(1985), FDIC, Bundesbank, Swiss National Bank, Bank of England calculations  Chart 3  Chart 4  Ratings uplift for systemic institutions  Implicit subsidy for systemic institutions  Notches  $ bn 1,200  4  1,000 3 800 2  600 400  1 200 0 02  03  04  05  06  07  08  09  10  11  Source: Moody’s, Bank of England calculations  10  12  0 02  03  04  05  06  07  08  09  10  11  Source: Bank of England calculations  BIS central bankers’ speeches  Chart 5  Chart 6  Expected system-wide loss  Bank ratings uplift in the US Notches  $ 800  4 700 600  Correlated  3  500  Independent  400  2  300  1  200 100  0.0%  1.0%  2.0%  3.0% 4.0% 5.0% Systemic surcharge  0 7.0%  6.0%  Source: Bank of England calculations  0 02  03  04  05  06  07  08  09  10  11  12  Source: Moody’s, Bank of England calculations  Chart 7  Chart 8  Sovereign and Bank CDS during bailout announcements  Economies of scale (assuming no implicit subsidy)  CDS Index: -20 days = 1  Average CDS - Banks  95th percentile Mean Constant returns to scale  Estimated scale economies 1.30 1.25  3.0  Average CDS - Sovereigns  1.20 2.5  1.15 1.10  2.0  1.05 1.5  1.00 0.95  1.0  0.90 0.85  0.5 0.0 -20 -16 -12 -8  -4  0  4  8  12  16  20  0.80 <100bn  100bn500bn  500bn- 1tn  1tn- 2tn  >2tn  Total assets $ Source: Markit, BoE calculations  BIS central bankers’ speeches  Source: Capital IQ, Bank of England calculations  11  Chart 9 Economies of scale (implicit subsidy-adjusted) 95th percentile Mean Constant returns to scale  Estimated scale economies 1.30 1.25 1.20 1.15 1.10 1.05 1.00 0.95 0.90 0.85 0.80  <100bn  100bn500bn  500bn- 1tn  1tn- 2tn  >2tn  Total assets $ Source: Capital IQ, Bank of England calculations  12  BIS central bankers’ speeches  References Acharya, V, Pedersen, L Philippon, T and Richardson, M (2010), “A tax on systemic risk”, NYU Stern Working Paper.

Brunnermeier et al (2009) use this framework to motivate levying a tax – a “Pigouvian tax” – on institutions posing systemic risk externalities. This tax would be set at levels which offset the effects of the bank’s actions on wider society. A number of academics have since proposed measures along broadly Pigouvian lines (Archarya et al (2010)). Rather remarkably, policy reforms in practice have followed closely in the spirit of these proposals. In 2010, the FSB announced its intention to introduce a “systemic surcharge” of additional capital on the world’s largest banks. In July 2011, the Basel Committee published a methodology for measuring systemic importance based on indicators of bank size, connectivity and complexity, with additional capital of up to 2.5% depending on this score. In November 2011, the FSB endorsed this methodology and announced the 29 systemicallyimportant entities to which it would apply. This framework will be finalised this year, before being phased-in from 2016. Legislation is already in place, or is being drawn up, to implement the systemic surcharge in the United States and Europe. These proposals are clearly a practical step in the right direction. By boosting levels of capital in the system, the probability of big bank failure will be reduced. You would have got good odds back in 2007 that something as seemingly elliptical as a Pigouvian tax on systemic risk would have found its way onto the regulatory statute books. Now we have it. “We are all Pigouvians now”, even if most of us cannot spell it.