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This paper investigates how bank profitability is affected by the corporate income tax (CIT). For this purpose it uses aggregate data of the banking sector of the main industrialized countries, for the period 1980-2003. The main novelties with respect to the existing literature are two. First, it explicitly considers that the CIT is not specific to the banking sector so that changes in CIT rate can affect both banks and borrowing firms. With the help of a simple theoretical model we derive a set of predictions about the impact of the CIT on banks' income statement. Second, we consider all main components of banks' profit and loss accounts: net interest income, interest expenses, non-interest income, operating costs, and provisions. In this way, we are able to disentangle the extent to which a bank is able to shift its tax-burden forward to its lenders, depositors, and purchasers of fee-generating services.-----JEL Classification: C53, G20, G21. Keywords: Tax-Shifting, Corporate Income Tax, Bank profitability. * We would like to thank Harry Huizinga and Stefania Zotteri for helpful discussions and suggestions. All errors are our own.† The opinions expressed in this paper are those of the authors and do not involve the Bank of Italy.

We analyze the main forces affecting financial system pro-cyclicality (the fact that developments in the financial sector can amplify business cycle fluctuations). We first review some major structural developments in financial markets that may influence pro-cyclicality and that have been overlooked in earlier analyses. We then examine three issues that are center stage in the current debate: capital regulation, accounting standards and managers' incentives. After reviewing the institutional set-up and the key mechanisms at work, we critically examine a series of proposals designed to mitigate pro-cyclicality.1 All authors are with the Banca d'Italia.

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