Financial Regulation and Government Revenue

Financial regulation affects government
revenue whenever it imposes both the mandatory quantity and
price of government bonds. This paper studies a banking
regulation adopted by the National Bank of Ethiopia in April
2011, which forces all private banks to purchase a fixed
negative-yield government bond in proportion to private
sector lending. Having access to monthly bank balance
sheets, a survey of branch costs and public finances
documentation, the effect of the policy on government
revenue can be tracked. This is compared to three plausible
revenue-generating alternatives: raising funds at
competitive rates on international markets; distorting the
private lending of the state-owned bank; and raising new
deposits through additional branches of the state-owned
bank. Three main results emerge: the government revenue gain
is moderate (1.5-2.6 percent of the tax revenue); banks
comply with the policy and amass more safe assets;
banks' profit growth slows without turning negative
(from 10 percent to 2 percent).