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Central bank sees gains in new bank rules

General Angela Calla 25 Aug

Jeremy Torobin

Ottawa Globe and Mail Update

Tougher rules for banks will bring economic benefits that dwarf the costs of forcing them to hold more capital, according to the latest salvos by central bankers and regulators in the debate about whether stricter standards might stifle the recovery.

A Bank of Canada analysis says that despite costs associated with the transition to new rules – such as more expensive credit – raising the amount of capital that financial institutions must keep on hand to backstop their loans would boost the economy “over time” by about $200-billion, or roughly 13 per cent of Canada’s current gross domestic product.

The report released Wednesday coincided with others by the world’s two leading financial authorities, which also sought to counter pessimistic views of the banking industry. The Bank of Canada study argues that although the country’s banking industry fared well in the financial crisis, the economy was still affected. Beefed-up regulations would help Canada by making meltdowns elsewhere less frequent and less severe, it said.

Like a study by the Basel Committee of central banks and bank supervisors, and another by the Financial Stability Board, Canada’s central bank acknowledges that financial institutions will pass higher costs from the new rules to customers, hampering investment and spending for years.

But the study says a lengthy transition would give banks time to adapt so the flow of credit would not slow enough to thwart the economy.

That endorsement of a lengthy phase-in meshes with compromise language agreed to by Group of 20 leaders in June, as well as preliminary concessions made by the Basel panel last month. The G20 leaders agreed to let countries with weak and undercapitalized banking systems implement the new regulations more slowly, in a transition period that would “reflect different national starting points and circumstances.”

A full agreement on new standards for banks’ capital and liquidity likely won’t be finalized before the G20 summit in South Korea in November. The Basel Committee, which was asked by the G20 to help sort out how to avoid another credit crisis, has already made concessions on how banks define capital and how quickly a new system will be introduced.

The Bank of Canada research indicates that if the new rules were phased in over four years, a one-percentage-point increase in the ratio of banks’ common equity to their risk-weighted assets would cause Canada’s GDP to drop by 0.3 per cent at first. That decline would shrink to 0.1 per cent within a decade. The initial drop in GDP would be 0.5 per cent if the transition period were two years instead of four.

The lowered risk of another financial crisis that would ensue if banks increased their capital ratios by two to six percentage points, would, however, potentially boost the level of Canada’s total GDP by between 1.1 per cent and 1.6 per cent, the central bank said.

In contrast, a June report from the Institute of International Finance said that the G20 proposals would cut GDP in the United States, the euro zone and Japan by three percentage points by 2015. That loss of output would mean 9.7 million fewer new jobs.

Even with their stricter capital and liquidity regime, Canadian banks are watching the reform efforts warily, joining bankers from around the world to warn about potential economic costs while pushing to ensure that a long phase-in doesn’t leave them at a disadvantage.

“Many important details remain to be settled which will have an impact on cost,” said Terry Campbell, vice-president for policy at the Canadian Bankers Association. “As the Bank of Canada noted in its report, a significant degree of uncertainty related to the economic impact will inevitably remain until the final rules are in place.’’