June 08, 2010
While Canada's federal government opposes the idea of a global bank tax, policymakers are trying to persuade their foreign counterparts to consider securities called embedded contingent capital (ECC) as an alternative.
ECC is envisioned as a kind of debt security that would convert into common shares just prior to a bank failing. That sudden infusion of equity would boost the bank's capital levels, helping to give the bank and regulators time to find a solution for the ailing institution.
Some Canadian bankers are skeptical about the feasibility of this new security that would enable banks to "self-insure" against failure. A key stumbling block, say some analysts, is that the contingent capital securities would come with so much risk that investors would demand a high interest rate to buy them. That would make selling the securities unattractive to banks and could even lead to the securities being more costly to banks than a bank tax.
In addition, big investors, such as some pension funds, are not permitted to buy debt that converts into equity. This shrinks the potential market – again increasing the cost for banks.
"If this is priced more like equity, it becomes very, very expensive, probably even more so than a bank tax," says Blair Keefe. Other fears include the possibility that hedge funds or other investors could game the system, and that the conversion features could actually create more instability for a troubled bank and lead to a death spiral of dilution, says Blair.
The primary benefit of the contingent capital idea, he says, "is that it’s better than the other alternatives that have been floated."
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