Canada is following Europe’s lead with a new bank bail-in scheme that would transfer responsibility for bailing out banks in the event of banking crisis from the taxpayer to shareholders and bondholders.
The 2016 federal budget introduces a new bank bail-in regime similar to those being adopted by a number of G20 countries. The new regulations were proposed by the Conservative government.
Bail-in schemes raise the specter of depositors’ accounts being seized and used to help stabilize a faltering bank, as was the case in Cyprus, when a portion of depositors’ savings were taken to prevent total bank failure.
But according to an analysis in 2014 by Peter Routledge of National Bank Financial, it’s common shareholders of bank stock who might be most at risk.
The 2008-2009 financial crisis in the U.S. triggered a banking crisis that spread to Europe, resulting in a sovereign debt crisis in several European countries. Canadian banks were insulated from the crisis.
But as Alberta – wounded by low oil prices, has demonstrated – Canada’s economy is vulnerable to economic shocks that could potentially weaken Canada’s big banks, in the event of wide-scale defaults.
To prevent the government from having to provide massive bailouts to protect ordinary Canadians from losing their savings, a bail-in scheme would force shareholders and creditors to backstop the bank through a recapitalization in which debt is converted to equity.
When a bail-in mechanism was used in Cyprus in 2013 to prevent bank failures there, bondholders and large depositors were forced to write off some of their debt and holdings. Larger depositors reportedly lost 40% of their savings.
According to Routeledge’s modeling of the Canadian bank system in a bail-in scenario, the big losers in a Canadian bail-in system would be common shareholders.
According to Routledge, should a bank be forced to recapitalize under a bail-in mechanism, “common shareholders will asymmetrically bear the cost of the new regime.”
There mere prospect of Canada considering a bail-in scheme resulted in Moody’s Investors Service warning in 2014 that it would result in a credit risk downgrading of Canada’s major banks.
