A tax on banks, not bigger capital cushion requirements, is the best way to limit future bank bailouts by the government, Minneapolis Federal Reserve President Narayana Kocherlakota said on Wednesday.
Kocherlakota's view puts him at odds with global leaders, who last month at the Group of 20 summit in Toronto advocated bigger bank capital requirements as a way to protect against future crises.
Such requirements are problematic, Kocherlakota told a group of economists in Montreal, in part because forcing banks to hold more capital creates an undue drag on economic growth.
Meanwhile, bigger capital cushions at banks will not bolster financial stability, Kocherlakota said in the text of prepared remarks before the annual meeting of Society for Economic Dynamics.
"Good regulation should deter them from creating the potential for adverse shocks bigger than those we have observed historically," Kocherlakota said. "The proposed capital standard does not."
A better approach, he said, is to tax banks according to the risks they take.
Theoretically, banks that take bigger risks will pay higher levies, and those funds will pay for what Kocherlakota called "inevitable" future bank bailouts.
To set tax rates, governments could keep track of market views on the health of individual banks by issuing "rescue bonds" that investors could buy and sell based on their expectations of the likelihood of a firm failure, he said.
"My proposed tax creates the right kinds of incentives for risk-taking," he said. "Alternatively, it may be desirable to simply re-label what I'm terming a 'bank tax' or 'risk tax' as a 'systemic insurance premium.' It could then be collected by a regulatory agency, as opposed to the Treasury."
Kocherlakota did not touch on monetary policy in his prepared remarks, the text of which was made available in advance in Chicago.
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