Liberal-NDP bank tax could set precedent for further taxation in the future: Financial analyst
The federal Liberals’ proposed surtax on major Canadian financial institutions’ profits just took a big step closer to becoming reality after Justin Trudeau’s government struck a power-sharing agreement with the New Democrats.
But it’s not necessarily the extra money these firms could potentially have to pay that’s the biggest risk, according to one Bay Street analyst, it’s the precedent it would set in targeting financial sector profits.
“It's not something that's going to impact the banks’ earnings growth, or the return on equity materially going forward. To me, the bigger concern isn't this tax rate itself, but whether it sets a precedent for more onerous taxation on bank profits in the future,” said Nigel D’Souza, investment analyst of financial services at Veritas Investment Research, in an interview on Tuesday.
During Trudeau’s election campaign, he promised to impose a three per cent surtax on bank and insurance company profits above a $1-billion threshold. By lifting the tax rate to 18 per cent, from 15 per cent, the Liberals said they expected to collect an additional $2.5 billion in government revenues over the next four years. The promise was light on details at the time and still hasn’t come to fruition, but the move does have NDP support.
While speaking at a news conference on Tuesday morning, Trudeau said implementing the surtax remains a priority.
D’Souza estimates such a surtax would result in a one to two per cent impact on the big banks’ bottom lines, which is “very manageable.” He said he doesn’t think investors should lighten up on their bank holdings based solely on this new potential tax.
“The tax rate increase by itself, I don't think is a sufficient enough reason to have a more bearish or concerned outlook for the banking sector,” he said.
However, D’Souza said the additional tax could change how the banks decide to deploy capital, and even make them reluctant to lend if they expect their profitability will be hit by an extra tax.
“When you think about bank earnings - they're cyclical, they're tied to the economic cycle, and banks need to generate higher earnings in the good times so they have sufficient capital to weather the bad times - whether that's lower earnings or potential credit losses,” D’Souza said.
“If we get more onerous taxation on banks simply because they're making more profits, I'm concerned that changes the calculus of the risk-reward for the sector.”
In addition to addressing ever-growing bank profits, another major pillar of the Liberal-NDP support agreement is housing affordability, which D’Souza thinks is part of the political rationale behind the surtax policy decision.
If that’s what the government is aiming for, then D’Souza suggested removing the government guarantee on mortgage insurance for newly-issued mortgages. He argued it would force the banks to be more prudent with their lending standards, which in turn could help tamp down Canada’s red-hot housing market.
“If you end that, the banks will likely have to hold more capital against those insured mortgages. That will rein in some mortgage originations. They also might tighten up the underwriting standards, either requiring higher down payments for being more selective on who they approve for a high-ratio mortgages,” he said.
“Both of those will have an effect of lowering demand for the housing sector or housing purchases, and that should in theory - if we have supply also increasing and lower demand - that should address housing affordability while also addressing banks earning higher profits.”