As you might have heard, the world seems to be moving towards a direction of levying a bank tax to cover for the cost of bank bailouts. In other words, like we have with other industries (such as the travel industry), every bank has to be taxed and the proceeds will be used for monies already been spent or that might need to be spent on bank bailouts. The IMF has proposed a plan, Germany is talking about a banking levy, the politicians in the UK are saying that they want to tax the banks and US President Obama is talking about imposing a bank levy. The G20 will be discussing it although some countries seem to be against the idea. The ECB is also a bit cautious about all this.
As you can imagine, the logistics of something like this is horrendous. Imagine HSBC, which works in more than 90 countries, is regulated by the FSA, but is pretty big in almost every country. What kind of levy are we talking about? Will it be applied in the UK on worldwide income or just UK income? Who holds the moneys? If we have a situation in Uzbekistan and there is a banking crisis there, how does the funding work? Which parts of the financial sector be affected? What about firms like HSBC which have both insurance and banking products? I am sure the big grand poo bah’s will work on this, but there is a bigger conceptual issue at stake.
What will the money be used for exactly? Will it go into the general taxation pool as suggested by France? Or should it go into a fund which will be ring-fenced and only used when a crisis happens as the travel industry emergency fund operates? I can see both ways, the current huge government budget deficits in so many countries has been primarily caused due to the government needing to bail out the banks, so the French proposal to push the bank levy funds to reduce the deficit is understandable. Then again, the flip side is the cynical side, where general tax pools belong to everybody and are the responsibility of none. The next time when we have another bank crisis, will the funds or the government fiscal situation be good to have a bail out? In other words, if the money raised by the bank levy is spent on say subsidies or the defence services or the health services and the welfare state which are not strictly investments (a quite possible situation), then the fiscal strength will not be powerful enough to get more monies to bail out the banks. Then again, I am unfortunately very cynical about politicians and their will power when it comes to taxes, spending and non hypothecated funds.
Which is why the HSBC proposal sounds very interesting. I quote:
HSBC is seeking support for a plan to direct any industry-wide bank levy into government-sponsored venture capital agencies, as part of a rearguard mission to change the terms of the ongoing bank regulation debate.
The bank has toured Europe seeking support for its ideas that include varying the capital buffers that banks are required to hold, depending on economic conditions. It believes banks should hold higher capital cushions in good times to absorb losses when conditions decline.
The HSBC plan would inject equity into capital-starved small and medium businesses. That would remove a big obstacle to lending – banks only lend to businesses that can prove they have sufficient equity in place. Critics say venture capital financing is not the business of government.
Now I think this is a ‘bloody’ good idea!The bank levy is thus used to encourage value addition, the investment in productive places, such as small and medium sized enterprises. Given the fact that currently the UK economy has 52% sunk in the public sector, the situation is crying out for investment to go into the private sector.
As for the critics who say that venture capital financing is not the business of government, could I point to some examples?
1. In the USA, the government has a range of funding bodies which assist in giving funding for firms, heck, the US government, in the form of Freddie Mac and Freddie Mae, assist in mortgage lending. If that isn’t capital financing, then what is?
2. In the UK, we have a similar situation. Do people remember 3i? Sounds like the HSBC plan is similar to this.
3. The French Government has funds and is definitely deeply interested in investments in industrial policy and funding for firms.
4. Then we have the whole industry of sovereign wealth funds. The wiki entry lists tens of countries which have this kind of a structure to invest national funds.
So I really don’t think that the critics are right to criticise this. If people are indeed concerned that the Governments cannot figure out the best way to invest, well, look at how the 3i firm works. Another way of looking at how to manage these funds is to look at how Sweden structured its pension fund system. Setup 4-6 different funds, ask fund or private equity or professional managers to bid for the right to run these funds transparently under a strong clear regulatory framework. If the managers don’t do their work properly or the returns are rotten, then switch them out.
I came across another post which talks about some more challenges with the plan: I quote (spelling mistakes are his):
· The first is I’ve run a venture capital backed company and I’ll happily say that some supposedly very good VC funds I dealt with knew nothing at all about running businesses. They’ve got wonderful MBAs. and not a clue how business works. Read Obliquity by John Kay if you want to know why. Entrepreneurs are foxes. VCs are hedge hogs - and poor ones at that.
· Second VCs screw entrepreneurs into the ground. There are few people on earth betting at devising disincentives than VCs.
· Third, they charge the earth for this privelige, and so requitre rates of return that usually prevent any useful business getting funding.
· Fourth, the vast majority of returns end up with the VC managers.
I am not sure how appropriate these criticisms are. Besides that rather gratuitous slagging off of MBAs (I am one myself in the interests of disclosure), the idea that Venture Capital funds have no clue about running businesses is rather interesting. All over the world we have VC funds merrily investing away, PE firms do the same, and quite often are providing business assistance to entrepreneurs. Finally, quite often the PE/VC firms are themselves run by entrepreneurs. As for the MBA’s asking for cash flows and plans, a bit of that discipline for running a business would not go amiss (again, in the interests of disclosure, I have run my own businesses).
VCs screwing entrepreneurs into the ground - hmmm, I am not really sure that this is indeed the case, because the economic incentive for a VC is to build the business, not plonk disincentives into the mix. Charging the earth is also fine, nobody is asking the entrepreneur to go ask for capital now, are they? But then, I am curious about the statement about VC’s not funding businesses. So I went looking for proof. Here’s a report by the British Venture Capital Association on how private capital injections and insolvencies work. The report finds, using a good quality quantitative study, that PE backed firms are stronger than other businesses. Also, they have over twice the debt recovery rate of publicly-owned companies. So I think we can categorically put paid to the objection that VC’s are useless in running businesses.
Now about the returns. Well, it’s a commercial arrangement, but here’s an interesting study on this situation. Good VC’s get start up equity at 10-14% discount. Now is that bad or good? If you ask me, the fact that the VC is bringing management and funding resources to the game means that a return has to be there. Here’s another study and I quote its abstract:
Using two complementary theoretical perspectives, we develop hypotheses regarding the determinants of the return required by venture capitalists and test them on a sample of over 200 venture capital companies (VCCs) located in five countries. Consistent with resource-based theory, we find that early-stage specialists require a significantly higher return than other VCCs when investing in later-stage ventures. Consistent with financial theory, we find that acquisition/buyout specialists require a significantly lower return than other VCCs when investing in expansion companies. Furthermore, in comparison to specialists, highly stage-diversified VCCs require a significantly higher return for early-stage investments. Independent VCCs require a higher rate of return than captive or public VCCs. In general, higher required returns are associated with VCCs who provide more intensity of involvement, have shorter expected holding period of the investment, and being located in the US or UK (in comparison to those in France, Belgium, and The Netherlands).
But I couldn’t find anything which corroborates the point being made that the VC grab all the returns. So I am not sure about the objections, I am afraid.
To conclude, it’s a good idea and needs to be pushed much more. I am quite impressed that the bank came up with this idea and is pushing it. It will do our reputation as a prudent bank thinking about our society and productive sectors a world of good.