Canada to gain from new banking rules

By Vikram Barhat | August 18, 2010 | Last updated on August 18, 2010
3 min read

Comprehensive financial sector reforms could be on the cards as Canada joins other G-20 countries aiming to set new banking rules, suggests a recent Bank of Canada report.

Raising the amount and quality of capital and liquidity that financial institutions must carry is a central component of the reforms, states the report titled ‘Strengthening International Capital and Liquidity Standards: A Macroeconomic Impact Assessment for Canada’.

The reforms, aimed at reducing the risk of future crises and tighten banking systems, are said to benefit Canada significantly.

“The recent global financial crisis left a legacy of damaged economies, failed financial institutions, lost jobs, and higher fiscal deficits. Canada was not immune. It too was buffeted by financial shocks from abroad, and could not escape the spillover effects of the ensuing global economic downturn,” said Governor Mark Carney. “It is thus clearly in Canada’s interest to work with other countries to develop stronger international capital and liquidity standards. This will improve the robustness of our own banking system, and contribute to the promotion of global financial stability.”

The G-20 is developing a set of proposals for agreement by leaders at their summit in Seoul, Korea, in November.

To help determine the appropriate calibration of the proposed new standards, the Financial Stability Board (FSB) and the Basel Committee on Banking Supervision (BCBS) conducted two studies to evaluate the macroeconomic impact of the proposals. The studies assessed the benefits and costs of the new standards over the longer-term period when the proposals are fully implemented and the initial transition period during which the new standards will be introduced.

The Bank of Canada also presented its own assessment of the implications of these new standards for the Canadian financial system and economy.

The report finds significant net benefit for Canada from the new banking rules resulting from the decreased likelihood of future financial crises. The macroeconomic costs of implementing the new standards in Canada are found to be small and broadly similar to those of other jurisdictions.

The findings of the study note that when the benefits and costs are assessed on a present-value basis, the estimated net economic benefits to be gained over time from improving the safety and robustness of the Canadian and international financial systems amount to about $200 billion for Canada – equivalent to about 13% of the GDP.

The potential impact of strengthened capital and liquidity standards on the level of economic output is reduced incidence of financial crises. To assess this, the probabilities and economic costs of historical financial crises were evaluated, and used as an indicator of likely future crises.

A modeling approach was employed to estimate the extent to which stronger capital and liquidity standards can help to reduce the incidence of crises. The benefits of higher capital and liquidity standards were then weighed against the potential costs to the Canadian economy. These costs arise from an increase in the cost of financial intermediation. It is expected that banks will seek to pass on the cost of the higher capital and liquidity requirements through higher lending rates to borrowers, says the report.

The Bank calculated the effect on lending spreads arising from increased capital and liquidity requirements. These results were then used as an input to the Bank’s macroeconomic models to gauge the impact on economic output. In assessing the costs of implementing the new standards, the Bank also analyzed potential credit rationing, recognizing that banks may restrict the availability of credit as they adjust their capital and liquidity positions to meet the new standards.

The report concludes that, for Canada, three-quarters of the benefits arise from the decrease in the likelihood of foreign financial crises, while the remainder represents the gains to be achieved from the reduced probability of a domestic financial crisis.

Vikram Barhat