TAX NEWS - JUNE 2010
Canada Tax: Canada pushes novel cure for world's banking woes, rejects bank tax
Officials say Canada — using its sway as co-chair of the G20 this year, and as one of the few countries that can boast of having an unscathed banking system — appears close to carrying the day on the bank levy.
Finance Minister Jim Flaherty and Bank of Canada governor Mark Carney will be making their final pitches to colleagues before the issue is handed off to government leaders at the G20 Summit in Toronto later this month.
Meanwhile, the International Monetary Fund is expected to weigh in again on the subject after its initial proposal for a global bank levy was slapped down by G7 finance ministers in April.
While some nations — particularly Germany, France, Britain and the U.S. — might decide to go ahead with the controversial levy, there appears to be almost no chance the idea will achieve consensus in the club of 20.
"There is not substantial support in the G20 for an ex-ante bank tax which has been proposed by a few countries," Flaherty said Wednesday during a visit to China.
But there remains general consensus that a rainy day fund needs to be created to ensure big financial institutions don't again literally bet the bank on high-return, high-risk instruments, leaving taxpayers holding the bag.
Canada is proposing something called "imbedded contingent capital." That would see banks issue bonds that would be converted into commonly traded stock if they run into trouble. The proceeds from the bonds in essence recapitalizes the institutions, saving them from bankruptcy.
The stinger in the model — and to Flaherty the selling point — is that it would dilute the value of the bank's shares, meaning the current owners who caused the problem would wind up absorbing the losses.
Officials say the idea, first championed by Canada's financial system regulator Julie Dickson, is catching on. Even the Canadian Bankers Association, which has not officially pronounced on the proposal, is warming to it — especially if it helps derail the plan to create a stand-alone fund financed through a bank levy
"The idea of each institution having its own bankruptcy fund is a better initiative, it's a better idea," said association president Nancy Hughes Anthony. "The institutions' ability to withstand risk is what this is all about, that's what we have to fix, and a bank tax doesn't address that."
One concern is that if governments create a stash of cash that is meant to bail out banks in an emergency, there will be too much temptation to raid the piggy bank before the emergency happens. Another is that rather than discourage risk-taking, the existence of a safety net will only encourage high-wire financiers to take greater risks.
But the Canadian proposal is far from a cinch. A disadvantage is that it has never been tried before. It also lacks the visceral appeal of a punishing tax on the fat cat bankers that brought the world's economy down in the first place.
University of Florida finance professor Mark Flannery, who has written on the subject since 2002 under the term "reverse convertible debentures," says a problem is that the Canadian plan seems tailored to the Canadian system.
Dickson is proposing that a regulator, like herself, would trigger the mechanism only when a bank is nearing insolvency. Flannery says that would never work in the U.S., where regulators are not trusted, and thinks there should be an automatic trigger whenever a bank's capital ratio falls below some pre-set number.
Another issue is when to trigger the re-financing of a bank. Dickson says it should be when an institution is near bankruptcy; Flannery says it should come earlier, before panic sets in.
"My sense is that the Anglo countries — Canada, U.S. and Britain — are pretty interested in this, but the rest of the G20 is much less interested," said Flannery.
Some countries are leaning toward something called "hybrid debt," where bond holders wind up holding the bag during a solvency crisis.
None of that would be necessary if reforms were put in place that would require financial institutions to hold sufficient capital reserves for all contingencies.
Flaherty says his main goal in South Korea is to make sure the G20 puts first things first, and that is to deal with the key reforms requiring banks to hold less debt, more capital and in forms to ensure sufficient liquidity.
But Scotiabank economist Derek Holt says that requiring too much capital reserves brings its own difficulties. It would limit banks' ability to lend at a time when the global economy needs credit markets to finance business investment and consumer spending.
"There are enough challenges facing the global economy. You need to find a happy compromise between ensuring stability in the financial system versus not nipping growth in the bud," he said.
That's where Canada's idea, or some version of it, may wind up being the compromise that satisfies all members. The alternative is for each country to go its own way — bank levy, contingent capital, or hybrid debt — but analysts believe a global approach would be preferred.
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