Why You Should Care About the Government’s Bail-In Plans

Understanding the Bail-In

The outlook for Canada’s banking system took a hit this week, slashed from stable status to negative by international credit ratings agency Moody’s. The cut comes in response to recent government plans to implement a “bail-in” system, with Moody’s citing “the evolving lower systemic support environment” from the government.

These bail-in plans were revealed in the “Banking System Outlook: Canada” report, which focuses on the seven largest Moody’s-rated Canadian banks, which combined hold approximately 93 per cent of system assets. However, despite this alarming news, Canada’s banking system still remains one of the strongest in the world.

So, should consumers be concerned?

What is a Bail-In?

A bail-in is a reverse of the bail-out method, when money is given by the government to struggling private companies whose success largely impacts Canada’s economy. The funds help such companies make their mandatory debt payments in order to stay solvent. This is what the Canadian government did for the struggling automotive sector after the 2008 financial crisis; without the billions in bailouts the automakers would have been unable to meet their debt and pension obligations.

By contrast, a bail-in system doesn’t support the use of taxpayer money to bail out banks in the event of a financial crisis. Instead, senior creditors are forced to bear some, if not all, of the burden by having a portion of the debt they are owned written off.

This saves taxpayers money, but the one major criticism is an increase in bail-ins could equal higher interest rates for business owners, as creditors protect their heightened risk. It’s this concern that has led to Moody’s credit cut.

Household Debt Still a Leading Concern

Moody’s focus is also on Canadians’ high household debt levels, and how lower interest rates discourage Canadians to save more.  Moody’s says “while the potential for external shocks to the Canadian economy has receded, high household indebtedness and elevated housing prices remain key risks to banking system stability in Canada.”

Banks Busted For Risky Behaviour

Canadian banks have made efforts to further diversify their assets and debts – but these changes are considered to be riskier types of business. And the risk isn’t always paying off. For example, CIBC recently reported issues with their operation in the Caribbean operations. Scotiabank also has operations in the Carribbean, while TD has embarked on a U.S. venture. Moody’s notes recent growth sought by the banks has led them into riskier geographies which dilute their strong domestic credit profiles and represent a growing risk to the Canadian system’s stability

Canada Still Stands Strong

Remember, Moody’s is not downgrading any individual bank, but the system as a whole. Its “assessment of the standalone credit profiles of its rated Canadian banks remains unchanged, and Canada remains one of the highest rated banking systems in the world.”

“The accelerating global trend of governments to share the burden of bank resolutions with senior bondholders could reduce the predictability of government support in bank failure scenarios,” said David Beattie, a senior vice-president at Moody’s. “Most of the Canadian banks we rate receive rating uplift based on our very high expectation of support from the Canadian government and that expectation may diminish in the future.”

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