Intelligent transaction tax could help reduce systemic risk in financial networks

A new IIASA study proposes a solution for mitigating the increasingly risky nature of financial markets, based on an analysis of systemic risk in financial networks.

A tax on individual transactions between —based on the level of that each transaction adds to the system—could essentially eliminate the risk of future collapse of the financial system, according to a new study recently published in the journal Quantitative Finance.

It relies on an analysis of the networks of the banking system, using central bank data from Austria."When banks collapse, it costs a lot to bail them out, and that money usually comes from the public, from taxpayers" explains IIASA researcher Stefan Thurner, who coauthored the study with IIASA researcher Sebastian Poledna. The proposed tax would go into a government fund which could be used to bail out a struggling bank, for example. "You could also consider it a form of systemic risk insurance," says Thurner.

Financial institutions are linked by multiple types of transactions, which Thurner and Poledna have modeled in a detailed network analysis. These transactions include deposits and loans between financial institutions. The study is the first to quantify the systemic risk that individual transactions add to the system.

"Since the international financial crisis in 2007 and 2008, policymakers have been discussing new ways to regulate the system in order to help avoid a repeat scenario. The new study provides just that," says Poledna. While introducing such a tax would require some work, the researchers argue that the data are there and the technical effort required for implementation is not overwhelming. Thurner has already presented the work to interested policymakers, supervisors, and central banks in the EU and Mexico.

"There's currently a lot of discussion about a Tobin tax in the European Union, but the version they are proposing would tax every transaction at a flat rate. The we are proposing would not have to be large, in order to act as an incentive scheme for avoiding transactions that would be the most harmful for the system—banks would try to avoid that generate that risk," says Thurner.


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More information: Poledna S, Thurner S (2016). Elimination of systemic risk in financial networks by means of a systemic risk transaction tax. Quantitative Finance doi: www.tandfonline.com/doi/abs/10 … 4697688.2016.1156146?
Citation: Intelligent transaction tax could help reduce systemic risk in financial networks (2016, April 11) retrieved 16 September 2019 from https://phys.org/news/2016-04-intelligent-transaction-tax-financial-networks.html
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Apr 12, 2016
What adds systemic risk is the creation of "money" via fractional reserve lending. The "fraction" is the amount of currency reserves a bank holds compared to the amount of deposits that the bank would have to pay to depositors if they all withdrew their money. https://en.wikipe..._banking

So if the fraction is 5%, then a loan that failed of that size would essentially make the bank bankrupt, and the depositors that attempt to take their money out last will find the bank doesn't have any more money.

Many people have been arguing for a financial transaction tax (e.g. a tax when you buy/sell stocks or bonds) because they want the government to have more money to spend, but IMHO this would be a big mistake. The authors appear to be suggesting only a tax when financial institutions borrow/loan money/assets with another financial institution. This might have some merit. It's more important we don't bail out failed financial institutions.

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