How much could a UK bank windfall tax raise?

As the new Labour government mulls ways to raise funds, the prospect of a windfall tax on UK bank profits has spooked investors.

Shares in Britain’s largest banks were among the biggest fallers on the FTSE 100 on Wednesday as fears grew of a tax raid in October’s Budget.

While Labour said before the general election that it had no plans to raise taxes on banks, the government has remained silent on the possibility this week.

The Treasury did not respond to a request for comment by City A.M.

Keir Starmer, in his first major speech since becoming Prime Minister, said on Tuesday that those “with the broadest shoulders should bear the heaviest burden” for filling what Labour claims is a £22bn “black hole” in the public finances left by the Conservative government.

The banking sector is considered an easy target for an energy-style windfall tax, with lenders enjoying record profits due to the Bank of England’s interest rate hikes last year.

“UK banks are potential targets as the Labour government looks to raise funds in the upcoming budget,” said Tomasz Noetzel, an analyst at Bloomberg Intelligence.

Dan Coatsworth, investment analyst at AJ Bell, added: “It’s about as easy a target as you can get. No one is going to shed any tears if the banks are forced to hand over more of their profits.”

How are banks taxed?

While the UK has not implemented a bank windfall tax, it has charged a bank levy since 2011 that applies to lenders’ balance sheet liabilities and equity.

The Office for Budget Responsibility expects the levy, introduced in response to the financial crisis, to raise some £1.4bn in the 2024 fiscal year.

Since 2021, short-term liabilities have been taxed at 0.1 per cent, down from 0.21 per cent in 2015. Long-term liabilities are taxed at 0.05 per cent, compared to 0.11 per cent in 2015.

Noetzel said doubling the current levy to raise roughly £3bn would be “manageable for the largest lenders”. Lloyds and Natwest would face potential “low-single-digit hits” to their earnings per share, he added.

Banks also pay a corporation tax surcharge on their profits, which was introduced in January 2016.

The tax was cut to three per cent from eight per cent last April. However, a rise in wider corporation tax to 25 per cent, from 19 per cent, brought banks’ total rate up to 28 per cent, from 27 per cent.

“In our view, the most likely option that could be utilised in the government in their Autumn Budget is an increase in the banking surcharge,” Benjamin Toms, an analyst at RBC Capital Markets, told City A.M.

He said this option would be the easiest to implement and estimated that a three per cent increase in the surcharge could add roughly £1bn per year to the Treasury’s coffers.

“However, this is a balancing act,” Toms added. “The government was elected on a pro-growth agenda, and the banks are a key synapse in that objective. Any additional tax on the banking sector, in our view, would represent a headwind to the government’s UK growth ambitions.”

‘Deposit tiering’

Another idea that has gained prominence in recent years is “deposit tiering” – a method of limiting the interest paid to lenders on their central bank reserves.

Natwest, Barclays, Lloyds and Santander collectively earned £9.2bn in interest on deposits held by the Bank of England last year, which is ultimately covered by the Treasury. This figure was up 135 per cent from 2022 as banks reaped the benefits of higher base rates.

The central bank has been criticised for deciding to pay interest on the entirety of the high street bank reserves it holds as part of its quantitative easing programme to buy government bonds, which peaked at £895bn.

Sub-two per cent interest rates made the scheme profitable when it was introduced in 2009, but they have since climbed to five per cent and made it lossmaking.

UBS estimated in April that a UK version of the reserve tiering model already used by the European Central Bank would cost the country’s eight biggest lenders roughly £200m each per year.

Influential lobby groups like the TheCityUK have staunchly opposed a tax raid on banks, arguing UK financial services already pay more corporation tax than any other sector and that it would deter investment.

Several European countries, including Spain, Italy and the Czech Republic, have approved bank windfall taxes in recent years.

Italy’s original plans for a 40 per cent one-off tax last year were sharply criticised by lobbyists and the European Central Bank amid concerns it could make lenders vulnerable during economic downturns.

The government later revisited the policy and gave banks the option of boosting reserves to avoid paying the levy.