Thursday, April 7, 2016

On Canadian Banks and “Bail-ins”

Over the last four decades, financial institutions in many countries have grown to an unprecedented
scale and degree of concentration. In the 2008-09 financial crisis, a wholesale collapse of the dominant banks might have portended a freeze of credit and capital markets—without which a modern economy cannot function. Rather than entertain that risk, policymakers in countries like the U.S., U.K., and continental Europe used a combination of public funds and liquidity created by central banks to rescue several major financial corporations. In other words, these institutions were “bailed out”; the costs of their errors have since been transferred in different forms to various stakeholders, including salary-earners in both the public and private sectors, savers and pensioners, debtors, and taxpayers.

The “bail-in” alternative

On the small island nation of Cyprus, in 2013, uninsured depositors and pensioners at the country’s two largest banks faced the choice of either sacrificing a substantial portion of their savings to keep the financial institutions afloat, or losing a much greater amount in the event of a bank collapse. This is arguably the most (in)famous contemporary example of a “bail-in”—the rescue of an ailing financial institution by its own creditors.

That same year, Canada’s Conservative government proposed a “bail-in” regime for Canadian banks as part of the 2013 federal budget. In its 2016 budget, the current Liberal government offered a virtually identical proposal, and even promised a concrete policy framework to follow. On page 223:

“To protect Canadian taxpayers in the unlikely event of a large bank failure, the Government is proposing to implement a bail-in regime that would reinforce that bank shareholders and creditors are responsible for the bank’s risks—not taxpayers. This would allow authorities to convert eligible long-term debt of a failing systemically important bank into common shares to recapitalize the bank and allow it to remain open and operating. Such a measure is in line with international efforts to address the potential risks to the financial system and broader economy of institutions perceived as ‘too-big-to-fail’.”

A few key details are worthy of note here:

1.    The word “creditors” is ambiguous; it may encompass not only investors and bondholders, but depositors too.

2.    Canada is not Cyprus. Unlike the Eurozone states, our country has its own sovereign currency and central bank, which means our government needn’t go cap-in-hand to a foreign central bank to borrow in its own currency. This enables potential policy alternatives to the kind of “bail-in” that Cypriots endured. For example, the Bank of Canada could theoretically pump liquidity into insolvent banks by acting as the buyer of last resort for those banks’ bonds.

3.    Canada has an insurance program covering various categories of deposits up to $100,000 through the Canada Deposit Insurance Corporation (CDIC). But the CDIC’s total holdings amount to a small fraction of the total value of insured deposits across Canada. In the CDIC’s 2015 annual report, the ratio was $3.044 billion in cash and investments held by the agency, plus a $20 billion borrowing limit, to $684 billion in insured deposits.

4.    The government’s “bail-in” proposal doesn’t actually rectify the too-big-to-fail problem—in fact, it doesn’t even purport to do so. Rather, the stated goal of the policy is to keep “systemically important” (i.e. too-big-to-fail) institutions “open and operating”, and transfer the costs of doing so from taxpayers to bank creditors.

Assuming the proposed “bail-in” regime takes effect, would the full value of your deposits in Canada’s major banks be safe in the event of another 2008-magnitude crash?

Maybe, but not certainly. At the very least, if you have a bank account in excess of $100,000 in any of the big Canadian banks, it might be a good idea to split it so that all of your deposits remain below the CDIC-insured limit.