The International Monetary Fund, Britain, Germany, France and the United States all support new global bank taxes. Jim Flaherty does not. And in the fight between global economic superpowers and Canada’s feisty finance minister, Flaherty is winning.
The IMF in April proposed a pair of new taxes for banks. One would begin as a flat levy and then escalate over time for riskier businesses; another would target bank profits and executive compensation. Proceeds would cover the costs of future bailouts.
Flaherty argues there is no need for an emergency fund in Canada, where there were no taxpayer-funded bank bailouts during the recent financial crisis. Brazil, Australia and Japan have raised the same complaint while India worries a tax might hamper its efforts to extend financial services to low-income groups. Despite this quietly mounting dissent, it was Flaherty’s vocal lobbying that was credited with stalling the proposal during a meeting of Group of 20 finance ministers and central bankers last month, while also garnering mild shock from international reporters who thought Canadians were meant to be conciliatory.
As Canada prepares to host the G20 leaders in Toronto this June, the debate over world banking reform is now widening beyond the tax plan to consider other alternatives. Most agree that banks need to have more cash, or capital, available to ensure they do not default on their obligations when the value of their other assets plunge, as happened during the recent mortgage crisis. The leaders of the world’s major economies now face a second question: If a bank tax isn’t the solution, what is? Fortunately, Canada has an answer for that quandary as well.
Julie Dickson, Canada’s Superintendent of Financial Institutions, recently championed a proposal built around “embedded contingent capital,” securities that convert to common equity when a bank faces trouble. The conversion replenishes the bank’s capital without a government bailout. “Surcharges, taxes, levies and size limits are not receiving universal acceptance, and are fraught with conceptual and practical difficulties,” Ms. Dickson said in a recent speech. “For this reason, embedded contingent capital deserves focus.”
Flaherty supports the proposal, arguing in an April letter to his G20 counterparts that embedded contingent capital would “force the costs of excessive risk-taking to be removed from taxpayers and placed on to the right people – shareholders and subordinated debt holders – thus improving market discipline.” The Canadian Bankers Association, which staunchly opposes a global bank tax, thinks Dickson’s proposal merits consideration. “The details have yet to be ironed out, but it’s a worthwhile concept to flesh out and pursue,” says Nancy Hughes Anthony, the CBA’s president.
The big question is whether investors will be willing to buy contingent capital securities, according to Hughes Anthony. And that will be impossible to determine until further details are sorted out, like when, precisely, the conversion from security to equity would occur. “You have to know when the trigger point would be reached and how it would be priced,” she says.
There are signs that other countries will support Dickson’s proposal. Even supporters of the bank tax, like U.S. Treasury secretary Timothy Geithner, agree there is also a need for financial institutions to increase their capital holdings. Dickson’s proposal is one way to meet that goal.
But there are others, notes Nick Rowe, an economics professor at Carleton University. Regulators could force banks to issue more preferred shares or hike capital requirements in other ways. Nonetheless, if Dickson, “the most successful regulator out there, says we need something else, then one does sit up and pay attention,” Rowe says. “She has some credibility.”
Indeed, Dickson, Flaherty and Bank of Canada governor Mark Carney all have huge credibility, thanks to their country’s performance over the past two years. All three appear willing to trade on their reputations to thwart the bank tax. Embedded contingent capital may lack the populist ring of a bank tax, but its proponents likely have the authority to push it forward, despite the lack of a catchy name.