Joe Oliver: How the budget’s bank ‘bail-in’ changes could cost Canadian depositors

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Joe Oliver: Bank customers have a right to know for certain that the government does not intend to undermine the safety of their unsecured deposits.

Customers have to pay an ‘insurance’ premium to keep our banks safe.

The arcane world of bank regulation is not everyone’s cup of tea. However, it can have important implications for taxpayers, bank creditors and customers, which is to say most Canadians. One example is a “bail-in” regime for banks in financial trouble.

The story begins with the financial crisis of 2007–09. International banks “too big to fail” were bailed out by governments in order to avert financial contagion that could have had disastrous consequences for a global economy reeling from the Great Recession. Taxpayers ended up footing a bill in the trillions of dollars for imprudent risks assumed by the big banks, inadequate oversight of systemic risk by regulators, failure of rating agencies to properly evaluate credit, money laundering, insider trading and speculators who shorted the market.

Fortunately, not a single Canadian bank had to be bailed out because of conservative bank practices and prudent oversight by the Office of the Superintendent of Financial Institutions (OSFI). That prudence continues. Indeed, the World Economic Forum declared our banking system the soundest in the world, for the eighth year in a row.


Alas, no good deed goes unpunished. As a participant in the international financial system Canada has to harmonize with other jurisdictions when they decide, however belatedly, to get their own houses in order. To reduce global systemic risk and not expose taxpayers to the cost of another bail-out, they came up with a bail-in process for non-viable banks.

The basic concept is that a failing domestic systemically important bank (D-SIB) could have its eligible contingent capital permanently converted into common shares to allow it to continue operating. Our six largest banks were designated as D-SIBs by OSFI. Last year’s budget provided that only unsecured debt that is tradable and transferable and with an original term to maturity of 400 days or more would be subject to conversion. That would have excluded all deposits.

This year’s budget says that responsibility for banks’ risks will rest with shareholders and creditors who hold eligible long-term debt. It is curiously silent about depositors, who are also creditors. And remember that GICs can have a maturity up to 10 years. Subsequently, the Finance Department indicated that all deposits, including guaranteed deposits, would be exempt from a bail-in. Yet it did not specifically refer to unsecured deposits, i.e., those deposits in excess of the $100,000 guaranteed by the Canada Deposit Insurance Corp. Assuming this is not studied ambiguity, it appears they are also exempt, which would be a good thing.

The implications of a different approach were dramatically illustrated in the spring of 2013 when desperate Cypriots lined up to withdraw their bank deposits. Ultimately, 47.5 per cent of bank deposits over 100,000 euros were converted into equity, for a loss of roughly 4 billion euros. Since confidence is absolutely central to any banking system, that scenario, however unlikely, should not even be a theoretical possibility here.

While the bail-in regimes elsewhere apply to uninsured deposits, we do not need to mimic their every detail. Also, their deposits are insured for more — US$250,000 or roughly $325,000 in the U.S. and 100,000 euros or almost $150,000 in Europe. Furthermore, our sound banking system is arguably in less need of protection. Then there is the issue of fairness and confidence. Canadians deposit their savings in banks with the expectation of getting their money back. They certainly do not contemplate that their savings might be converted into common stock when a bank is in trouble. People may use banks for longer-term savings or to park money temporarily in a safe place, for example when they sell their home or a family business. Concern about the safety of bank deposits would erode confidence in the banking system.

The new system is not without cost. When a bank issues non-viable contingent bonds or preferred shares, it must pay investors a higher rate than for senior debt. The result is an increased cost of capital for the banking system, which will be transferred to consumers. So, while taxpayers are protected from an unlikely financial disaster, bank customers (which is to say, pretty much all of us) have to pay an “insurance” premium to keep our banks safe.

There is another unintended consequence. When the financial crisis hit Canada, several banks raised equity to bolster their capital. The recapitalization process will make that unlikely. After all, who would want to invest in a bank’s common stock if its contingent capital is about to be converted into equity, with massive shareholder dilution?

Overall, Canadians will benefit from the greater safety of a bail-in regime. However, the Parliamentary Budget Office called this year’s budget less transparent than previous Conservative and Liberal budgets. Unnecessary doubt about who can be bailed-in is another instance of that. Bank customers have a right to know for certain that the government does not intend to undermine the safety of their unsecured deposits.

Joe Oliver is Canada’s former minister of finance.

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