UPDATE 2-Lithuania hits banks with windfall levy after interest rate hikes

(Adds background, government and banking association comments) VILNIUS, May 9 (Reuters) - Lithuania's parliament on Tuesday approved a windfall tax on the banking industry's net interest income for 2023 and 2024 following a sharp rise in European Central Bank interest rates to tackle soaring inflation. The 60% levy on the part of net interest income that exceeds the average of the previous four years by 50% is estimated to raise 410 million euros ($451 million) for the government's budget, and will be used to boost the military. Before the levy, which was originally proposed by the Lithuanian central bank, the Baltic country had expected to spend 1.9 billion euros on defence in 2023, or 2.52% of gross domestic product. A NATO member, Lithuania borders Russia as well as Russian ally Belarus. Spain in December approved a temporary windfall tax on banks, charging 4.8% on net interest income and net commissions above a threshold of 800 million euros. Lithuania's government argued its banks earn "economic rent" due to rising interest rates, with profits forecast to be twice as high in 2023 as last year. "Rent in the economy should be treated as a distorting and unjust phenomenon," it said in a submission to the parliament. "It is appropriate to redistribute the large unplanned increase in bank profits by applying fiscal measures, thereby correcting market imperfections." The European Central Bank said in early April that imposing a financial contribution on Lithuanian banks "could have negative economic effects by making credit institutions less resilient to economic shocks". Two Swedish-owned groups hold over 50% of Lithuania's banking assets: Swedbank , whose 2022 profits in Lithuania increased by 64% to 148 million euros, and SEB , whose profits were up 49% to 172 million euros. British fintech firm Revolut owns the third-largest bank, with about one-fifth of total assets, serving the European Union and European Economic Area, with Lithuanian residents accounting for less than 2% of the customer base. The Lithuanian Banking Association said the legislation was drafted without a proper impact analysis and without considering banks' suggestions. "It's really sad for the largest and most loyal investors (the banks) that yet another chaotic, anti-Constitutional idea to tax the sector is destroying the idea that Lithuania is a reliable state, with a transparent and predictable tax environment", it said in a statement. ($1 = 0.9084 euros) (Reporting by Andrius Sytas in Vilnius Editing by Terje Solsvik and Mark Potter)