How Safe are Canadian Banks?

Canada Banks' BailoutIn November 2011 Minister of Finance, Jim Flaherty, claimed that the Canadian banking system is the soundest in the world. However, Canadian banks received $billions in financial support from the government between 2008 and 2010 and the federal government has plans to deal with a banking failure. So really, how safe are Canadian banks?

Since the 2008 banking collapse the Canadian government and the big banks have been bragging that they are safe in contrast to other banks around the world. Indeed, the 2013 budget states that an important Canadian bank becoming insolvent is “an unlikely event” (Economic Action Plan, 2013, pp. 144-145).

The Conservative government claims that Canadian banks had more sensible investment policies. It is true that the banks did not indulge in as much wild speculation as US and European banks, but only because the Canadian government had not gotten around to de-regulating the banks.

However, contrary to government claims, Canada’s five largest banks (RBC, TD Bank, Scotiabank, BMO and CIBC) were bailed out. The banks’ borrowing from the US Federal Reserve peaked at $33 billion, while loans from the Bank of Canada peaked at $41 billion in December 2008. In addition to this, in an unusual move, the Canada Housing and Mortgage Corporation (CHMC) bought $69 billion of bank held mortgages from the banks – in other words a $69 billion injection of cash.

To put this bail-out into perspective, the money would have “made up 7% of the Canadian economy in 2009 and was worth $3,400 for every man, woman and child in Canada.” (CCPA, 6, 2012). In early 2009 CIBC, BMO and Scotiabank were bankrupt, only staying afloat with government support which was equal to or greater than the value of the companies. Nevertheless, while being bailed out the five biggest Canadian banks reported $27 billion in profits. In addition, their CEOs remained among the highest paid 100 CEOs of Canada’s public companies and received substantial raises.

This raises the question – are Canadian banks too big to fail? The amplitude of the financial support given to Canadian banks in 2008-2010 suggests that the Government of Canada, the Bank of Canada and the big banks themselves believe that the major banks are ‘too big to fail’ and will be bailed out irrespective of the cost.

Meanwhile, the 2013 Canadian federal budget, released on March 21st, makes provisions for possible bank defaults that raise some serious questions. Chapter 3 “Supporting Jobs and Growth” in the budget lays out the framework for bankrupt Canadian banks to recapitalize themselves using ‘bank liabilities’ (Economic Action Plan, 2013, pp. 144-145). The budget states that:

The Government proposes to implement a “bail-in” regime for systemically important banks. This regime will be designed to ensure that, in the unlikely event that a systemically important bank depletes its capital, the bank can be recapitalized and returned to viability through the very rapid conversion of certain bank liabilities into regulatory capital [emphasis added]. This will reduce risks for taxpayers. The Government will consult stakeholders on how best to implement a bail-in regime in Canada. Implementation timelines will allow for a smooth transition for affected institutions, investors and other market participants.” (Establishing a Risk Management Framework for Domestic Systemically Important Banks”, pages 144 and 145)

The proposal disingenuously does not define “bank liabilities.” Bank liabilities are the debts incurred by a bank, what a bank owes. While a bank has traditional business liabilities and debts (for electricity, office supplies, employee wages), the bulk of a bank’s liabilities are financial, of which the most important liability category is clients’ deposits. In its present wording, the proposal seems to allow insolvent banks to use clients’ bank accounts to recapitalize themselves.

During March mainstream media reported that Cypriot depositors were going to get a ‘haircut’ to pay for Cyprus’ economic crisis. The Cypriot government, agreed to a Troika (IMF, ECB and EU) imposed plan to seize up to 40% of the money in people’s accounts with more than 100,000€.

This strategy became known as a ‘bail-in.’ As a result of these levies, many small, family businesses will face ruin, and many middle class savings will be severely hit. The news that everyday Cypriots will be losing parts of their savings was alarming, but seemed far removed from the reality of most Canadians’ lives until the release of the 2013 budget.

Initially, none of the major Canadian media outlets reported on this section of the federal budget. Analysis could only be found on small blogs and through foreign news agencies like RT. Then, on April 2nd The Globe and Mail ran an article with the Minister of Finance’s response to depositors’ concerns. The article reported that the Canadian government “is scrambling to clarify the language around its proposed “‘bail-in’” scenario for Canadian banks in the event of a financial crisis, hoping to distance itself from the type of bail-in that occurred last week in debt-riddled Cyprus.” Apparently, Canadian bank regulators had been using the term ‘bail-in’ for a few years to describe their proposed plan to stabilize the banking sector, but the term took on new meaning due to the situation in Cyprus.

The Finance Department issued a statement emphasizing that depositors’ money would not be used to help stabilize an insolvent bank and that instead, Canadian banks would have to rely on their own capital. Under the proposed Canadian plan, banks would set aside contingent capital, such as shares, which could be quickly converted to cash to provide liquidity and stabilize their operations should a crisis hit. It also stated that depositors’ accounts will continue to remain insured through the Canada Deposit Insurance Corporation (CDIC), preventing tax-payers from taking a hit like they did in Cyprus in case of a bank default.

Ministry of Finance’s statement, that banks will have to rely on themselves, seems to support the budget’s conclusion that “this risk management framework will limit the unfair advantage that could be gained by Canada’s systemically important banks through the mistaken belief by investors and other market participants that these institutions are ―too big to fail.”

The Tories are claiming that the Canadian state will not back failing banks. However, they also claim that the banks did not receive a bail-out in the last financial crash. It is clear that if, or when, the next financial crisis hits, Canadian banks will be vulnerable. Canadians have one of the highest rates of household debt in the world, standing at 165% of disposable income. Household debt was 128% of disposable household income in the USA in 2007, the year before the economic crisis hit. Much of Canadians’ debt is tied up in housing mortgages and there is still a housing bubble in many parts of Canada. Without state intervention the next financial crisis will be devastating.If banks are expected to convert their liabilities (especially if these remain loosely defined) into regulatory capital, there would just be all the more reason for depositors to make a run on their banks in case of an economic crisis.

Of course the Ministry argues either way depositor insurance would protect bank accounts. However, it should be noted that Cypriot accounts were also insured as Cyprus is a signatory of European Community agreements which protect depositors’ investments up to 100,000€. However, initially the Troika’s bank levy would have hit both small and large savings with a 10% levy across the board. The Cypriot parliament only rejected this plan under intense popular pressure, which took the form of protests outside the parliament.

In the case of a Canadian ‘bail-in,’ depositors holding under $100,000 would probably be safe, as accounts up to $100,000 are insured by the Canada Deposit Insurance Corporation (CDIC), a Federal Crown Corporation. However, anything above $100,000 could hypothetically be seized. In such a scenario small businesses and the middle class could be severely hit.

If deposits under $100,000 were included, either the CDIC insurance would have to be voided, causing a huge political row, or the CIDC would be bankrupt and so the government would have to bail it out. The CDIC does not have nearly enough money to cover all the deposits it insures. The 2012 CDIC report shows that the Crown Corporation is increasingly pessimistic about its own ability to intervene successfully (guarantee deposits) in the case of bank insolvency. According to its annual report, the CDIC insures $622 billion and but only has $2.4 billion in funding and a $18 billion borrowing limit.

The 2013 budget proposal indicates that in private the government is less confident about Canadian banks than it states in public. The proposal also shows that if there would be a problem with Canadian banks, the government would mainly go after the middle layers of society, those with accounts exceeding $100,000, while ‘respecting’ the CDIC. The poor, those with under $100,000 in savings would probably be spared, as would the very wealthy, assuming that they have their assets in complex financial portfolios, stock options, and off shore accounts.

What does all this mean in the end? The 2008-2010 bail-out and the proposal in the 2013 Federal Budget mean that Canadian banks are not as safe as the Canadian government and the big banks claim. Moreover, the ongoing secrecy about the 2008-2010 bail-outs also casts serious doubt over the sincerity of Flaherty’s statement and his assurances that taxpayers and depositors will remain untouched in the event of a bank becoming insolvent.

Nowhere does Flaherty propose to make the rich pay for a future crisis anymore than they did for the last one. He has made sure that the big banks and the inflated salaries of the top management are protected.

Posted in: Canada, Economy