Italy surprises with a bank tax

On 7 August 2023 the Italian government announced an extraordinary tax on banks’ profits. The next day European bank shares fell sharply, and the government later softened the measure. It was a decision that surprised the market by its speed and its scope.

The episode showed that a change of rules in a single country can affect an entire sector across Europe. Investors did not know whether other governments would follow the same path, and that uncertainty was enough to provoke an immediate reaction in share prices. The later softening of the measure eased the pressure, but left a lesson about the sector’s sensitivity. Beyond the Italian case, the episode recalled that a sector’s extraordinary profits are always a temptation for public finances, especially when they coincide with pressure on budgets and complaints from consumers and companies.

An unexpected measure

The announcement caught the market off guard: it came quickly, its scope was not priced in and the stock-market reaction was immediate, before the government chose to soften the tax.

An extraordinary tax is one imposed exceptionally, normally for a limited period, to raise revenue in specific circumstances. Unlike ordinary taxes, it is not usually included in companies’ calculations, and so it can abruptly alter their expected results. The government’s later change of course also shows that rules of this kind can change quickly, both upwards and downwards, depending on the reactions they provoke.

Why banks were a target

With high rates, bank profits were growing and so was political pressure. When rates rise, banks charge more on loans and do not always pass that rise on to what they pay on deposits, so their margin widens.

That makes the sector visible and an easy target for governments seeking revenue. When families and companies pay more on their loans and see banks earning more, pressure for an additional contribution finds favourable political ground. It is a pattern that could be repeated in other countries and sectors in similar circumstances. Depositors and borrowers have different interests: the former would like to be paid more, the latter to be charged less. Regulatory policy sometimes tries to respond to both pressures at once. For customers, a high-rate environment is also an opportunity to negotiate the return on their deposits and the terms of their financing, comparing offers between institutions rather than accepting the first proposal.

Regulatory risk

For investors, regulatory risk in highly visible sectors was a factor not to be ignored. Rules can change suddenly, and extraordinary taxes, because of their exceptional nature, are hard to anticipate.

It is worth bearing in mind when assessing any investment concentrated in a single regulated sector, and discussing it with the adviser. This also applies to anyone with a business in a heavily regulated sector: regulatory changes are part of the risk of the activity, and it is sensible to leave room in plans to absorb them. It is not a recommendation to buy or sell, but an invitation not to concentrate. Regulatory risk is not limited to taxes: it includes changes in capital requirements, in customer information rules or in limits on certain fees, which can alter a business’s profitability.

In a regulated sector, the rules are part of the risk.

This article is general information. It is not legal, tax or investment advice, and it does not take anyone’s particular circumstances into account.