A long-shot Canadian proposal for banking reform suddenly seems considerably less far-fetched. The Basel Committee, the body that sets international banking standards, last month endorsed the idea of embedded contingent capital, an instrument to avert taxpayer-funded bank bailouts championed by Canadian regulators and Finance Minister Jim Flaherty.
Under the scheme, banks would issue securities that function like bonds, but convert into shares when the institution faces crisis. Investors, not taxpayers, would then bear the cost of replenishing the bank’s capital reserves. “This proposal should reduce the number of circumstances in which public sector rescues are deemed to be necessary,” the committee notes in its report.
The proposal would also reduce one source of moral hazard, the belief that governments will save banks that collapse due to risky lending. But while global regulators seem enamoured, Canadian bankers say the idea is too vague to be properly evaluated. Decisions must be made about how the securities will be priced, what will trigger a conversion into stock and who will determine if a conversion is necessary, says Jean Dagenais, senior vice-president of finance, taxation and investor relations for National Bank of Canada. “All the details are very nebulous.”