On April 20^th, the Federal Government introduced legislation to implement a bail-in regime for domestic systemically important banks (D-SIB). The regime is intended to reduce the likelihood that one of these banks would require a government bail-out in the event that the bank experienced significant losses. The Office of the Superintendent of Financial Institutions (OSFI) had previously designated the six largest banks in Canada, Bank of Montreal, Bank of Nova Scotia, Canadian Imperial Bank of Commerce, National Bank of Canada, Royal Bank of Canada, and Toronto-Dominion Bank as D-SIBs.

How bail-in will work

Under the proposed regime, D-SIBs will be required to maintain a minimum capacity to absorb losses being a combination of capital, and prescribed shares and liabilities that is specified for the bank by OSFI. The legislation does not specify the minimum amount but a prior consultation document indicated that a range of between 17% and 23% of risk weighted assets was being considered.

The draft legislation also provides that the shares and the liabilities that will count against this requirement will be prescribed by regulations to follow. However, again based on prior consultations, it is expected that this will include all shares issued by the bank, subordinated debt and senior unsecured debt that is tradable and transferable with an original term to maturity of over 400 days.

If OSFI believed that a D-SIB had ceased or was about to cease to be viable, under the bail-in regime the government could recapitalize the bank by converting all non-common shares, subordinated debt and the prescribed senior liabilities into common shares. Assuming that the minimum capacity to absorb losses established for the bank was sufficient to address the losses that had been incurred, the bank would return to viability with all critical functions remaining intact and without the need for a government bail-out.

If bail-in were triggered, the Canada Deposit Insurance Corporation (CDIC) would be appointed as receiver of the bank to supervise the bank during a stabilization process that could last as long as five years. As receiver, CDIC would also have the power to take other steps to restructure the bank to support its return it to viability.

The formula for converting shares and liabilities to common shares will be established in regulations. In the earlier consultation document, the government indicated that the number of common shares that would be provided for each dollar of par value of a claim that is converted would be tied to the conversion formulas of any outstanding Non-viability Contingent Capital instruments that the bank had issued and would respect general rules regarding the priority of claims.

Next steps

The legislation must now move through the normal parliamentary process before it becomes law. The government chose to include the amendments in legislation dealing with other aspects of its recent budget. It is unclear at this point whether this will result in a faster or slower timetable for passage of the legislation.