Can Taxes Tame the Banks? Evidence from the European Bank Levies

Abstract

In the wake of the 2007-2008 financial crisis, a large number of countries have introduced levies on bank borrowing with the aim of reducing risk in the financial sector. This paper studies the behavioral responses to the bank levies and finds that banks exposed to levies increased their reliance on equity financing, but at the same time increased the risk of their assets. This represents the first empirical evidence of banks shifting risk from the liability side of their balance sheets to the asset side to mitigate the impact of government intervention. Our analysis also shows that while levies were successful in reducing the overall risk of the average bank, the effect was concentrated among banks that pose no or little threat to financial stability.