Italian markets plummeted, causing a loss of $10 billion in bank stock value, following the unexpected implementation of a windfall tax by the right-wing government.

Italian markets plummeted, causing a loss of $10 billion in bank stock value, following the unexpected implementation of a windfall tax by the right-wing government.

Italy unveils a 40% levy on bank profits: A creative approach to financing economic relief

Italian Banks

Italy’s Deputy Prime Minister, Matteo Salvini, made a surprise announcement late Monday night, revealing a new 40% levy on lenders’ extra profits. As part of a wide-ranging decree approved at a cabinet meeting, this move aims to address the cost-of-living crisis faced by Italian families. The government is seeking inexpensive methods to finance economic relief initiatives, including tax cuts and support for first-time homebuyers.

However, the implementation of this levy requires parliamentary approval, leaving room for potential changes or legal challenges, as seen with a similar measure in Spain. Yet, the immediate impact on Italian banks was undeniable. Shares in UniCredit SpA dropped by as much as 6.7%, while Intesa Sanpaolo SpA saw a decline of about 8.6%. Consequently, the market value of Italian lenders shrank by a staggering €9.5 billion.

The news also sent shockwaves through the markets, with Italy’s FTSE MIB benchmark index experiencing a 2.1% drop. Additionally, the euro-area banks index slumped by 3.4%, the most significant decline since March. Investors and analysts worldwide are now closely monitoring Italian credit risk compared to German credit risk.

John Bilton, the head of global multi-asset strategy at JP Morgan Chase Bank, expressed concerns about the motivations underlying the Italian economic policy. This uncertainty could have implications for the pricing of Italian credit risk.

The surprising levy announcement followed a streak of positive news for Italian banks. The recent earnings reports indicated impressive performance, with Intesa and UniCredit even raising their full-year guidance for the second consecutive quarter. UniCredit, for instance, saw a surge of 42% in net interest income during the first half of the year.

A Burden on Italian Banks

According to analysts at Bloomberg Intelligence, Italian lenders, particularly domestically focused banks, could face a cumulative tax liability of over €3 billion if the government’s levy is enforced. This estimate is based on the coverage of six Italian banks. For some institutions, such as BPER and Monte Paschi, this tax would represent the majority of their excess capital. However, it is expected to be a lesser burden for UniCredit and Mediobanca.

While a similar pattern of banks benefiting from higher interest rates and unveiling share buybacks has emerged across Europe, Italy’s new levy seems to counter this trend. The cost-of-living crisis has sparked a growing backlash against banks, and accusations of profiteering have also been directed at UK financial institutions.

Antonio Tajani, another deputy premier in Italy, blamed the European Central Bank (ECB) for the situation. He argued that the ECB was mistaken in raising interest rates, thereby creating an inevitable consequence for Italian banks.

Citigroup Inc. analysts echoed concerns, viewing the levy as substantially negative for banks. The impact on capital, profit, and the cost of equity for bank shares is expected to be significant. In fact, Citigroup’s simulation now predicts a higher impact than the one they ran in April.

Luigi Tramontana, an analyst at Banca Akros, estimated that the tax could generate over €2 billion for Italy. Furthermore, he projected an average impact of 7% on the earnings per share of the Italian banks under coverage.

The Tax Mechanism and Allocation

The Italian government will choose between two options, selecting the one that generates the highest amount. The tax revenue will be deposited into a fund designed to alleviate fiscal pressure on families and companies. The first option imposes a 40% levy on the difference between net interest income in 2022 and 2021, as long as the difference exceeds 5%. Alternatively, the second option targets the difference in net interest income between 2023 and 2021, setting a floor of 10%.

It is worth noting that the tax cannot exceed 25% of a bank’s shareholders’ equity. By specifying the use of this revenue for measures supporting families and companies, the government hopes to justify the levy as a necessary step towards economic relief.

A Wider European Trend

Italy is not alone in exploring unconventional approaches to banking taxes. Last year, the Spanish government surprised investors by introducing a windfall tax on banks due to soaring interest rates. This tax aims to raise €3 billion over two years and forms part of a broader set of measures to mitigate the impact of inflation. Spain’s largest banks, including Banco Santander SA and Banco Bilbao Vizcaya Argentaria, have expressed their dissatisfaction and may challenge the tax in court.

Similarly, some Baltic countries are considering measures to raise taxes on banks following rate hikes that have driven higher profits. Lithuania has already implemented a temporary windfall tax on banks to finance defense spending, while Estonia plans to increase the tax level from 14% to 18% as part of efforts to narrow the budget deficit. Latvia may also follow suit.

The global banking landscape is witnessing novel fiscal policies that seek to balance the interests of financial institutions, customers, and governments. As governments grapple with economic challenges and cost-of-living crises, they are exploring alternative sources of revenue to fund essential relief measures. The impact of Italy’s levy on banks, both in the short and long term, remains uncertain. However, its introduction reflects the creative and sometimes controversial measures being implemented to finance economic relief.

This article was written based on the original content from Bloomberg.