TAX NEWS - June 2010

Foreign bank tax won't hurt Canada

Canada's banks could benefit as other countries such as Britain and Germany push ahead with a bank tax, said Mark Carney, governor of the Bank of Canada.

Canada has staunchly opposed proposals by other G20 members for a levy on banks as a way to pay for government bailouts of the financial system, arguing that such a move would be counterproductive.

Mr. Carney said the bank tax now being imposed in other countries would only reinforce the idea that financial institutions will always get rescued when they get into trouble.

"It just reeks of moral hazard ... The end-game [of financial reform] is to take the moral hazard out," he told business leaders in Toronto yesterday.

Mr. Carney said Bay Street could end up with a competitive edge, since the federal government has made it clear it won't follow suit.

"It doesn't hurt" if other countries opt to put a tax on their financial institutions, Mr. Carney said.

Many G20 countries are in favour of a bank tax because they see it as a way to recoup some of the taxpayer money handed out to banks as rescue packages during the meltdown.

Mr. Carney said policy-makers should be focusing on the core issues of financial reform, such as how much capital banks should be required to hold, the quality of that capital, as well as leverage and liquidity.

Most of those discussions are taking place under the so-called Basel process, which is expected to result in revamped global financial rules with implementation set for 2012. Most of the details are yet to be hammered out.

Despite disagreements regarding such issues as the timing of new rules, the Basel committee on banking supervision is on schedule to come up with details of new regulations later this year, he said.

The Canadian banks are already boosting capital levels in preparation for planned implementation in 2012, even though they are already among the best capitalized in the world and likely to be the least affected, a strategy the bank governor said makes sense.

Yet another focus of global regulators is the private derivatives market, a sector that grew exponentially in the run-up to the crisis as banks and hedge funds placed massive bets that ultimately nearly toppled the financial system.

There has been a general push led by the United States to move these markets onto public exchanges as a way of increasing transparency and limiting risk. Mr. Carney said Canada is moving in the same direction.

Critics charge that moving products such as credit default swaps onto exchanges will likely prove difficult because of the lack of standardization. At least part of the market will have to be treated differently, they argue.

Mr. Carney said that such bespoke trades "will take place, there's no question." He suggested the task for policy-makers is to figure out a way to make it more attractive for such trades to happen in pub lic markets.

However, experts anticipate that the new regulations will require banks around the world to hold significantly more capital.

Meanwhile, according Moody's Investors Service Inc., there are signs of the regulatory reform may be losing momentum in recent months.

In a report released yesterday, the rating agency said the G20 meeting held at the beginning of June in Busan, South Korea, "seems to point to a weakening consensus among member countries about the content of the financial regulatory reform package and the pace at which it should be implemented."

But Mr. Carney said he is confident the international effort to reform global banking rules is "very much on track."


CARNEY: 'WE HAVE THE TOOLS WE NEED'

Below are comments by Mark Carney, Governor of the Bank of Canada in conversation with Reuters global editor-at-large Chrystia Freeland yesterday in Toronto at the Art Gallery of Ontario:


THE BANK TAX

"We don't view it as a central issue. What we've been campaigning hardest on is what's most important. It's capital and liquidity, market infrastructure and how you resolve an institution. A bank tax in many jurisdictions, not all-- the U.K. is one slight variant on this--is to recover money that's been put into the system and it's to save an institution.

"There's this objective [that] we the government take the money and we're either going to put it in a big fund or we're just going to create the 'fiscal space' so that when the next crisis comes we are going to have the resources.... To me, that just reeks of moral hazard.

"The end-game is to take the moral hazard out. In our view, the bank tax does not do that."


INFLATION TARGET

"The issue on lowering the target rate. On the margin, we see benefits, as others do, of lower inflation. It just reduces this.... All the benefits of going from 10% to 5% to 2% are also there as you go from 2% to below. The order of magnitude is a question, but they're still there, it's still net positive. There are some transition costs associated with that.

"We have the tools we need, both conventional and unconventional, and we use them just to the extent to achieve that objective I think was quite valuable.

"The existing system, it's worked well; it worked well through the crisis. We think it will work well in the exit. But our job is to see whether we can do better and that's why we're looking at the issues that were raised."


CAPITAL FLOWS

"Total common equity is the core ... it's the predominat of Tier 1 capital.

For banks in Canada it was 75% that was the threshold. In other jurisdictions it was 50%, 51%. In the end you have to have loss-aborbing capital because the issue is when you have losses and there is a question about the viability of an insitution, the market looks through hybrids, looks through fancy capital elements, ignores deferred taxes and goes straight to total common equity."

Mr. Carney declined to say when new financial rules would come into effect but said: "We will not create a situation where banks are moving to a new capital standard by shedding assets or not extending credit just to meet the deadline." And he said the fact Canada will not impose a bank tax may be helpful to Canada. "It doesn't hurt."


COMMON EQUITY

"We're going to attract capital to Canada and we're going to continue to be seen, yes, as an attractive destination and that's, as you say, that's a good thing. We're not afraid of that and that is the right objective. It will bring some adjustment pressures but I think we'd all rather be in that position than be in the alternative fighting for attention, trying to convince about the effectiveness of our policies, trying to re-establish credibility. So maybe a bit of an advantage is developing and our collective job is to widen that advantage."


CHINA' S MOVE TO LOOSEN YUAN

"It's an important step. The quality of the discussion and the seriousness of the discussion with the Chinese around the G20 table around these issues has gone up tremendously."


STIMULUS AND FISCAL DISCIPLINE

"It's a question of getting the balance right. Nobody should be looking to balance their budget next year. The economy is too weak.... Nor should anybody be in a position where they think there's no need to start laying out a plan to stabilize their debt position, the United States included."