In Budget 2013, Finance Minister Jim Flaherty proposed the establishment of a risk management framework for systemically important banks. At first glance, the proposal looks fairly innocuous (See Pages 144-145 of the Budget document available here) because the Minister is simply proposing that the Government of Canada “intends to implement a comprehensive risk management framework” for the Big Six banks. The framework will include higher capital requirements, a “bail-in” regime that will convert “certain bank liabilities” into regulatory capital and more oversight from regulators.

Many Canadians (aided and abetted by certain vested interests) began to conclude that the Canadian Government is calling for insured bank deposits to take a haircut in the event of a major bank failure. That does not appear to be the case. Bail-in simply refers to a partial conversion of certain unsecured debt into equity under specific conditions. A 2011 paper titled Contingent Capital and Bail-In Debt: Tools for Bank Resolution put out by the Bank of Canada has some ideas on the liabilities that can be converted into equity [emphasis mine]:

There is some debate about the scope of the liabilities that should be subject to such bail-in conversion, but a focus on senior, unsecured debt instruments would be relatively straightforward. This particular scope of application would leave secured creditors, insurable depositors, short-term securities holders and a bank’s counterparties unaffected by bail-in provisions.

In other words, deposits in a bank up to CDIC insurance limits will likely be safe during a bank failure. In fact, The Financial Post is now reporting that a Finance Ministry spokeswoman clarified that “the bail-in scenario described in the budget has nothing to do with depositors’ accounts and they will in no way be used here.”

One would think that a bail-in mechanism for banks is a good thing because recapitalizing too-big-to-fail institutions with tax payer money (a.k.a bail outs) while leaving bond, preferred-share and sometimes even equity investors with little or no losses will incentivize reckless risk taking. After all, who wouldn’t love to gorge on a free lunch if someone else gets a stomach ache?

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This article has 35 comments

  1. Matthew Lausch

    Great post!

  2. Excellent article as always! Great blog!

  3. Always enjoyed your blog. Thanks for the post!

  4. I guess maybe I’m more than a little naive, but I find it remarkable that seemingly many people (in Cyprus) don’t understand that their deposits should be at risk, and that they should have some stake in how prudent their banker is. Just saying.

  5. Interesting article. A suivi to see how it plays out. Some have concluded that the government policy would allow it to seize deposits to offset the possible failure of a bank a la Cyprus.

  6. I always enjoy reading your posts.

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  11. I actually use Ufile as my yearly tax software, but have never touched the online filing site.

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  13. Longtime reader, one-time winner. Love the site. I’m glad you’re posting more regularly again.

  14. Thanks for your writing, I find it very informative for us Canadians.

  15. CDIC insured deposits should rank senior to all obligations of the bank. Senior management bonuses and employment security should rank junior to common stock holders.

  16. Always interesting to read your blog and well-informed opinions.

    Please count me in for the draw.

  17. Regular reader of your blog. Thanks

  18. Sign me up!

  19. Thanks for the article, there’s been a lot of wild talk around this in the last week. Keep up the good work! Also, UFile is great, I’ve used them for several years now.

  20. Good to know bank deposits should be safe up to insured limits; one less thing to worry about!

    Please enter me in your draw. Thanks.

  21. It’s not clear what the consequences of greater capital requirements would be. I thought, in my very basic understanding of economics that in effect removed money from the economy…

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  24. Fooled us. I’m not interested in the program, but I saw the comments count and thought I was missing out on a heated discussion about bail-ins.

    Classic bait and switch eh?

  25. Keeping the Faith

    Love the blog and once again great post!
    Thanks.

  26. Thanks for using your platform to clarify this issue. I was shocked at how quickly this idea spread and how certain the proponents were. Likely because they wanted it to be so (confirmation bias).

  27. Kevin Johnston

    Glad to see your posts are back after a hiatus in January. I would like to try UFile.
    Thanks.

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  29. Hi there!
    Yes, the bail-in discussion is something we should have…

    Looking forward to giveaway too 🙂

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