Too Big To Fail: Government Guarantee

Read news story about increased capital requirements for Canada’s “Big Six” banks, based on Julie Dickson, the federal Superintendent of Financial Institutions deeming them to be “too big to fail”.

Capital is not the equivalent to cash reserves, but rather a measure of the funds that have been invested in the financial institution, such as by way of shares, and not yet repaid. Customer deposits are not part of a bank’s capital, but part of its liabilities.

The funds from a bank selling shares could have been funds received by the bank from selling shares a year ago, or ten years ago, and bear no relationship to a bank’s current cash position. Capital bears a relationship to the degree to which a financial institution is permitted by regulation to lend or otherwise invest its cash, and effectively acts as a monitor of what is perceived to be safe financial institution growth.

Thought about “too big to fail” in context of doctoral dissertation. Completed twenty years ago this year, and relating to events now nearly thirty years old: the collapses of the Canadian Commercial Bank, the Northland Bank and the Principal Group. With respect the two banks, the government paid out all depositors 100%, irrespective of deposit insurance Most of the depositors in the two banks were institutional depositors, such as pension funds, provincial governments and municipal governments. A view then that, to the extent that a financial institution is categorized by government as “too big to fail”, or to the extent that there are general government representations as to a financial institutions solvency, the government has effectively guaranteed depositors against financial loss in the event of actual failure. At the time of the failures of the Canadian Commercial Bank and the Northland Bank, Gerald Bouey, then Governor of the Bank of Canada, had made public assurances as to financial institution solvency. So, the more that persons on behalf of government, or in regulatory authority, provide general assurances as to financial institution solvency, or speak about “too big to fail”…

(Not the) same as it ever was?

The Pathologies of Regulatory Inaction: Political Dimensions

Extract from Chapter 9 of B. La Rochelle dissertation, Canadian Financial Institution Failures: The Pathologies of Regulatory Inaction.

My perception is that the Canadian system has no tolerance for the failure of a financial institution. Any failure would lead to a great public outcry in the press and elsewhere. It’s my perception that when something fails, it’s considered to be the regulator’s fault.

Comments in speech to real estate developers and pension fund managers by Michael Mackenzie, Federal Superintendent of Financial Institutions, as reported by Milner (l991a).

I deny liability on the part of the government, but that doesn’t mean we won’t consider trying to compensate our citizens.

Grant Schmidt, Minister of Consumer an Corporate Affairs, Province of Saskatchewan, responding to findings of fault in government regulation by the Ombudsperson of Saskatchewan, as reported by Fisher (l989c)

It’s not perfect, of course, but that’s the way things work. I think that we can finally write “finis” to this little episode

Comments of Bob Mitchell, Saskatchewan Minister of Justice, during the course of announcing an offer of $7.5 million to Principal Group investors, as reported in the Globe and Mail (l992)

It is not the case that a finding or admission of regulatory fault heralds an offer of compensation by the government responsible for the regulatory body. With respect to compensation awards associated with Canadian financial institution failures, inconsistent patterns emerge. In this regard, compensation refers to payments in excess of deposit insurance or payments in circumstances where deposit insurance is not available. With respect to the collapses of the Canadian Commercial Bank and the Northland Bank, the federal government compensated all depositors, irrespective of amounts held in excess of deposit insurance limits. Compensation was paid immediately upon the closures of the financial institutions, independently of the subsequent findings of fault by Mr. Justice Estey. For example, at the time of the collapse of the Canadian Commercial Bank, banks contributing to the previous support program for the Canadian Commercial Bank received no compensation for their investment, while depositors were compensated for both the insured and uninsured portions of their deposits (Estey, 1986: 405,406,530; Johnson, l986: 241). The payments were based in part on the arguments of then Bank of Canada Governor Bouey. Governor Bouey believed that all depositors of the failed institutions should be compensated, in part due to the previous public assurances as to the solvency of the institutions and continued government support made by government representatives, including himself (Estey, l986: 529-530).

The attempt to salvage the (Canadian Commercial Bank), with an official endorsement of its viability, constituted a guarantee to the public which was honoured by paying uninsured depositors over the $60,000 limit. This cost the government $850 million in spite of the fact that many wholesale depositors, in being attracted to above-market deposit rates, were taking calculated risks with the (Canadian Commercial Bank) and Northland.

Patterson (l987: 943)

That the effort to save the Canadian Commercial Bank was not successful does not mean that none should have been attempted. I believe that the blow to confidence in our financial system both to Canada and abroad would have been very severe indeed if the first bank failure in over 60 years had been allowed to occur suddenly without a serious attempt to prevent it.

From address given by Governor Gerald Bouey, as quoted by Senator J. Godfrey in proceedings of the Standing Senate Committee on Banking, Trade and Commerce (l985 [October 15]: 19)

With respect to both banks, the depositors primarily benefiting from the government’s policy of full compensation were institutional investors: banks, provinces and provincial agencies, municipalities and investment dealers. Individual deposits comprised less than 3% or $27.1 million of the approximately $935.6 million in uninsured deposits in the two banks, leading to speculation that the offer to compensate all depositors, whether insured or uninsured, was based on political considerations associated with depositor types (Little, l985). At first instance, the government refused to disclose the names of entities to be fully compensated, citing confidentiality of dealings between a bank and its customers. Those institutional investors who initially became known were municipalities, such as St. Catharines and Kanata in Ontario, Surrey, in British Columbia and Dartmouth, Nova Scotia, whose representatives publicly acknowledged having deposits in the failed banks totalling in excess of $45 million (Horvitch, l985b).

Compensation to institutional investors, irrespective of deposit limits, is further complicated by the fact that the extent of financial difficulties of the financial institution will most readily be known by such investors. For example, throughout the period prior to their demise, the extent of liquidity advances to the Canadian Commercial Bank and the Northland Bank were well known within the financial community. This knowledge was due in part to the requirement in the Bank Act and in the Bank of Canada Act that liquidity advances of the Bank of Canada be published weekly and monthly, with identification of the recipient banks (Estey, l986: 167-168). Under such circumstances, the assurance by the Governor of the Bank of Canada of support for the Canadian Commercial Bank and the Northland Bank may have been taken by institutional investors to mean that such advances would continue indefinitely…

Since pension funds were significant shareholders of the Canadian Commercial Bank and credit unions (and later, native interests) were significant shareholders of the Northland Bank, it would appear that institutional size may predict likelihood of full compensation, provided the larger institutional participant is a depositor, as opposed to being a shareholder or debtholder.

The U.S. treasury stood behind those deposits and that’s the problem. If the TV cameras showed people wailing and moaning outside S&Ls because they lost their savings, maybe the public would pay attention.

Economist George Benston, Emory University, as quoted by Yakabuski (l990a: F5)

An apt name for these insolvent hellbent-for-leather thrifts is institutional zombies. The economic life they enjoy is an unnatural life-in-death existence that, if they had not been insured, the firms’ creditors would have taken control from stockholders once it became clear that their enterprises’ net worth was exhausted. In effect, a zombie has transcended its natural death from accumulated losses by the black magic of federal guarantees.

Kane (l989: 4)

If you borrow $100,000 and you can’t pay it back, the bank owns you. If you borrow $100 million and can’t pay it back, you own the bank.

Aphorism related by Sloan (l991)

With respect to depositor compensation, one may rephrase the foregoing as “If you deposit $100,000 and the bank can’t pay you back, the bank owes you. If you deposit $100 million and the bank can’t pay you back, the government owes you.”…

While the phenomenon of full compensation irrespective of deposit insurance limits is sometimes explained as the concept of “too big to fail” (or, colloquially, as the “financial zombie” concept [Sloan, l991]), it is submitted that this may be a simplistic explanation for a more complex process with assessing the relative economic interests of depositors. An issue therefore arises as to whether “too big to fail” regulatory conduct is moderated by predominant depositor type, irrespective of the monetary size of the financial institution.


Estey, Hon. W.Z. 1986
Report of The Inquiry Into The Collapse of The CCB (sic) and Northland Bank. Ottawa: Supply and Services Canada

Fisher, M. 1989c
Harsh report on Principal rejected by Saskatchewan. The Globe and Mail, November 25: B1

Globe and Mail l992
Compensation offered. The Globe and Mail, February 25: B2

Horvitch, S. l985b
Doubts persist on depositor payoffs. The Financial Post, November 30: 4.

Johnson, A. 1986
Breaking the Banks. Toronto, ON: Lester & Orpen Dennys Limited.

Kane, E.J. l989
The S & L Insurance Mess: How Did It Happen? Washington, DC: The Urban Institute Press.

Little, B. 1985
Banks, provinces to benefit most in bailout. The Globe and Mail, October 9: B20

Milner, B. l991a
Mum’s word for financial regulator. The Globe and Mail, November 14: B1, B4

Patterson, R. l987
Recent Canadian Bank Failures: Lessons Painfully Learned. Queen’s Quarterly 94: 935-958

Sloan, A. l991
Financial zombies prey on lenders. Financial Times of Canada, February 4: 9.

Standing Senate Committee on Banking, Trade and Commerce, l985
Proceedings of 33rd Parliament, 1st Session, part (October 15)

Yakabuski, K. 1990a
How safe are our banks and trusts? The Toronto Star, July 15, l990, F1, F5.

About brucelarochelle
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