The Players
The Basel Committee on Banking Supervision is an institution which unites the ten nations’ central bank governors. The committee gathers four times a year and discusses recommendations, guidelines and best practices that the member and other affiliated countries should implement in their individual legal system. The committee’s resolutions do not have any direct power over each national market, but they are mostly obeyed because unified rules help ensure that the national branches of multinational banking houses are not required to use their own compliance management.
The Rules
Under the new law, banks could be allowed to turn parts of their debt to equity in case of a financial crisis. Such a transformation would come as a ruling of the federal government and will let banks improve their capital reserves immediately. More capital will allow the bank to survive for a longer time – hopefully for the duration of the crisis. Embedded contingent capital therefore describes capital that is embedded in the bank’s debt, is always accessible to the bank, and is contingent upon a financing need and the consent of the federal government.
What the new regulations are meant to achieve is – in addition to improved banking sector stability – greater scrutiny of investors and lenders over the performance of the bank and lending practices. The Basel Committee believes that the lenders, being exposed to greater risk, will be more motivated to monitor their banks, the Basel Committee believes.
The Theory
LSM Insurance believes that the chief implication of this new law will be the banks’ ability to source their financing in a third way that is cheaper than equity but a bit more expensive than just ordinary (unconvertible) debt. That is if they can find a market to sell it to.
Debt in the form of loans and bonds normally obliges the debtors to pay back in regular agreed upon instalments – annuities – according to a contract. The face value of the loan or bond is paid back to the lender at the end of the term. Equity, on the other hand, gives the shareholder a portion of ownership, including voting and other rights. The disadvantage is that it is at the company’s sole discretion to choose the size of the dividends in a given year, or whether there are any at all. Also, shareowners can’t expect the face value of their investment to be returned to them at the end of the term and the only way they can ever recoup their investment is to sell their share hold to somebody else.
Impact on Performance
As reported by Reuters, Canadian banks say they are ready to embrace the new rules and from their current position continue in their growth. Many banks and analysts are forecasting acquisitions and mergers both in Canada abroad. Canadian banks could be expected to intensify their presence especially in the US and European markets.