Canada’s bail-in regime: adding strength to a robust system
CDIC articles and updates
With the coming into force of the bail-in regulations on September 23, 2018, Canada’s bail-in regime is now in place. This is a major milestone for Canada’s resolution regime and provides CDIC with a powerful tool to resolve a domestic systemically important bank (D-SIB) in the unlikely event that it fails or is about to fail.
Bail-in designed to reduce risk
In a bail-in, CDIC would take control of a failing D-SIB and recapitalize it by converting bail-in debt into equity, while ensuring that the bank remains open and continues to provide critical services to its customers. This is designed to preserve financial stability, minimize disruptions to the financial system, reduce taxpayer exposure and reduce incentives for systemically important banks and their shareholders to take excessive risk.
For further information on the bail-in tool and how it could be used, consult our backgrounder.
The 2008 financial crisis: impetus for change
The 2008 global financial crisis brought to light that some banks are “systemically important.” In other words, they are so important to the functioning of the financial system and economy that they cannot be wound down under a conventional bankruptcy and liquidation process without resulting in unacceptable costs to the economy. These institutions are commonly labelled as “too-big-to-fail.” With inadequate tools to deal with failed systemically important banks, authorities in other jurisdictions were forced to rely on taxpayer-funded capital injections (“bail-outs”) to support these institutions, in the interests of broader financial and economic stability. In contrast, a “bail-in” is intended to ensure that a failing bank’s creditors and shareholders—not taxpayers—bear the burden of the failure, by having their debt converted into common shares.
Regulations to implement the bail-in regime
While legislation established the bail-in framework, it left much of the details of the regime to regulation. There are two bail-in regulations:
- The Bank Recapitalization (Bail-in) Conversion Regulations. These regulations (under the CDIC Act) set out which instruments are subject to the bail-in power and factors that CDIC must consider in exercising the bail-in power. They apply to Canada’s D-SIBs.
- The Bank Recapitalization (Bail-in) Issuance Regulations. These regulations (under the Bank Act) set out requirements that D-SIBs would have to follow when issuing bail-in debt. They apply to Canada’s D-SIBs.
These two bail-in regulations, which came into force on September 23, 2018, along with the Office of the Superintendent of Financial Institution’s (OSFI) Total Loss Absorbing Capacity (TLAC) Guideline, ensure that D-SIBs have sufficient loss-absorbing capacity to support their recapitalization in the unlikely event of a failure. Under OSFI’s TLAC Guideline, D-SIBs are required to hold a minimum capacity to absorb losses, which acts as a buffer to protect depositors and taxpayers from loss. D-SIBs have until November 2021 to build these buffers, which can be composed of regulatory capital instruments and bail-in eligible senior debt.
With the coming into force of the bail-in regulations, D-SIBs are now able to issue bail-in eligible instruments, and one D-SIB has already done so. On September 24, 2018, the Royal Bank of Canada (RBC) launched the inaugural issuance of bail-in eligible senior notes in Canada. RBC issued $2 billion in senior notes with a 5-year maturity attracting a broad investor base. The notes were issued at a spread of around 10 to 12 basis points over outstanding non-bail-inable senior notes. It is expected that other D-SIBs will also begin issuing bail-in eligible instruments in the short term in a number of markets.
Planning for bail-in resolution
In order to ensure CDIC is prepared for any banking failures, CDIC requires D-SIBs to develop resolution plans. These plans describe how D-SIBs could be resolved in an orderly manner, while ensuring the continuity of critical financial services. As part of this work, D-SIBS will be expected to demonstrate that they are prepared to support a bail-in conversion, including having the necessary data, systems and capabilities in place. CDIC is working with the D-SIBs to ensure these plans are realistic, credible and implementable so that Canadians can have confidence in the stability of the financial system.
In addition to the bail-in regulations, new compensation regulations came into force in March 2018. The Compensation Regulations (under the CDIC Act) set out an updated process for providing compensation to shareholders and creditors of CDIC federal member institutions if they are made worse off as a result of CDIC’s actions to resolve the institution (including through bail-in) than they would have been if the institution were liquidated. The regulations apply to all CDIC member institutions, and to all resolution tools (except payout and liquidation).