UK Bank Tax Storm: Fiscal Patch-up and Financial Stability in a Dilemma, Chancellor Hunt and Bank of England’s Bailey Game Intensifies

According to Zhitong Finance APP, UK Chancellor John Healey plans to raise taxes on banks in the October 28 budget to fill the rapidly shrinking fiscal buffer caused by surging borrowing costs due to war. However, this plan quickly triggered a public warning from Bank of England Governor Andrew Bailey and strong opposition from the banking sector, with UK bank stocks retreating on Friday. The policy debate over a banking tax is pushing deep-seated contradictions between HM Treasury, the central bank, and the City of London into the open.

Fiscal pressure forces tax hikes

Since Prime Minister Andy Burnham took office in July and appointed Healey as Chancellor, the issue of the bank tax has been hanging over the market. Borrowing costs related to the US-Iran war are estimated to have halved the £23.6 billion fiscal buffer Healey inherited from former Labour Chancellor Rachel Reeves. To keep deficit reduction plans on track, Healey needs new sources of revenue.

Market research estimates that a full reversal of the 2023 Conservative Government's move that cut the bank surcharge from 8% to 3% would raise an additional £3 billion ($4 billion).

The Guardian reported on Friday that Healey has decided to impose higher taxes on banks in the budget, with analysts generally considering a 3% surcharge increase as one possible path.

The market reacted swiftly. Barclays, Lloyds, and NatWest all dipped slightly in pre-market trading, then edged up but still underperformed the 0.9% rise in Eurozone bank stocks. Investors fear the tax hikes will erode the recently recovered profitability and return on capital of UK banks.

“Shadow war” between Bank of England and Treasury

When asked about the proposal at the Institute of International Finance meeting in Bangkok on Friday, Bailey responded cautiously: “This isn’t my remit. I’m not involved. This is for the Treasury.” But he has multiple times warned clearly that any punitive moves against lenders would simply raise mortgage rates, reduce deposit interest, and threaten financial stability. Bailey believes that reducing the interest paid by the central bank on reserves to lending institutions is, in essence, equivalent to a bank tax.

He told the House of Lords Economic Affairs Committee in June that if banks cannot generate returns, shareholders will not provide the capital needed for growth. After the financial crisis, UK banks failed to cover their cost of capital for over a decade, only returning to health in the past three years. “Without financial stability, we cannot deliver growth.” Bailey’s position is in direct conflict with Healey’s fiscal needs. Despite attending the same Bangkok meeting this week, stark policy differences are evident.

Banking sector fights back: burdened tax, competitiveness undermined

The financial industry is also strongly resisting the tax hike. Wim Mijs, CEO of the European Banking Federation, stated that taxing UK banks will ultimately be passed along “somewhere in the economy,” and is not an effective way to stimulate growth. The UK Finance Association cited House of Commons Library data showing that in the 2024/25 fiscal year, banks have already paid £8.8 billion in corporation tax, £1 billion in surcharges, and £1.3 billion in the bank levy, with staff payroll taxes contributing another £35.2 billion.

The association warned that further tax increases will weaken the UK's competitiveness, suppress investment and employment, and run counter to the government’s goal of delivering “growth in every region.”

Industry research shows the UK's big four banks—HSBC, Barclays, Lloyds, and NatWest—are projected to earn a combined pre-tax profit of around £60 billion from 2027 to 2028. Critics label this as “windfall profits”, but the banking industry argues that the profit recovery is due to a high interest-rate environment, which itself stems from inflation driven by war and is not a sustainable “windfall.”

JPMorgan CEO Jamie Dimon has even hinted at abandoning plans to build a £10 billion European headquarters in Canary Wharf in protest against the tax hikes.

The difficult balance between growth and stability

In an interview in Bangkok on Thursday, Healey described the City of London as one of the “jewels in the crown” of the UK economy while emphasizing the need for sound public finances. This neatly sums up his dilemma: on the one hand, the fiscal gap needs to be filled; on the other, excessive taxation may damage the City’s competitiveness, suppress growth, and ultimately erode the tax base.

The October 28 budget will be a key moment. If Healey sticks to the tax hike, it could heighten tensions with the Bank of England and the financial industry and spark further volatility in bank stocks. If he backs down, he will have to find alternative resources, making it harder to meet deficit reduction targets. Either way, the bank tax debate has made one thing clear: with war, inflation, and fiscal pressure intertwining, the space for the UK to find a balance between “growth” and “stability” is rapidly narrowing.