Archived - Backgrounder: Consultation on a Proposed Taxpayer Protection and Bank Recapitalization Regime

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Context

Canada’s financial system weathered the 2008 global financial crisis better than any other major industrialized economy. Canadian banks were able to maintain their access to debt and equity markets throughout the crisis, compared with some banks in other countries that were shut out of these markets. Not a single Canadian financial institution failed in the Great Recession of 2008-2009.

These achievements demonstrate the value of Canada’s approach to financial sector regulation and supervision. But the crisis also highlighted to all our Group of 20 (G-20) peers that some banks are “systemically important”. A bank is systemically important where its failure could have a detrimental impact on the functioning of the financial system and the economy.

Some of Canada’s trading partners lacked adequate legal authorities to deal with a failed major bank, and some of them had to resort to taxpayer bail-outs to keep these banks functioning in the interests of broader financial and economic stability.

But using taxpayer money to cover those banks’ riskier investments and their resulting losses created another risk: the impression that no risk is too high for systemically important banks because of the unacceptable costs to the economy of letting them fail, and the expectation that taxpayer dollars will always be available in an emergency.

This is called moral hazard.

Proposed Regime and Consultations

The proposed regime is intended to prevent such moral hazard by enhancing the set of tools available to handle the failure of a major Canadian bank. The regime shifts the burden of bailing out failed or failing major banks to those institutions’ shareholders and creditors, rather than putting the burden on taxpayers.

While the 2008 global financial crisis demonstrated the soundness of Canadian banks, we must continue to take all steps necessary to prepare for future threats.  That is why the Government of Canada endorsed a G-20 plan in 2011 to make sure all major industrialized countries enhance their resolution regimes to be able to handle the failure of systemically important financial institutions without relying on taxpayer funds, while preserving financial stability.

To that end, Economic Action Plan 2013 articulated a plan to establish a risk management framework for Canada’s domestic systemically important banks.

This consultation outlines the key features of a proposed Taxpayer Protection and Bank Recapitalization regime, which is intended to prevent a disorderly failure or taxpayer-funded bail-out of a major bank from happening in Canada. The regime shifts the burden of bailing out failed or failing major banks to those institutions’ creditors, rather than putting the burden on taxpayers when a crisis hits. The consultation paper sets out the terms and conditions under which certain liabilities of a failing or failed bank would be converted to create common equity to recapitalize the bank. Banks’ shareholders and creditors who are responsible for the risks taken should bear a failed bank’s losses, not Canadian taxpayers.

Deposits are excluded from the proposed regime. In addition, insured deposits will continue to be guaranteed by the Canada Deposit Insurance Corporation.

The public is invited to provide feedback on the regime and the questions posed in the consultation paper.