As we sit in our locked-down building in Toronto because of the proximity of the G8/G20 protesters, I thought it would be the right time to highlight what is happening in the global financial markets – specifically on capital market and investment banking regulation.
The Global Bank Tax
In many countries, most notably the US and the UK, taxpayer money was used to prop up banks deemed too big to fail. As economies and markets stabilize, the governments in those countries have begun to look for ways to recoup their investments and develop safeguards against this happening again. One proposal being put forward is a global tax on banks. While this may make sense for those individual countries looking to get some of their money back, it would unfairly penalize the responsible actors (i.e. our Canadian banks).
The Canadian Alternative: Contingent Capital
Canada has come out as the leading voice of dissension. In May, Prime Minister Harper was quoted as saying “”You can’t tax an economy into prosperity; likewise you can’t tax a financial sector into stability”.
Banks are required to maintain minimum capital ratios – a balance between banks capital and its risk-adjusted assets. As the stock markets plunged, the value of the banks’ capital dropped, and they began to violate these minimum standards. The money used to top up the banks came from one of two places: either the banks issued new shares (at record low prices badly punishing existing shareholders) or the government provided funding (where taxpayers were forced to become shareholders).
Canada has come up with an alternative. Allow a bank to issue debt that converts into equity should the regulator determine that the bank has violated a threshold for risk. It is a simple solution that removes the taxpayer from the equation, and shares risk across two asset classes. The only real problem with the program is that there would not be a sufficient market for these instruments, and the bank would not receive adequate compensation for issuing the security. We will have to wait and see if the proposal makes it onto the agenda for this weekend.
Either way, Canada can be proud of its financial markets – as they are both stable and innovative. Now if we could only field a soccer team…
