The right way to regulate and rescue banks

When it comes to the question of how (or even if) we should rescue failing and insolvent banks, so far the choice on offer has been between two equally unpalatable brands of medicine. Either the State should do nothing (as the neo-liberal Right are forever demanding) and risk contagion spreading within the financial system as the collapse of one bank leads to the decreasing creditworthiness of others, or the State should act as ultimate guarantor for all deposits and thereby institutionalize moral hazard, effectively legitimizing every bad investment every bank or investor has ever made. As I pointed out in my last post, the central problem is a triangular paradox at the heart of the current bailout provisions. For an orderly restructuring of a bank to be achieved while protecting the wider banking system, the economy and the taxpayer, three key objectives need to be met.
(i) No taxpayer funds should be used in any bank rescue.
(ii) The bank's customers must still be able to access some deposits.
(iii) There must be no capital flight or run on the bank.

As I also pointed out previously, these three conditions are fundamentally incompatible with each other. Only two of the three can be achieved at any one time. If the bank remains open for business in order to service the day-to-day needs of its customers, and at the same time the taxpayer is to be relieved of any compensation obligation, the depositor will be forced to bear the cost of bank restructuring. The inevitable result will be capital flight as the depositors seek to avoid the impending financial penalties, and so the taxpayer will be forced to step in. If, however, the bank is closed for business to protect against capital flight, then the taxpayer will be protected but the wider economy will suffer as businesses and their customers run out of cash, many firms will be forced to close down, and the economy will start to slump.

There is though a second iniquity with the current system as I again outlined previously. This applies to customers who may have the misfortunate of receiving a once-in-a-lifetime large cash deposit (e.g. from a house sale or lottery win or business deal) that temporarily flows through their bank account at the very instant that the bank enters its state of crisis. So when the bank's restructuring or liquidation is complete these unfortunate souls will lose almost everything. Unlike conventional depositors, these customers have yet to make any investment decisions with regard to their new deposits. They are merely using their bank as a conduit through which to transfer the money to its final destination, a destination that may ultimately involve payment to a third party with no net gain for them (as for example during the process of moving house). So why should they be punished when they have not yet sought any high-risk reward? Clearly they should not. In which case, how can we then ensure that we protect these customers from suffering catastrophic and life-destroying financial penalties?

The answer to both this question and our initial capital flight problem is the same. Our initial paradox rests on the fact that we want bank accounts to operate in two distinctly different ways. On the one hand we want them to be fully accessible while at the same time we wish to prevent excessive withdrawals in a time of crisis. The solution, therefore, is to define two classes of account within each bank with each class having its own distinct rules with regard to its level of accessibility in return for differing levels of insurance protection. As a result one class will be applied to current accounts, with the other being for savings. This leads logically to the following 8-point plan, as this post will explain.

1) Set different compensation and access rules for current accounts and savings accounts. .
2) Current accounts to remain instant access.
3) Current account deposits to be fully insured by the Government.
4) Current accounts to be restricted to low interest rates.
5) The bank's own capital reserves (Tier 1 capital) to be set to cover at least 100% of all current account deposits.
6) Savings deposits to be used to cover bank losses when Tier 2 capital is exhausted.
7) Savings accounts to be time-locked in an emergency to prevent capital flight.
8) Bank restructuring to be by debt-for-equity swaps.

The key to the bank insolvency problem ultimately lies in the accessibility of the bank's different customer accounts. One type of account needs to be "instant access" so that normal banking functions can continue for most customers. But if the deposits in such an account are to be freely accessible, then they must be fully guaranteed by the State in order to guard against capital flight. As the generosity of this protection necessarily brings with it the risk of creating moral hazard, the guarantee must therefore be limited to only the most conservative of all investments. That means those carrying the lowest financial reward or yield. So a state-backed 100% deposit guarantee can only be applied to accounts with the lowest of interest rates, with the additional quid pro quo for the customer being that the guaranteed deposits remain available for instant withdrawal at all times.

However, while the taxpayer may act as guarantor in the above scenario, he must also be protected from having to fund the bailout. He may provide liquidity during the bailout process, but he expects to get all his money back (with interest) when it is complete. This means that the bailout must be self-financing. For this to be the case, the bank's own reserves of capital - its equity - must be greater than the liabilities that these reserves are required to cover, namely the current account deposits. In addition, the reserves it maintains would need to be of the same class as the deposits that they are designed to protect. That means that they would have to be in the form of cash, or government bonds that are highly liquid, easily convertible to cash and of secure value.

The next and complementary step is obviously to equate accounts with higher financial rewards with having a higher level of risk and therefore reduced level of state-backed guarantee. With no 100% guarantee over the security of their deposits these accounts will inevitable experience severe capital flight if they too are granted instant access. Therefore some form of time-lock must be imposed on such accounts such that no money can leave these accounts until the restructuring process is complete.

In the event of a bank suffering such increasing levels of bad debt that it begins to affect the very creditworthiness of the entire institution, then the following event sequence would play out. First the bank would freeze all high interest accounts while restructuring took place. This is a similar move to that imposed on the main Cypriot banks in March with the exception that in the Cypriot case the entire bank was closed for business, not just access to its savings accounts. The funding for any bailout would then come from deposits in these high interest accounts via a haircut. However, unlike the Cypriot case, the haircut would not be in the form of a simple forfeiture or confiscation, but should instead be a debt-for-equity exchange with depositors receiving new shares in the bank with the same market value as the total amount of funds that they stand to lose. The same deal should be granted to bondholders and the holders of any other form of the bank's debt. The only remaining question then concerns how the bank's new shares should be valued. Should it be determined by the price pertaining at the very instant that the bank's share were suspended prior to it ceasing to trade normally, or should it be set by the price pertaining at some earlier point in time when the bank's share price was still stable? Ultimately the answer will depend on a political decision as to which parties should be forced to forfeit the most: shareholders or creditors?

The advantages of this scheme are four-fold. Firstly it extends the haircut to other creditors of the bank like bondholders but on similar terms. Secondly, the large increase in shares results in a diluting of the share capital thereby extending the haircut to shareholders. As the value of deposits in the bank prior to its collapse will massively exceed its market capitalization, these measures will ensure that the shareholders suffer greater percentage losses than depositors as should be the case. The third advantage of this deal is that it ties in the depositors to the bank when the restructuring is complete. If depositors start a run on the bank once it reopens by removing their remaining savings, then they risk collapsing the bank and wiping out the value of the shares they received in lieu of their confiscated deposits. Finally, the new share issue ensures that once the bank reopens after its restructuring, not only will it be financially sound (as its liabilities will be much less than its assets), but it will be able to begin trading as normal immediately, as will trading in its shares.

With these measures in place the State would not in any likelihood actually have to bail out the bank. The State would merely stand as guarantor of last resort perhaps providing bridging loans or liquidity to enable the bank to smoothly implement the above process.

Finally, as the two types of account are clearly distinguished by their relative rewards (i.e. interest rates), with the risk associated with each account being dependent on that reward, it logically follows that the division line between the two account types should itself be set by the level of reward. As that reward is the interest rate in each case, so the division line must be based on an objective standard of this type, in other words a standard market interest rate (e.g. BoE base rate, or LIBOR, or base rate + x, etc.). Given the relative values of the Bank of England (BoE) base rate, current account interest rates and most savings rates at the current time, it is likely that under current market conditions the boundary line between our two classes of bank accounts would be set by the BoE base rate.

The mechanism outlined above therefore requires banks to hold two types or levels of capital. One must be highly liquid and sufficient to cover current account deposits. The second would be used to protect against bad loans. This is similar to the current system as introduced under the 1988 Basel I accords where Tier 2 capital was supposed to be used as a reserve of capital that banks could use to cover the cost of bad debts and defaults by customers, and Tier 1 capital was supposed to provide a capital reserve of last resort that would fund the winding up of any insolvent bank.

As we now know, Basel I rules were insufficient to prevent the collapse of banks and other financial institutions after 2007. The new Basel III rules are designed to strengthen financial regulation by forcing banks to hold more capital. Yet these new rules are fundamentally flawed for two reasons. First, they take no account of asset price inflation and how that undermines the solvency of banks by allowing them to increasingly leverage their balance sheets to an extent that only becomes critical when there is a massive crash in asset values. But secondly, there is nothing in Basel III that provides for safe defaults of banks, or that will protect economies from the moral hazard that comes from cleaning up the mess arising from bad banks that are too big to fail.

The structure outlined here might just help do the latter, although other measures are needed as well. These would include provisions for other bank liabilities such as redundancy payments for staff as the bank downsized and rules for the protection and sustainability of pensions. There would also need to be a new set of rules concerning the level of deposit protection afforded to high-risk savings accounts and the necessary capital reserves needed to fund such protection. Imposing haircuts on small savers will never be politically acceptable, but the level of any deposit guarantee will have to be determined by issues of affordability and risk.

Equally important, though, is the need for better preventative measures. These should include new rules that actively discourage and de-incentivize acquisitions and mergers, as well as limiting the activities of overseas subsidiaries. Too many banking failures in the UK over recent decades have had their origins in policies of aggressive expansion. The remainder are generally due to sudden corrections in overheated markets in speculative assets, mainly in the property sector. In the case of asset price inflation, what is needed, therefore, is a new set of rules governing the risk-weighting of assets in measures of Tier 1 and Tier 2 capital ratios that are self-limiting as house prices or share prices increase more rapidly than the rest of the economy. Only then will our banks begin to exhibit the financial strength and resilience that we desire.

Banking lessons from Cyprus

Why is it that six years on from the collapse of Northern Rock there is still no semblance of any workable administration procedure having been put in place to deal with distressed or collapsing banks? With the recent banking crisis in Cyprus still fresh in the memory it is apparently not only me who is asking this question. Yet there is still no political or economic consensus regarding how governments should rescue banks. Perhaps the reason is because most people have failed to appreciate the paradoxes that the current system creates. The solution to this problem is, I believe, to fundamentally change the structure of bank deposits, as well to limit the way banks capital ratios are set and the way banks are allowed to operate over national borders. 

After 2007 the two big issues were contagion and moral hazard. The Brown government acted swiftly to protect all bank deposits in first Northern Rock and then other UK banks and building societies such as HBOS and RBS because they were worried about contagion. They feared that the collapse of one big bank could bring down another, and then another, and ultimately the whole system. 

The Bush administration in the USA on the other hand allowed both Lehman Brothers and AIG to collapse because they were more concerned about moral hazard. They were also politically antipathetic to any form of state subsidy or intervention. 

Now we have the Cypriot banking crisis where depositors are facing a 'haircut' on deposits above the EU depositor protection limit of €100k. The problem that we are now seeing is that all three of these approaches have significant downsides. At the crux of the problem is a triangle of paradox and conflicting aims or interests that renders the conventional approach unworkable. 

Ideally what most economists and policymakers want to see is an orderly restructuring of a bank in crisis. That means that three key objectives must be met. 

(i) The losses of the bank should be met by the customers and owners of the bank, not the taxpayer. This is the necessary condition to eliminate moral hazard. 

(ii) The bank must be able to continue operating normally throughout its restructuring without adversely affecting the wider economy. In other words, businesses that use that bank need to have their normal cash-flow operations protected so that they aren't destabilized. 

(iii) The restructuring must be carried out in such a way that there is no capital flight or run on the bank. Otherwise the restructuring won't work. The money to pay for it will vanish. 

The problem is that these three conditions are mutually incompatible. It is currently possible to satisfy at best only two of these conditions simultaneously, but not all three. 

For example, it is currently the wish of the overwhelming majority of people and also of most politicians for the excessive risk-taking of the bankers to be borne by the bankers themselves and not by the taxpayer. If a bank fails it should be the shareholders and the senior management that should bear the cost. However the RBS and HBOS situations show that this will never be enough to cover the cost of most bank bailouts. Depositors will invariably have to take a haircut on some of their savings above the €100k limit. But the Cyprus situation shows how politically difficult this could be to enforce. 

Suppose though that the €100k deposit limit can be implemented so that the taxpayer is protected from the cost of the bailout. The depositors will then know that they are all expected to forfeit a fraction of their savings over €100k. Now suppose also that the banking authorities attempt to continue normal operations of the bank while it is being restructured. Such action is essential to ensure that the bank's business customers can pay their bills and thereby safeguard the normal operations of their own businesses. Without this provision businesses will fail due to cash-flow problems, and there will be a domino effect of redundancies and business bankruptcies that will ripple outwards from the stricken bank over time. 

The problem is, if the bank is allowed to operate normally while it is being restructured, and the depositors are forewarned of impending deposit forfeitures, then capital flight is inevitable. No rational depositor is going to leave all their savings in a bank in the full knowledge that most could be confiscated. Thus if conditions (i) and (ii) above are implemented successfully, condition (iii) will clearly fail. 

On the other hand, if capital flight is to be avoided so that condition (iii) is achieved, then only one of the other two possible actions can be implemented. Either the bank is closed for business while the restructuring takes place (as happened in Cyprus) and the deposit write-downs are performed, or the bank remains open but deposits and depositors are fully protected. The first of these options means that only conditions (ii) and (iii) are met, while the second means that only (i) and (iii) are, with the State inevitably having to pick up the final bill for the cost of the bailout instead of the depositors. 

Finally there is a fourth problem. In most discussions of depositor haircuts there is an implicit assumption amongst most neoclassical economists that all depositors are fully aware both of the risks inherent in their choice of bank, and of the limitations in extent of the deposit assurance scheme. While the latter is certainly true now, the former is not and will never be. The balance sheets of most banks are impenetrable to even the most expert of financial advisers. You only have to see how the credit crunch developed post-2007 to appreciate how the culture of rumour and counter-rumour within the financial markets highlighted the widespread ignorance that existed over the size and whereabouts of all the toxic debt. If the market players don't know where the problems are, how can the humble customer? 

And then there is the question of fairness. Implicit in the €100k deposit protection limit is an assumption that those who fall foul of it are only those guilty of chasing excessive returns. Yet what about the homeowner who sold his home for more than €100k on the very day his bank collapsed. Or the business that received payment for a major order on that same day. They too will lose almost everything, not because they sought to overplay their hand, but simply because they happened to have accounts with the wrong bank at the wrong time. Such instances may be rare, but such instances of large payments happen every day in every bank. The probability that such misfortune happens to you may be small, but the probability that it happens at all will be close to unity. So you know it will happen to somebody. Should the financial system play Russian roulette with people's lives in this way? Isn't that what the insurance and regulatory systems are supposed to prevent? 

These then are some of the problems, but there are others, not least in the disjointed and often illogical approach that the current system of regulation takes. These regulations are enshrined in the latest Basel accords, denoted as Basel III. As I will argue in later posts, Basel III is unlikely to correct all the major problems within the banking system. It won't tackle the paradox inherent in the three conditions (i)-(iii) above. Nor will it address problems associated with capital adequacy, reserves, or banks being too big to fail. What are needed are new rules that are fit for purpose. These rules need to resolve the triangular paradox I have outlined here so that insolvent banks can restructure in an orderly and fair manner. But we also need rules that reduce the likelihood of bank failure occurring in the first place. That means introducing new rules on capital requirements that will actively compensate for asset price bubbles, thereby removing some of the main sources of risk in the banking system. It also means having reserve requirements that recognize the systemic risk of large banks and which therefore financially penalize excessive size.

Let's pay the people to vote

Another election; another poor turnout. 

In this week's county council elections the turnout was barely above 30%, not that we should be surprised. Four years earlier when the same seats were contested the turnout was again only 39.2%. In the local elections of 2011 the turnout was 42.6%. In fact the only recent local election with a turnout of over 50% was in 2010 when it coincided with the general election, and yet even for that general election the turnout was a fairly pitiful 65.1%. While this was an improvement on the 59.4% in 2001 and the 61.4% in 2005, it is still a long way short of the 77.7% in 1992. 

These figures should be worrying for Labour because it is the Labour Party that suffers disproportionately from differential turnout. At the last general election the average turnout in consistencies that returned Labour MPs was about 61%. For those electing Tories it was over 68%, and in one Conservative-held seat (Kenilworth and Southam) the turnout was a staggering 81%. Overall this means that approximately 10% more people vote in Tory-held seats than in Labour-held ones. This goes some way to explain why the Tories need a greater number of national votes to gain a parliamentary majority, and why with 24.6% more votes than Labour in 2010 they only won 19% more seats. 

It is partly this issue of differential turnout that allows the Tories to (falsely) portray the electoral system as being biased in favour of Labour, and thus to provide cover for their attempts to gerrymander the electoral system with policies like the recent one to equalize constituency sizes in terms of voter numbers. Of course their approach conveniently overlooks the other issue that damages Labour: the problem of voter non-registration in many urban areas. As a result there could be as many as an extra 10% of potential voters missing from the electoral roll in these predominantly Labour constituencies.

Taken in combination with the differential turnout problem, these figures suggest that the Labour vote may be over 20% below what it should be, which means that even at the 2010 election Labour's total vote should have matched that of the Tories at around 10.5 million votes, ceteris paribus. The question is, how many extra seats would this have yielded for Labour? I suspect not many as most of these missing votes are in safe Labour seats. Of course that suggests that the 19% extra seats that the Tories won in 2010 is entirely down to an electoral system that actually favours them, not one that penalizes them. So the big question is: how can this problem be rectified? 

So far most of the media analysis has concentrated on issues centred around political apathy. There are many causes for this malaise. The electoral system is clearly one. The combination of a first-past-the-post (FPTP) system and a large number of safe seats clearly makes many voters feel that their vote is worthless. 

Another problem is of course the lack of voter/consumer choice. With elections dominated by swing voters in marginal seats there is a tendency for all three parties to converge on the "centre ground" and to steal each other's policies. As a result most of the potential remedies have focused on changes to the electoral system, of which the AV referendum was a prime example. 

Other solutions have focused on improving the ease of voting. Thus strategies for increasing the number of postal votes have been proposed, as well as making polling day a bank holiday or putting it on a weekend. So far, however, no-one really appears to have considered financial incentives, with the possible exception of implementing some form of lottery. Why? 

Perhaps because it seems to resemble a form or bribery reminiscent of the rotten boroughs of the late 18th and early 19th centuries. Yet politicians bribing the electorate is nothing new, old, or unusually. The tax cuts, privatizations and council house sell-offs under Thatcher in the 1980s were little more than bribes to a certain section of the electorate. In that sense they were truly insidious because they were selective and divisive rather than universal. They only benefited those with large incomes, spare cash or current tenure of council properties. Those who fell outside these groups were left out of the feeding frenzy. Doubtless some would argue that such a measure would run counter to the provisions of the Ballot Act of 1872, but if the "bribe" is merely conditional on voting and not on voting for a particular candidate or party, would that still be so? 

Of course the principal reason why paying people to vote has probably not been considered is the cost. To make it attractive enough to the potential voter each would need to be offered over £100. Yet with around 45 million potential voters the total cost could then be over £4.5bn. If this was only applied to general elections, though, it would still only equate to £900m per annum. That is peanuts for the UK government. Yet there is another solution that would cost nothing in nominal term. Use the shares the government already owns in the privatized banks. The total government stake in RBS and Lloyds TSB is currently valued (according to their FTSE-listed share price) at over £30bn. That is enough to fund a voter giveaway at the next six general elections. 

Earlier this year Lloyds TSB claimed it was close to being ready for privatization. Now RBS is saying the same. However it is highly likely that any share sale would need to be staggered over a number of years in order to get the best price. 

Nor is the idea of giving these shares away a new idea. This is an idea that was originally proposed by some LibDems a couple of years ago. Then in February there were reports that George Osborne may consider giving bank shares away to all taxpayers (does that include poor pensioners and the unemployed?) It is therefore only an additional small step to suggest that such a gift should be conditional in some way. So why not make it conditional on a citizen exercising their democratic right, nay duty, at the ballot box? Let us call it the citizen's dividend. 

It should be clear that while all may benefit from this idea, the Labour Party and Labour voters will benefit the most. A typical Labour voter is more likely to be incentivized to register on the electoral roll and to subsequently vote by a cash windfall of £100-£200 than is a merchant banker living in Surrey. And when they vote they are more likely to vote Labour in order to ensure that the policy would not be discontinued. If the Tories and LibDems copied Labour's policy then they would still lose out because of the greater benefit to Labour in terms of differential turnout. If they fail to support the idea then they risk the loss of even more votes to Labour. And then there are the economic benefits. Most of the shares will be sold on receipt, and the proceeds spend. The result will be an urgently needed fiscal stimulus for the economy, while the universality of the share allocation will help reduce inequality. So where is the political downside?

Tax avoidance #2: The GSK loan trick

In an earlier post I argued that tax avoidance is not as immoral as many politicians insist on claiming, but instead reflects the failure of those same politicians to enact laws that are designed to be consistent and foolproof. I also argued that, contrary to conventional wisdom, tax avoidance cannot and should not be tackled through the use of international treaties or agreements, but should instead be countered through the use of unilateral action. The growing use of "baseball arbitration" by the USA and other countries is a salutary warning in this respect for it could in particular enable multinationals to reduce their tax bills by playing countries off against each other in an increasingly damaging game of winner-takes-all. 

The solution therefore must be for countries to be self-reliant, rather than being reliant on others. To demonstrate the point I will outline some of the most common tax avoidance schemes currently in use by multinational companies and then demonstrate how I believe such schemes could be countered through simple changes to UK tax law. The first such example I have chosen centres on one of Britain's biggest companies. 

GlaxoSmithKline (GSK) is a world-renowned pharmaceutical company. However in recent years it has also found itself in the media headlines regarding its tax avoidance strategies in various countries around the world. 

In 2006 it settled a long-running transfer pricing case in the USA, while more recently it won another transfer pricing case against the Canadian government. However, last year a Panorama programme for the BBC highlighted a different type of avoidance scheme employed by GSK that specifically affects its UK operations. The scheme itself used intra-company loans to reduce GSK's corporate tax bill, but as the Panorama programme also highlighted, GSK is not the only company that has apparently used this type of scheme. The programme also alleged that Northern & Shell, the company run by Richard Desmond that owns Express Newspapers and Channel 5 has also operated a similar scheme. But the implications for this type of tax avoidance stretch much wider than the practices of these two companies as this type of avoidance is also closely related to other schemes used by companies such as Wales and West Utilities and the holding companies of certain well-known football clubs that have been subject to corporate takeovers. These so-called leveraged buy-outs (LBOs) also rely on debt to reduce future corporation tax liabilities, and it doesn't stop there. Much of the housing buy-to-let market also exploits similar tax loopholes. The big question then, is how should the tax rules be changed so that such schemes can be permanently outlawed? 

In the Panorama programme it was claimed that the GSK tax avoidance scheme worked as follows. The parent company in the UK sets up a subsidiary in an overseas tax haven (e.g. Luxembourg). The overseas subsidiary then loans the UK parent company a large sum (say £6.34bn) and the UK parent then pays interest (totalling maybe £124m) back to the offshore subsidiary. This interest is then deducted from the UK company's gross profits before it has to pay its corporation tax (at 28%). The scheme thus saves the parent company £34.72m in UK corporation tax. 

Of course the money paid in interest to the offshore subsidiary will be taxed instead by the overseas tax authority (in this case Luxembourg ), but as the tax haven is chosen so that this tax rate is generally much lower than the normal rate of UK tax the net saving can be considerable. In this particular case the money GSK allegedly paid to its subsidiary in Luxembourg was apparently only taxed in Luxembourg at 0.5%, thereby representing a considerable saving. 

Richard Brooks of Private Eye summarized such schemes as follows: "The company puts its money into Luxembourg and borrows it back. It just sends money round in a circle and picks up a tax break on the way." 

As a result, even to the most casual of outside observers, these schemes appear to be performing an "artificial" function. This "artificialness" arises from four distinct properties of the schemes that differentiate them from "normal" business loans. 

(i) The lender and the borrower are essentially the same person, group of people, or organization. 

(ii) The loan is issued by a company that is not necessarily a registered financial services company. 

(iii) The interest rate of the loan is not market tested. In other words, the same loan from the same source and under the same conditions is not freely available to other borrowers or lenders. 

(iv) The borrower is generally seeking to maximize the interest paid, not to minimize it. As a result the interest rate can in effect be set unilaterally by the borrower rather than through competitive negotiation with the lender. 

Properties (iii) and (iv) are clearly evident in the loan arrangements of Wales and West Utilities. The company was created as a result of National Grid's decision to sell part of its gas distribution network in 2005. Since that sale National Grid has paid over £1bn in corporation tax, yet Wales and West Utilities has paid nothing on its similar activities over the same period. 

The reason for this is that the holding company of Wales and West Utilities charges Wales and West Utilities an interest rate of 21% on the loan used to purchase the company. This interest rate is more than three times the standard market loan rate and coincidentally is just sufficient to wipe out the operating profit of Wales and West Utilities. Therefore it pays no tax. 

The Solution: 

This form of tax avoidance could be tackled quite simply by outlawing tax deductions for any loans that exhibit any of the features labeled (i)-(iv) above. Instead the following restrictions should be applied to the eligibility of all loan interest for tax relief in order to eradicate the problem once and for all. 

(i) The company loaning the money and the company borrowing the money must have no significant commonality of ownership. They must have different directors and different shareholders, and one company cannot be owned in any significant part by the other, or be part of the same corporate group, even if one company is operating in a different tax jurisdiction. 

(ii) The company providing the loan must be a financial institution regulated in the UK by the FSA or FCA. Loans from institutions outside the UK would then not be tax deductable. While some will argue that this might put up finance costs for legitimate loans, the counter argument is that using such overseas lenders increases the UK balance of payments deficit which is also undesirable. This condition is however essential if large multinationals are not to exploit their dominant position within the shadow banking system to further inflate their own already considerable stockpiles of cash at the expense of ever lower national tax revenues and greater wealth inequality. 

(iii) The company receiving the loan must also be able to show that the interest rate is market tested. In practice this will mean that the company receiving the loan must be able to demonstrate that it is not the only customer of the company providing the loan but that there are many other customers of the same financial provider. 

(iv) The company receiving the loan must be able to show that the interest rate has been set in line with the market rate and has not been inflated for its own benefit. In practice this will mean that the company taking out the loan must be able to point to tenders from other FSA/FCA regulated loan providers that are at a higher rate of interest. 

If these measures were enacted and implemented then most of the loan schemes used by companies like GSK and Wales and West Utilities would immediately become either unworkable or unprofitable. None of this requires new tax treaties with other countries (although it may require existing treaties to be shredded - no bad thing!) All that is required is political will, a bit of intelligence from our elected politicians, and a new tax law.