New Rules Mean Cypriotic Meltdown Unlikely for Canada

The Canadian banks face a shifting regulatory regime in the wake of the Cyprus fiasco.

| More on:

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.

The S&P/TSX Composite Index is loaded with financial and resource stocks.  Because of this, investors that rely on Canadian Index funds or ETFs severely lack diversification in their portfolio, opening them to undue risks.  “Buy These 5 Companies Instead of Following a Flawed Piece of Advice” is our special FREE report that outlines an easy to implement strategy and 5 Canadian stocks that reduce the risks involved with passively investing in the Canadian market.  Click here now to receive the report – FREE!

Follow us on Twitter and Facebook for the latest in Foolish investing.

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.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

More on Investing

Hands holding trophy cup on sky background
Dividend Stocks

3 of the Top Dividend Stocks in Canada

Top TSX dividend stocks are still on sale.

Read more »

Index funds

Got $500 to Invest in Stocks? Put it in This Index Fund

Here's why I like this index fund.

Read more »

A colourful firework display
Tech Stocks

3 TFSA Stock Picks With Explosive Potential

Want some explosive growth in your TFSA. These small-cap stocks have risks, but they could also have some massive reward.

Read more »

Dollar symbol and Canadian flag on keyboard

1 Canadian Stock to Buy and Hold Forever in Your TFSA

Shopify (TSX:SHOP) stock is back on the retreat, but it's still a top tech buy for TFSA investors seeking value…

Read more »

tsx today
Stock Market

TSX Today: What to Watch for in Stocks on Thursday, July 25

The U.S. GDP quarterly growth numbers will remain on TSX investors’ radar today as they continue to assess the Bank…

Read more »

Family relationship with bond and care

Retiring Soon? Add These Dividend-Paying Stocks to Your Portfolio

Here are two of the best TSX dividend stocks you can add to your retirement portfolio today and hold for…

Read more »

man touches brain to show a good idea
Dividend Stocks

Pembina Vs. Brookfield Renewable: Which High-Yield Dividend Stock Is Better?

Both Pembina Pipeline (TSX:PPL) and Brookfield Renewable Partners (TSX:BEP.UN) look like strong dividend stocks, but is one better?

Read more »

Road signs rerouting traffic
Tech Stocks

Forget Nvidia Stock: 2 Tech Stocks to Buy Instead

There are clear winners, and then there are popular choices. And Nvidia stock (NASDAQ:NVDA) has erred towards simply popular.

Read more »