A bank levy to cover the cost of future bailouts is a flawed idea, a global banking group said on Saturday, calling instead for a global agreement for unwinding failing banks without resorting to taxpayer money.

The Institute of International Finance, which represents 390 firms worldwide, sent a letter to finance chiefs of the Group of 20 rich and emerging nations after their meeting in Washington, explaining why it opposes an International Monetary Fund proposal for a tax that would ensure banks cover the cost of future crises.

Though the United States and some European countries back a broad levy, G20 leaders split over the issue, asking the IMF to consider individual countries' circumstances.

Canada slammed the proposal, saying its banks did not need bailouts during the crisis and so should not be punished with a new tax.

The IIF said it is developing a proposal and will soon release a report on ways for allowing systemically important banks to fail without bringing down the entire financial system.

The IIF sees no merit in the idea that any levy on the financial sector should be paid into general revenue. Neither do we believe that an ex-ante levy on the banking system should be used to finance the bailing out or recapitalization of failing institutions, IIF Managing Director Charles Dallara wrote in the letter.

Dallara said a tax on banks designed to fund future bailouts would make firms more comfortable in taking excessive risk in the knowledge the cash is there to rescue them. That would contribute to the persistence of moral hazard and weaken market discipline, he said.

The industry group said a tax aimed narrowly at financing previous bailouts is more practical, he said.

Dallara took issue with the IMF's assumption that bailouts will be inevitable in the future, saying a coordinated plan for managing failures would minimize any risk of another global crisis.

We can no longer contemplate a world in which public or private sector funds are used to bail out or recapitalize failing firms.

The IIF will put forward a paper on a proposed resolution arrangement to the Financial Stability Board, which is made up of G20 central bankers and regulators and coordinates financial reforms.

The proposal will be based on the following principles: institutions should be allowed to fail without trauma to the overall system, shareholders and unsecured creditors should pay for failure, national rules must be coordinated globally and the need for a global framework that takes into account the geographical distribution of an institution's assets and debt.

Mario Draghi, chairman of the FSB, said in a news conference on Friday that he was working on improving coordination between supervisors in different countries.

If we will not be able to achieve a resolution system that works in different jurisdictions, the national surveillance authorities should have the power to ask big and interconnected banks to split into different subsidiaries, he said.

(Reporting by Louise Egan and Francesca Landini; Editing by Padraic Cassidy)

Canada International Monetary Fund