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. Although most of that assistance was ultimately recovered, it could have resulted in great cost to taxpayers. That assistance 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 the firms’ 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 provided the Federal Deposit Insurance Corporation (FDIC) with orderly liquidation authority. That authority is intended to allow the FDIC to quickly and efficiently settle the obligations of such institutions, which can include companies that control one or more banks (also known as bank holding companies) or firms that predominantly engage 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. The law 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 2017 on financial institutions subject to the orderly liquidation authority—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 Board of Governors of the Federal Reserve. The annual fee would be 0.15 percent of firms’ covered liabilities, defined primarily as total liabilities less deposits insured by the FDIC. Covered liabilities also include certain types of noncore capital and exclude certain reserves required for insurance policies. The sums collected would be deposited in an interest-bearing fund that would be available for the FDIC’s use when exercising its orderly liquidation authority. The outlays necessary to carry out the FDIC’s orderly liquidation authority are estimated to be the same under this option as under current law. If implemented on January 1, 2017, such a fee would generate revenues totaling $103 billion from 2017 through 2026, the staff of the Joint Committee on Taxation 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 2017–2026 period, the Congressional Budget Office accounted for 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. Net proceeds from such assessments are projected to total roughly $5 billion over the next decade. Under the option, CBO expects that the receipts from the fee would provide a significant source of funds for the FDIC to carry out its orderly liquidation authority and thus reduce the likelihood that an assessment would be needed during the coming decade. Therefore, to determine the net effect on revenues, CBO subtracted $5 billion in projected assessments under current law from the amount the new fee is projected to generate ($103 billion), yielding net additional revenues of $98 billion from 2017 through 2026.

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 two main disadvantages. 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. In addition, 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.