Over the years Canadian Finance Minister Jim Flaherty has alternately played bank toady and scourge to financial interests. Right now Flaherty opposes European calls for a “Tobin tax” type levy on financial institutions to recoup the cost of future bank bailouts. There are several reasons to aim rotten tomatoes at Flaherty, but his idea to require banks to hold “contingent capital” has merit.
In lieu of the financial transactions tax, Canada is proposing that banks include in their capital structures bonds that would be converted automatically into equity if a bank becomes financially distressed. The idea is to have an additional layer of private capital in place so that governments are less likely to be called for cash. The best thing about this idea is that it would pit bond banker against bond management and I would bet that in a potential bankruptcy brawl the bondholders will wipe the floor with the management team
Kidding aside, Flaherty’s idea would also introduce an extra watchdog over bank management. Of course, bondholders should have been playing this role all along, but repeated bailouts over the decades have made bank bondholders lax. However, Flaherty’s contingent capital requirement would reinforce a principal that should have been enforced all along – if management and equity holders ride the company off the rails then:
a) management gets booted out,
b) equity holders take a big bath, and
c) bondholders possibly take a haircut and are left in the driver’s seat.
Flaherty is still playing bank toady for opposing a financial transactions tax on the pretense that Canada did not bail out its banks. This is a lie, for the Canadian government has provided hundreds of billions in backstops and subsidies to its banks quietly (see Canada Housing Bubble – Hold Judgement; Don’t Praise Canada’s Banking System Just Yet). He is correct in stating that a financial transaction tax is only a revenue raiser and that his contingent capital plan is better designed to address bank failures. But the financial transaction tax has other uses, such as increasing slightly the cost of mindless speculation. And never mind paying for future bailouts…a financial transaction tax is justified to pay for the cost of the current bailout.
So far, Flaherty’s proposal is buried in the pile, but perhaps that will change when he presents it formally at the G20. Europe favours a financial transactions tax while the U.S. and U.K appear to oppose it. Among the G20 beyond the G7, some media have reported that India and China apparently see no need for any new bank tax, as they believe their banks are well capitalized. It’s not clear to me that the latter is accurate reporting. I’ll leave you with a link to a March 18, 2010, speech by YV Reddy, former Governor of the Reserve Bank of India, in which is expertly outlines the history of FTT (Financial transactions tax, or Tobin taxes), experience of some countries and the level of potential support among policymakers. He also dissects the opposition arguments and lays out the case for an FTT. Governor YV Reddy concludes:
“The case for Tobin Tax is well established now to meet the objectives set by Professor Tobin and revenue is an additional attraction. It cannot be the case that Tobin Tax by itself would be effective, but it has immense potential when the instrument is used along with complementary policies, in particular, counter-cyclical and macro-prudential measures. A review of the existing taxes at national level in some jurisdictions would point to the feasibility of such taxes at national level. International coordination for levy of such taxes must be pursued vigorously, but national level initiatives for Tobin Tax as part of measures to achieve financial stability by individual countries also has much to commend for itself. It is undeniable that globally coordinated action will enhance the effectiveness of policies at national level”.
Governor YV Reddy is not a toady.
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Filed under: Canada, India, Taxes & Regulation Tagged: | bank bailouts, bank regulation, bank tax, Canada, contingent capital, economics, financial crisis, financial reform, financial regulation, financial transaction tax, global financial crisis, India, India economy, Jim Flaherty, laissez faire, Tobin tax, YV Reddy