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New Rules Mean Cypriotic Meltdown Unlikely for Canada

The unrest that the tiny economy of Cyprus caused global markets over the past several weeks is likely to be soon forgotten, however, its legacy will live on for some time.

In its March musings, Sprott Asset Management highlighted a passage in the recently released Canadian federal budget that lays down the following template for how a similar crisis (bank insolvency) shall be handled if one were to emerge in this country.

“The Government proposes to implement a – bail-in regime for systemically important banks. This regime will be designed to ensure that, in the unlikely event that a systemically important bank depletes its capital, the bank can be recapitalized and returned to viability through the very rapid conversion of certain bank liabilities into regulatory capital. This will reduce risks for taxpayers.”

We all know who the Government is referring to when it mentions “systemically important banks”.  Royal Bank (TSX:RY,NYSE:RY), Bank of Nova Scotia (TSX:BNS,NYSE:BNS), Bank of Montreal (TSX:BMO,NYSE:BMO), TD (TSX:TD,NYSE:TD), and CIBC (TSX:CM,NYSE:CM) all fit this moniker.

What it means

Because the banks in Cyprus carried total assets (loans) that were about 7x larger than the underlying economy, when these loans went bust, taxpayer funds were insufficient to cover the gaping hole they blew in the banks’ capital structure.  Deposits were required to prop up the banks and ensure they remained solvent.  This move to use deposits to stave off bankruptcy was termed a “bail-in”.

As the passage above suggests, the Canadian government has instituted a similar “bail-in” template should we ever get into a similar situation.

Sprott measured total assets (loans) of the Canadian banks to be approximately 2x the size of our economy (UK was highest at 3x, U.S. lowest at .5), therefore we are less likely to get into a similar state, however, should it occur, deposits (bank liabilities) will be relied upon to prop up the Canadian banks.

As Sprott points out, depositors are effectively lenders to the bank and going forward will have the onus placed on them to ensure their bank of choice does not face a solvency issue.

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Fool contributor Iain Butler does not owns shares in any of the companies mentioned at this time.  The Motley Fool has no positions in the stocks mentioned above.

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