lightning is about to strike. We see a high risk in the Netherlands (ING, ABN Amro), Poland (BNP, BCP, Santander, Commerzbank, ING), Sweden (Handelsbanken, Nordea, Swedbank, SEB), Estonia (SEB, Nordea, Swedbank) and Romania (SocGen, Erste, ING, Raiffeisen, Unicredit).

Impact

The impact on valuation of windfall tax measures depends on many factors including the duration of the measures, their strength and their nature. Taking the Spanish example, the impact of the windfall tax represented c.4% of Caixabank’s market cap at the time of the announcement of the law and up to 10% for Sabadell. This represents an impact on domestic banks with nearly all of their operations in their home country. Banks being hit in foreign-located branches will likely see a lower impact even in the case of harsher measures given the low proportion of the relevant group’s assets being affected by the measure.

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