Flaherty Pushes Contingent Capital

Julie Dickson recently wrote an opinion piece for the Financial Times that was startling in its lack of rigour, absence of detail and non-existent support in OSFI’s published papers. This bumbling approach to a serious issue has now been adopted by Canada’s finance minister, her boss:

While some countries may choose to pursue an ex ante systemic risk levy or a tax, I do not believe that this would be an appropriate tool for all countries. Such a levy would remove capital from an institution to an external fund or to general government revenues, which could result in weakening an institution’s ability to absorb losses. A global levy could also result in excessive risk taking as a result of a perceived government guarantee against an institution’s failure. In my view, contingent capital is aligned with the principles above and should be considered. As noted in the attached Financial Times editorial by Julie Dickson, the Canadian Federal Superintendent of Financial Institutions, contingent capital would create a notional systemic risk fund embedded in the capital structures of financial institutions. Embedded contingent capital would force the costs of excessive risk taking to be removed from taxpayers and placed on to the right people – shareholders and subordinated debt holders – thus improving market discipline and significantly reducing moral hazard in the banking sector. Moreover, for the same reduction in credit intermediation, contingent capital has the advantage over a levy or charge of leaving capital available in the institution to facilitate a more stable provision of credit during economic downturns.

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