The new Labour government’s consideration of ways to raise funds has sparked fears of a windfall tax on UK bank profits, unsettling investors. Shares in Britain’s largest banks experienced significant drops on the FTSE 100 on Wednesday due to growing concerns about a potential tax raid in the upcoming October Budget.
Despite Labour’s pre-election assurance that it had no plans to increase taxes on banks, the government has remained tight-lipped on the matter this week. The Treasury did not respond when asked for comment. In his first major address since becoming Prime Minister, Keir Starmer stated on Tuesday that those “with the broadest shoulders should bear the heaviest burden” in addressing what Labour alleges is a £22bn “black hole” in public finances left by the Conservative government. The banking sector, which saw record profits last year thanks to the Bank of England’s interest rate hikes, is viewed as an easy target for an energy-style windfall tax.
“UK banks are potential targets as the Labour government looks to raise funds in the upcoming budget,” commented 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.” The UK has not yet implemented a bank windfall tax, but it has levied a bank charge since 2011 that applies to lenders’ balance sheet liabilities and equity. The Office for Budget Responsibility anticipates that the levy, introduced in response to the financial crisis, will generate around £1.4bn in the 2024 fiscal year. Since 2021, short-term liabilities have been taxed at 0.1 per cent, a decrease 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 suggested that doubling the current levy to raise approximately £3bn would be “manageable for the largest lenders”. He added that Lloyds and Natwest could face potential “low-single-digit hits” to their earnings per share.
Banks also pay a corporation tax surcharge on their profits, which was introduced in January 2016. The tax was reduced 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. Benjamin Toms, an analyst at RBC Capital Markets commented “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.” 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 remarked. “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.”
A strategy drawing increased attention in financial discussions is “deposit tiering”, a technique aimed at reducing the interest paid by banks on their reserves held at the central bank. Last year, major banks including Natwest, Barclays, Lloyds, and Santander made £9.2 billion from interest on deposits at the Bank of England, a cost ultimately borne by the Treasury. This represents a significant increase of 135 per cent from 2022, thanks to the benefits gained from heightened base rates. The decision by the central bank to pay interest on all reserves of high street banks—tied to its quantitative easing programme for purchasing government bonds that surged to £895bn—has faced criticism. The scheme was profitable at its 2009 inception with sub-two per cent interest rates but became loss-making as they have since risen to five per cent.
UBS projected in April that implementing a version of reserve tiering—similar to that used by the European Central Bank—could impose an approximate annual cost of £200m on each of the UK’s eight largest banks. Prominent lobby groups such as TheCityUK have strongly resisted a tax raid on banks, arguing that UK financial services already pay more corporation tax than any other sector and that it would deter investment. In recent years, several European countries, including Spain, Italy, and the Czech Republic, have approved bank windfall taxes. Italy’s initial plans for a one-off 40 per cent tax last year were heavily criticised by lobbyists and the European Central Bank due to concerns it could make lenders vulnerable during economic downturns. The government later revised the policy, offering banks the option of boosting reserves to avoid paying the levy.
The potential implementation of a windfall tax on UK banks is a contentious issue, with significant implications for both the banking sector and the broader economy. Analysts suggest that while such a tax could generate substantial revenue, it could also pose challenges to growth and financial stability. The situation remains fluid, with the government’s final decision expected to be closely watched by investors and industry stakeholders alike.
