The European Central Bank (ECB) has attacked Italy’s windfall taxes on banks. It warned that the tax could make the sector more susceptible to an economic recession and encouraged Rome to carefully evaluate the impact of this levy.
The ECB’s nonbinding Legal Opinion was published on Wednesday as its governing Council met in Frankfurt, and is likely to increase tensions between Rome and the ECB, which are already high after Rome’s sharp rise in borrowing costs.
In an interview on Wednesday night, Italian Prime Minister Giorgia meloni said that the tax would not be scrapped, but she did say the details of the tax could be changed, as long as the revenue remained “unchanged”, and it still generated the “just below” €3bn Rome now expects.
She said, “I don’t want to go backwards, even if there are corrections that need to be made.”
Her comments come after the ECB warned banks with lower capital levels and smaller institutions that are more reliant upon traditional lending activities, “could be less able” to absorb potential downside risks from an economic downturn as a result of the tax .
The report added that Italy tax could also harm the financial stability of the eurozone, as it would reduce banks’ retained profits, limit their lending capacity, and hinder their ability to accumulate capital buffers for future losses.
Matteo Salvini, the deputy prime minister of Italy, announced last month that a 40% tax would be imposed on a portion (the margin) of net interest incomes for Italian banks. This is the difference between what Italian banks earn on loans and what they pay depositors. The decision shocked investors, and the next morning bank stocks tumbled.
As banks and investors sought clarification, different versions of the proposed tax were released. After almost 24 hours, the Finance Ministry partially reversed and reduced the scope of the tax. The collection was capped at 0.1 percent of total bank assets.
The ECB has criticized similar moves by the EU governments of Spain, Hungary and the Czech Republic in the last year.
Meloni has defended this one-off tax repeatedly, saying it was necessary to curb the “illegitimate profit” of lenders who failed to increase deposit rates despite the ECB policy rates increasing. She called it “a tax on unfair margin” in a video posted to social media.
Lenders have challenged the tax and questioned its legality. In a testimony to the Italian Parliament this week, the Italian Banking Association stated that the tax violated the Italian constitution’s right to property principle because it was “expropriation-like” in nature.
The association argued, too, that comparing the current margins to those of a time when “interest rates were hovering around zero” is not an accurate comparison and may violate EU principles on free competition.
ECB has warned that the retroactive nature of this tax “may fuel perceptions of a taxation framework which is uncertain and lead to extensive litigation leading to problems of legal insecurity”.
The ECB warned that this trend may not continue, as banks could face lower lending volumes or higher default losses on their existing loans.
The Italian economy shrank by 0.4 percent in the three-month period ending June compared to the previous quarter. This was due to a slowdown in manufacturing and a reduction of tax incentives for renovating houses.
The ECB recommended that the decree law, in order to assess if its application poses a risk to financial stability and, in particular, whether it could impair the resilience of the banking industry and cause market distortion, be accompanied with a thorough assessment of any potential negative consequences to the banking sector.
The ECB said that this analysis should include a look at the impact of the tax on the banks’ “long-term profitability, capital base and access to financing, as well as the creation of new lending conditions and competition in the market and its possible impact on liquidity”.
The report said that some lenders could make higher net incomes while still losing money if their fee-earning activities suffered a setback. This tax could fragment the European banking system due to its heterogeneous nature.