Treasury should consider the option of allowing financial institutions to pay their fees for the Financial Claims Scheme by way of cancellation of franking credits, an industry research group has proposed.The Australian Centre for Financial Studies issued a discussion paper yesterday, recommending that Treasury consider a range of payment options.Last month, the Government announced that authorised deposit-taking institutions would be charged a fee for the protection provided to depositors by the Financial Claims Scheme. The fee is expected to be five to 10 basis points per dollar of deposits covered by the scheme (which protects balances of up to A$250,000 per customer per institution).The ACFS discussion paper, written by Kevin Davis, says: "It is generally assumed that the fee would be paid in the form of cash. But there is another option that could reduce one existing tax distortion in the financial system."If payment could also be made by way of cancellation of franking credits, this option would be of value to mutual ADIs, which cannot distribute accrued franking credits and [so] perceive this as a disadvantage vis-à-vis banks."Companies accrue franking credits as they pay income tax. These credits can be attached to dividends and distributed to shareholders, who can then use the credits to reduce their taxable income.Mutuals do not have shareholders and do not pay dividends. The franking credits that they accrue in their franking accounts therefore go to waste. Davis said: "Assessing whether it is, in fact, a competitive disadvantage is a complicated, empirical matter. But, to the extent that the option to pay the fee by way of franking credit cancellation is available to all ADIs, this could not be viewed as introducing a new distortion."Mutuals have argued that a Financial Claims Scheme fee would impose a heavier burden on them than on large banks because a larger proportion of their funding takes the form of insured deposits.Davis has estimated that about 75 per cent of mutuals' funding takes the form of insured deposits, compared with about 30 per cent of the major banks' funding."It is thus a larger fee per dollar of assets for the mutuals. If the fee were to be passed on to customers the required increase would be higher for the mutuals," he said.